Conditions for rational investment short-termism

In this paper we examine the theoretical conditions under which a firm will have incentives to optimally choose investment projects of duration that deviates from its stated horizon objective. Our approach considers a context in which investment horizon is subject to randomness and its length is optimally chosen by each firm's manager so that to maximize his/her objective function in the form of expected wage. Our framework derives the distribution of optimal horizon choices for which all managers would obtain the same level of expected wage. It is shown that the presence of asymmetric loss preferences in the form of higher costs from managers' investment duration over-statements (under-statements), results in a shift of the distribution of optimal durations to the left (right), thus making investment short-termism (long-termism) more likely to appear. The degree of the shift and the shape of the distribution of optimal investment durations depend on the trade-offs between preference asymmetries and the shape of the data generating process. © 2011 Springer-Verlag.