By spreading both the costs and benefits of ownership over a long period of time, long-term investors can be very effective at monitoring corporate managers, besides enhancing profitability and lowering risk, notes a report from University of Washington.
Jarrad Harford of University of Washington, Ambrus Kecskes of York University and Sattar Mansi of Virginia Polytechnic Institute in their paper titled:”Do Long-Term Investors Improve Corporate Decision Making” study the effect of investor horizons on a comprehensive set of corporate decisions.
Can long-term investors reduce corporate misbehavior?
The authors of the study examined whether long-term investors reduce the occurrence of corporate misbehaviors. For this purpose, they examined several aspects including accounting misconduct, financial fraud, option backdating and executive turnover. Their study reveals long-term investor ownership increases the number of shareholder proposals by 3.5 or about 15% relative to the mean. Similarly, the study notes long-term investors increase the rate of executive turnover by 0.87 or roughly 7% compared to the mean:
The authors conclude that their results are consistent with long-term investors generating improvements in corporate behavior.
Long-term investors’ effect over corporate investment
As part of the study, the authors also examine whether long-term investors affect a range of corporate investment, internal/external and short/long-term. For this purpose, the authors used the usual measures of long-term investment such as capital expenditures, research and development expenditures, and acquisitions and expenditures. Moreover, they also considered investment in trade credit and inventories:
The study points out that long-term investors cause a generalized reduction in investment, which is consistent with corporate managers engaging in empire building if they are not adequately monitored.
Turning their focus to the effect of long-term investors on financing, the authors examined financing from a variety of sources including the issuance of short-term and long-term debt on the balance sheet:
The study notes long-term investor ownership would reduce balance sheet debt issuance by 0.48% of total assets of which 0.05% comes from short-term debt and 0.43% is attributable to long-term debt. The study also points out that incremental off balance sheet debt usage falls by 0.34% of total assets, while equity issuance diminishes by 0.58% of total assets.
Finally, the study also examined the effect that long-term investors have on payouts. For this purpose, the authors considered both dividends and share repurchases:
The authors point out that long-term investor ownership increases both dividends and share repurchases by 0.29% and 0.35% of total assets, respectively.
The study concludes that long-term investors play an effective external governance role for firms. They impact corporate behavior by occupying the middle ground between voting with their feet and voicing their dissatisfaction with corporate management. Moreover, long-term investors restrain a wide range of potentially problematic corporate behaviors in publicly traded firms, which ultimately benefits shareholders.