Long-Term Investment and Monitoring in Financial Relationships

Abstract

Are firms prone to pursuing short-term goals, although long-run strategies would be superior? Especially in the USA, with the surge of takeovers in the 1980s and the increased use of stock options as managerial incentive schemes, this question has been related to possible deficiencies in the workings of the capital markets. For example, in a discussion of the recent wave of hostile takeovers in the USA, Scherer (1988) writes:

Perhaps the most controversial and least understood consequence of the 1980s takeover movement is its alleged propensity to shorten managerial decision-making horizons and bias profit maximization toward the short run. If the allegation is true, it could be the most important implication of takeovers, since American industry is confronted by European and especially Asian rivals who invest heavily and practice penetration and learning curve pricing — manifestations of a long-run strategy.

I am indebted to Martin Hellwig for his advice. I have also benefited from comments by Eric Berglöf, Helmut Bester, Mathias Dewatripont, Marc Fleurbaey, Eric Hansen, Colin Mayer and John Moore. Financial support by Schweizerischer Nationalfond is gratefully acknowledged.