Abstract
We present evidence that the negative impact of CEO short-termism on firm value can be attributed to a sub-optimal exercise of real options. Accordingly, the value relevance of firms’ real options portfolios is maximized in the absence of CEO temporal myopia. Moreover, the impact of real options on firms’ stock returns’ idiosyncratic characteristics is more pronounced when CEOs’ decision horizons are longer, in line with the view that enhanced operating flexibility from longer decision horizons can amplify the convexity of real options’ payoffs. These findings have important implications regarding the impact of CEO career horizons on corporate strategies and board decisions related to CEO incentives and succession.
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Notes
Shell Corporation, for example, systematically overstated its oil reserves between 1997 and 2001. Although the firm’s management realized as early as 2000 that this could be a problem, it did not disclose the truth but rather engaged in an aggressive search for new reserves to support its overly optimistic estimates. Eventually, in 2004, Shell had to admit that its oil reserves were overstated, causing its stock price to plummet by more than 10% and its credit rating to be downgraded by Standard & Poor’s (S&P)..
For example, The Economist (August 13, 2016) points out that because the average tenure of airline CEOs is short, they are reluctant to replace their obsolete IT systems because the risks associated with such a project outweigh their short-term benefits.
Idiosyncratic returns arise from factors unique to a particular company as opposed to returns that arise from industry- or market-induced factors. For example, suppose a pharmaceutical company is spending a significant amount researching a new class of drugs. A successful introduction of the drug will boost that company’s stock price, but will have a much weaker effect on the prices of other pharmaceutical companies’ stocks or stocks in general. Conversely, if that drug is not approved by the FDA, the stock would decline but there would be limited adverse impact on similar industry stocks or the market.
We are grateful to an anonymous referee for designing this valuable test.
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We are especially grateful to Cheng-Few Lee (Editor) and an anonymous reviewer for their many insightful and constructive suggestions. We also appreciate helpful comments and suggestions from Patricia Nickinson.
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Antia, M., Pantzalis, C. & Park, J.C. Does CEO myopia impede growth opportunities?. Rev Quant Finan Acc 56, 1503–1535 (2021). https://doi.org/10.1007/s11156-020-00934-5
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DOI: https://doi.org/10.1007/s11156-020-00934-5