Large Shareholder Trading and Investment Complexity

Abstract:     
Complex investments are investments that are difficult to value in the short-term. In this paper, we analyze the incentives of a manager who is compensated based on short-term stock prices to invest in complex long-term investments. In particular, we explore how the manager’s investment decision is affected by the presence of a large institutional shareholder whose horizon is finite. The analysis focuses on the observation that the horizon mismatch between the large shareholder and the project can result in a bias in the trading of the institutional investor. The resulting equilibrium is such that investment in long-term complex projects lowers the incentive of institutional investors to collect costly information and hence reduces the informativeness of the short-term stock price. Furthermore, a larger ownership by institutional investors increases their trading bias upward, which in turn induces the firm to invest in more complex projects. Thus, our model suggests that large ownership by institutional investors may actually exacerbate concerns of uninformative stock prices.

Number of Pages in PDF File: 25

Keywords: Large Shareholder, Information Collection, Investment Horizon, Mutual Fund

JEL Classification: G32, D82, G14

working papers series