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Costly Trading, Managerial Myopia, and Long-Term Investment

28 Pages Posted: 6 Oct 2005 Last revised: 2 Sep 2017

Leonard L. Lundstrum

Northern Illinois University

Craig W. Holden

Indiana University - Kelley School of Business - Department of Finance

Date Written: September 16, 2005

Abstract

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.

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

JEL Classification: G14, G31

Suggested Citation

Lundstrum, Leonard L. and Holden, Craig W., Costly Trading, Managerial Myopia, and Long-Term Investment (September 16, 2005). Journal of Empirical Finance, Vol. 16, No. 126-135, 2009. Available at SSRN: https://ssrn.com/abstract=809507 or http://dx.doi.org/10.2139/ssrn.809507

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 - Kelley School of Business - 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: http://www.kelley.iu.edu/cholden

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