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Shareholder Trading Practices And Corporate Investment Horizons

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  • Kenneth A. Froot
  • Andre F. Perold
  • Jeremy C. Stein

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.

(This abstract was borrowed from another version of this item.)

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Bibliographic Info

Article provided by Morgan Stanley in its journal Journal of Applied Corporate Finance.

Volume (Year): 5 (1992)
Issue (Month): 2 ()
Pages: 42-58

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Handle: RePEc:bla:jacrfn:v:5:y:1992:i:2:p:42-58

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References

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  1. De Long, J. Bradford & Shleifer, Andrei & Summers, Lawrence H. & Waldmann, Robert J., 1990. "Noise Trader Risk in Financial Markets," Scholarly Articles 3725552, Harvard University Department of Economics.
  2. James M. Poterba & Lawrence H. Summers, 1987. "Mean Reversion in Stock Prices: Evidence and Implications," NBER Working Papers 2343, National Bureau of Economic Research, Inc.
  3. Brennan, Michael J, 1990. " Latent Assets," Journal of Finance, American Finance Association, American Finance Association, vol. 45(3), pages 709-30, July.
  4. Case, Karl E & Shiller, Robert J, 1989. "The Efficiency of the Market for Single-Family Homes," American Economic Review, American Economic Association, vol. 79(1), pages 125-37, March.
  5. Kenneth A. Froot & Andre F. Perold, 1990. "New Trading Practices and Short-run Market Efficiency," NBER Working Papers 3498, National Bureau of Economic Research, Inc.
  6. Froot, Kenneth A & Scharftstein, David S & Stein, Jeremy C, 1992. " Herd on the Street: Informational Inefficiencies in a Market with Short-Term Speculation," Journal of Finance, American Finance Association, American Finance Association, vol. 47(4), pages 1461-84, September.
  7. Culter, D.M. & Poterba, J.M. & Summers, L.H., 1990. "Speculative Dynamics And The Role Of Feedback Traders," Working papers 545, Massachusetts Institute of Technology (MIT), Department of Economics.
  8. Kaplan, Steven, 1989. "The effects of management buyouts on operating performance and value," Journal of Financial Economics, Elsevier, Elsevier, vol. 24(2), pages 217-254.
  9. Kenneth A. Froot, 1990. "Short Rates and Expected Asset Returns," NBER Working Papers 3247, National Bureau of Economic Research, Inc.
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Citations

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Cited by:
  1. Seida, Jim A. & Wempe, William F., 2000. "Do capital gain tax rate increases affect individual investors' trading decisions?," Journal of Accounting and Economics, Elsevier, Elsevier, vol. 30(1), pages 33-57, August.
  2. N. K. Chidambaran & John Kose, 1998. "Relationship Investing: Large Shareholder Monitoring with Managerial Cooperation," New York University, Leonard N. Stern School Finance Department Working Paper Seires, New York University, Leonard N. Stern School of Business- 98-044, New York University, Leonard N. Stern School of Business-.
  3. Patrick Bolton & Jose A. Scheinkman & Wei Xiong, 2003. "Executive Compensation and Short-termist Behavior in Speculative Markets," Levine's Working Paper Archive 506439000000000124, David K. Levine.
  4. Singh, Ajit, 1996. "Catching up with the West: a perspective on Asian economic development," MPRA Paper 54925, University Library of Munich, Germany.
  5. Rajgopal, Shiva & Venkatachalam, Mohan, 2011. "Financial reporting quality and idiosyncratic return volatility," Journal of Accounting and Economics, Elsevier, Elsevier, vol. 51(1-2), pages 1-20, February.
  6. John Y. Campbell & Kenneth A. Froot, 1994. "International Experiences with Securities Transaction Taxes," NBER Chapters, in: The Internationalization of Equity Markets, pages 277-308 National Bureau of Economic Research, Inc.
  7. Frank Gyamfi-Yeboah & Alan Ziobrowski & Philip Seagraves, 2014. "Institutional Ownership and the Dynamics of Trading Volume around FFO Announcements," The Journal of Real Estate Finance and Economics, Springer, Springer, vol. 49(1), pages 73-90, July.
  8. Peter Cziraki & Moqi Xu, 2014. "Ceo Job Security And Risk-Taking," FMG Discussion Papers, Financial Markets Group dp729, Financial Markets Group.
  9. Konstantin Milbradt & Martin Oehmke, 2014. "Maturity Rationing and Collective Short-Termism," NBER Working Papers 19946, National Bureau of Economic Research, Inc.
  10. Ajit Singh, 1998. "Savings, investment and the corporation in the East Asian miracle," Journal of Development Studies, Taylor & Francis Journals, vol. 34(6), pages 112-137.
  11. Kamakshya Trivedi & Garry Young, 2006. "Defined benefit company pensions and corporate valuations: simulation and empirical evidence from the United Kingdom," Bank of England working papers 289, Bank of England.
  12. Francis, Jennifer & Smith, Abbie, 1995. "Agency costs and innovation some empirical evidence," Journal of Accounting and Economics, Elsevier, Elsevier, vol. 19(2-3), pages 383-409, April.
  13. Bushee, Brian J. & Matsumoto, Dawn A. & Miller, Gregory S., 2003. "Open versus closed conference calls: the determinants and effects of broadening access to disclosure," Journal of Accounting and Economics, Elsevier, Elsevier, vol. 34(1-3), pages 149-180, January.
  14. Ferris, Stephen P. & Yan, Xuemin (Sterling), 2009. "Agency costs, governance, and organizational forms: Evidence from the mutual fund industry," Journal of Banking & Finance, Elsevier, vol. 33(4), pages 619-626, April.
  15. John Thanassoulis, 2013. "Short-Term Shareholders, Bubbles, And CEO Myopia," Economics Series Working Papers 663, University of Oxford, Department of Economics.
  16. John Thanassoulis, 2011. "Industrial Structure, Executives' Pay And Myopic Risk Taking," Economics Series Working Papers 571, University of Oxford, Department of Economics.
  17. Calcagno, Riccardo & Heider, Florian, 2007. "Market based compensation, price informativeness and short-term trading," Working Paper Series, European Central Bank 0735, European Central Bank.

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