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Costly Trading, Managerial Myopia, and Long-Term Investment

Leonard L. Lundstrum

Northern Illinois University

Craig W. Holden

Indiana University - Department of Finance

September 16, 2005

The costly trade theory predicts that it is much more difficult to exploit long-term private information than short-term. Thus, there is less long-term information impounded in prices. The managerial myopia theory predicts that a variety of short-term pressures, including inadequate information on long-term projects, cause asymetrically-informed corporate managers to underinvest in long-term projects. The introduction of long-term options called LEAPS provides a natural experiment to jointly test both theories, which are otherwise difficult to test. We conduct an event study around the introduction of LEAPS for a given stock and test whether corporate investment in long-term R&D/Sales increases in the years following the introduction. We find that over a two year period of time LEAPS firms increase their R&D/Sales between 23% and 28% ($125-$152 million annually) compared to matching non-LEAPS firms. The difference depends on the matching technique used. Two other proxies for long-term investment find similar increases. We find that the increase is positively related to LEAPS volume. We also find that the increase is larger in firms where R&D plays a larger and more strategic role. These results provide both statistically and economically significant support for the costly trade and managerial myopia theories.

Number of Pages in PDF File: 28

Keywords: Trading, Myopia, Investment, LEAPS, R&D

JEL Classification: G14, G31

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Date posted: October 6, 2005  

Suggested Citation

Lundstrum, Leonard L. and Holden, Craig W., Costly Trading, Managerial Myopia, and Long-Term Investment (September 16, 2005). Available at SSRN: http://ssrn.com/abstract=809507 or http://dx.doi.org/10.2139/ssrn.809507

Contact Information

Leonard L. Lundstrum
Northern Illinois University ( email )
Wirtz Hall
DeKalb, IL 60115
United States
815 753 0317 (Phone)
815 753 0504 (Fax)
Craig W. Holden (Contact Author)
Indiana University - Department of Finance ( email )
Kelley School of Business
1309 E. 10th St.
Bloomington, IN 47405
United States
812-855-3383 (Phone)
812-855-5875 (Fax)
HOME PAGE: www.kelley.iu.edu/cholden
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