Short-Term Managerial Contracts Facilitate Cartels

This paper shows how a series of commonly observed short-term CEO employment contracts improves cartel stability compared to a long-term contract. When a manager’s short-term appointment is renewed if and only if the firm hits a certain profit target, then (a) defection from collusion results in superior firm performance and thus reduces the chance of being fired immediately, while (b) future punishment results in inferior firm performance, thereby increasing the chance of being fired in the future. The introduction of this reemployment tradeoff intertwines with the usual monetary tradeoff and weakly improves cartel stability. Studying the impact of fixed versus variable salary components, I find that fixed components facilitate collusion with a short-term contract, while not affecting cartel stability with a long-term contract. I extend the model to argue how short-term renewable contracts are a source of cyclical collusive pricing. Finally, interpreting the results in the light of firm financing shows how debt-financed firms can form more stable cartels than equity-financed firms

Time-varying managerial overconfidence and pecking order preference

This paper examines whether managerial overconfidence enhances or weakens pecking order preference. We construct time-varying managerial words-based (i.e. tone of Chairman’s Statement) and action-based (i.e. firm investment and directors’ trading) overconfidence measures. Both optimistic tone and industry-adjusted investment have significant and negative impacts on the pecking order coefficient in the Shyam-Sunder and Myers (J Financ Econ 51:219–244, 1999) regression framework. Overconfident managers tend to use more equity than debt to finance deficits. This new evidence is consistent with the proposition that overconfident managers who underestimate the riskiness of future earnings believe that their debt (equity) is undervalued (overvalued) and therefore prefer equity to debt financing. Thus, managerial overconfidence can lead to a reverse pecking order preference. We also find that managerial overconfidence significantly weakens pecking order preference especially in firms with high earnings volatility and small firms