Shareholder Trading Practices and Corporate Investment Horizons

54 Pages Posted: 13 Dec 2010 Last revised: 5 Jan 2012

See all articles by Kenneth Froot

Kenneth Froot

National Bureau of Economic Research (NBER); Harvard University - Business School (HBS)

André Perold

Harvard Business School - Finance Unit

Jeremy C. Stein

Harvard University - Department of Economics; National Bureau of Economic Research (NBER)

Date Written: February 1991

Abstract

We investigate how shareholder trading practices might be linked to corporate investment horizons. We examine two possible linkages and analyze a range of data relevant to them. The first is excess volatility, which occurs when stock prices react not only to news about economic fundamentals, but also to trades based on non-fundamental factors. Excess volatility could lead to a higher cost of capital, and thereby reduce long-term corporate investment. The second linkage derives from an information ea between management and outside shareholders. In the presence of such a gap, maximizing short-run and long-run stock prices are not the same thing. Management may be able to raise current stock prices by undertaking certain actions that will reduce long-run value. In such a case, management faces the dilemma of which shareholders to please: those who do not plan to hold the stock for the long-run versus those who do. As shareholder horizons shorten, it can become more difficult to focus exclusively on maximizing long-run value. With respect to excess volatility, our basic conclusions are that neither changes in trading practices over time nor differences in trading practices across countries contribute significantly to any underinvestment problem. There is no evidence to indicate that measures to reduce trading volume (such as transactions taxes) would lower stock-price volatility in a way that would stimulate investment. With respect to the information gap hypothesis, we find "circumstantial' evidence consistent with certain preconditions for underinvestment. This is not, however, evidence of underinvestment itself. In addition, many of the forces that can lead to underinvestment -- such as hostile takeovers -- are also related to other, positive aspects of economic performance. Policy responses therefore involve a difficult set of tradeoffs.

Suggested Citation

Froot, Kenneth and Perold, André F. and Stein, Jeremy C., Shareholder Trading Practices and Corporate Investment Horizons (February 1991). NBER Working Paper No. w3638. Available at SSRN: https://ssrn.com/abstract=1724044

Kenneth Froot (Contact Author)

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
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Harvard University - Business School (HBS) ( email )

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Morgan 270C
Boston, MA 02163
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André F. Perold

Harvard Business School - Finance Unit ( email )

Boston, MA 02163
United States
617-495-6680 (Phone)
617-496-6592 (Fax)

Jeremy C. Stein

Harvard University - Department of Economics ( email )

Littauer Center
Cambridge, MA 02138
United States
617-496-6455 (Phone)
617-496-7352 (Fax)

HOME PAGE: http://post.economics.harvard.edu/faculty/stein/stein.html

National Bureau of Economic Research (NBER)

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Cambridge, MA 02138
United States

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