“Bonus payments give managers a share in short-term company profits, which is why they often neglect long-term investments,” says Matthias Meier of the EPoS Economic Research Centre. “Compensating executives in-stead with equity options has the advantage that their value increases if the company generates higher profitsin the long run. In our view, this is a better way to promote economic performance. They encourage much-needed investments and contribute to overall productivity.”
Short- and long-term investments
Typical long-term investment projects are new production facilities, whereas buying new computers and spending on marketing are rather short-term investments. If managers focus primarily on the short term, investment in new production facilities and other long-term projects will be low, creating less value added and reducing productivity. This affects the whole economy.
Policymakers should make long-term incentives attractive
“Managerial compensation is an important factor not only for the development of a particular company, but also for the overall economy,” says Meier. “A 35 per cent increase in managers’ share of short-term profits reduces gross domestic product by one to three per cent in the long term.” Policymakers have a wide range of options for intervening through taxation or accounting rules. Thereby they can influence the attractiveness of different compensation systems and investment incentives. “To promote economic performance, policymakers should establish frameworks that promote long-term incentives in managerial compensation,” says Meier.
About the study
In their empirical study, the researchers analyze the impact of new accounting regulations in the USA from 2005 on the compensation of managers and their investment decisions. They study a total of 725 listed companies from various industries between 2000 and 2014.