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Shareholder Trading Practices And Corporate Investment Horizons

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Listed:
  • 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.)

Suggested Citation

  • Kenneth A. Froot & Andre F. Perold & Jeremy C. Stein, 1992. "Shareholder Trading Practices And Corporate Investment Horizons," Journal of Applied Corporate Finance, Morgan Stanley, vol. 5(2), pages 42-58, June.
  • Handle: RePEc:bla:jacrfn:v:5:y:1992:i:2:p:42-58
    DOI: 10.1111/j.1745-6622.1992.tb00489.x
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    References listed on IDEAS

    as
    1. 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, vol. 47(4), pages 1461-1484, September.
    2. 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 125-137, March.
    3. 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.
    4. G. William Schwert, 1988. "Why Does Stock Market Volatility Change Over Time?," NBER Working Papers 2798, National Bureau of Economic Research, Inc.
    5. Kenneth A. Froot, 1990. "Short Rates and Expected Asset Returns," NBER Working Papers 3247, National Bureau of Economic Research, Inc.
    6. 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 703-738, August.
    7. Kaplan, Steven, 1989. "The effects of management buyouts on operating performance and value," Journal of Financial Economics, Elsevier, vol. 24(2), pages 217-254.
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