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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.

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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 & Andrei Shleifer & Lawrence H. Summers & Robert J. Waldmann, 1990. "Noise Trader Risk in Financial Markets," Journal of Political Economy, University of Chicago Press, vol. 98(4), pages 703-38, August.
  2. Cutler, David M & Poterba, James M & Summers, Lawrence H, 1990. "Speculative Dynamics and the Role of Feedback Traders," American Economic Review, American Economic Association, vol. 80(2), pages 63-68, May.
  3. Kaplan, Steven, 1989. "The effects of management buyouts on operating performance and value," Journal of Financial Economics, Elsevier, vol. 24(2), pages 217-254.
  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. Brennan, Michael J, 1990. " Latent Assets," Journal of Finance, American Finance Association, vol. 45(3), pages 709-30, July.
  6. Poterba, James M. & Summers, Lawrence H., 1988. "Mean reversion in stock prices : Evidence and Implications," Journal of Financial Economics, Elsevier, vol. 22(1), pages 27-59, October.
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Cited by:
  1. Rajgopal, Shiva & Venkatachalam, Mohan, 2011. "Financial reporting quality and idiosyncratic return volatility," Journal of Accounting and Economics, Elsevier, vol. 51(1-2), pages 1-20, February.
  2. 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.
  3. Patrick Bolton & Jose Scheinkman & Wei Xiong, 2003. "Executive Compensation and Short-termist Behavior in Speculative Markets," NBER Working Papers 9722, National Bureau of Economic Research, Inc.
  4. Riccardo Calcagno & Florian Heider, 2007. "Market based compensation, price informativeness and short-term trading," Working Paper Series 735, European Central Bank.
  5. 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, vol. 34(1-3), pages 149-180, January.
  6. 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.
  7. 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 98-044, New York University, Leonard N. Stern School of Business-.
  8. Seida, Jim A. & Wempe, William F., 2000. "Do capital gain tax rate increases affect individual investors' trading decisions?," Journal of Accounting and Economics, Elsevier, vol. 30(1), pages 33-57, August.
  9. 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.
  10. John Thanassoulis, 2011. "Industrial Structure, Executives' Pay And Myopic Risk Taking," Economics Series Working Papers 571, University of Oxford, Department of Economics.
  11. Francis, Jennifer & Smith, Abbie, 1995. "Agency costs and innovation some empirical evidence," Journal of Accounting and Economics, Elsevier, vol. 19(2-3), pages 383-409, April.

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