Abstract: This paper studies how the allocation of capital within firms is shaped by short-termist incentives. We first present empirical evidence on the existence of within-firm (mis)allocation of capital caused by distortions of managerial incentives using the reform of the FAS 123 accounting statement in the U.S. as a quasi-natural experiment. Based on within-firm variation across investments with different durabilities, we find that firms systematically shifted expenditures towards less durable investments in response to a shift towards more short-term incentives. This reform-induced alteration of the firm-specific capital mix effectively shortened the durability of firms' capital stock. By calibrating a dynamic model of firm investments in which managers determine investment policies, we then seek to quantify the impact of such incentive distortions on output, investment and capital (mis)allocation. Equity-based compensation contracts can induce managers to make investment decisions corresponding to quasi-hyperbolic time preferences and relatively small deviations in incentives induced by the accounting reform caused substantial distortions within and across firms. Overall, this reform-induced shift in capital structures away from the social optimum lowered long-run profits by about 0.54% on average.