The Short-Termism Trap: Catering to Informed Investors with Limited Horizons

Swedish House of Finance Research Paper No. 21-24

96 Pages Posted: 2 Nov 2021 Last revised: 27 May 2024

See all articles by James Dow

James Dow

London Business School - Institute of Finance and Accounting

Jungsuk Han

Seoul National University - College of Business Administration; Finance Theory Group (FTG)

Francesco Sangiorgi

Frankfurt School of Finance & Management

Date Written: March 28, 2024

Abstract

Does the stock market exert short-term pressure on listed firms, do they respond, and is this response value reducing? We show that limited investor horizons indeed have those consequences, as follows. First, informative stock prices increase firm value; in our model, they reduce the agency cost of incentivizing managers. Second, short project maturity improves stock price informativeness by catering to informed investors with short horizons. Third, since informed trading capital is a scarce resource, attracting informed investors cannot increase an individual firm’s price informativeness in equilibrium: it simply destroys shareholder value. This "short-termism trap" can potentially destroy up to 100% of the benefits of stock market listing.

Keywords: informed trading, managerial compensation, short-termism, optimal contracting, race to the bottom, strategic complementarities

JEL Classification: G14, G32, G38

Suggested Citation

Dow, James and Han, Jungsuk and Sangiorgi, Francesco, The Short-Termism Trap: Catering to Informed Investors (March 28, 2024). Swedish House of Finance Research Paper No. 21-24, Available at SSRN: https://ssrn.com/abstract=3953799 or http://dx.doi.org/10.2139/ssrn.3953799

James Dow

London Business School - Institute of Finance and Accounting ( email )

Sussex Place
Regent's Park
London NW1 4SA
United Kingdom
+44 20 7262 5050 (Phone)
+44 20 7724 3317 (Fax)

Jungsuk Han (Contact Author)

Seoul National University - College of Business Administration ( email )

Seoul, 151-742
Korea, Republic of (South Korea)

Finance Theory Group (FTG) ( email )

United States

Francesco Sangiorgi

Frankfurt School of Finance & Management ( email )

Adickesallee 34
Frankfurt am Main, 60322
Germany

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