Research Brief: How Long-Term Investors Shape Management Decisions
What Did the Study Look At?
Over the past three decades, one of the most significant stories in the investment world has been the rise of the institutional investor. These market players — insurers, commercial banks, pension and endowment funds, mutual funds, and hedge funds — manage nearly $100 trillion of assets in OECD countries alone. Given their size and sophistication, institutional investors have the means and incentive to ferret out information and to monitor — and influence — the corporations in which they hold a stake. But that may not be the case. While some of these investors take patient, long-term positions, many others, particularly hedge funds and mutual funds, frequently turn over their portfolios and may have less incentive to act as watchdogs. This study examines the influence of institutional investors’ investment horizons on a wide variety of key corporate policies.
How Was the Study Designed?
Researchers started with quarterly financial statement data for publicly-traded U.S. firms between 1980 and 2014. They added institutional and firm accounting information and used several measures of investment horizons and portfolio turnover.
What Did the Study Find?
- Publicly-traded firms with a greater long-term institutional investor base maintain lower investment outlays, higher dividend payments, lower levels of cash, and higher levels of leverage.
- In the time period studied, the churn rate for the average short-term investor increased; there was only a 3 percent chance that a given short-term institutional investor would still hold their stock after three years. More than two-thirds of long-term institutional investors held their stock over the same period.
- The importance of long-term investors has increased to the average firm, with the ratio of market values of their shares held by long-term investors relative to short-term investors having increased from approximately one-to-one to around three-to-one.
What Do I Need to Know?
These results support the researchers’ view that long-term institutional investors influence the corporate policies pursued by corporate executives. As a result of closer monitoring and better quality information flowing to investors, there are lower “agency” costs that arise from conflicts between shareholders and company management. This means less chance of over investment by management, which manifests in higher dividends, greater use of leverage, and lower cash levels.
The results line up with other studies that show the positive outcomes from having investors with long investment horizons. As the researchers note, the benefits include: improved management bargaining position in acquisitions; superior post-merger performance; lower firm debt costs; better firm performance; lower costs of equity; and fewer cases of financial fraud.
For company leaders, long-term institutional investors are a force to be reckoned with. Consider these two trends that showed up in this study: There has been an increase in the market value of shares owned by long-term investors relative to short-term investors. And short-term institutional investors are turning over their portfolios at a greater rate.
As the researchers note, “Combining these facts with an observed increase in proactive investing by long-term institutional investors suggests that the influence of long-term investors on management decisions has never been of greater importance than it is today.”
Title: “Institutional investors, monitoring and corporate finance policies”
Authors: Sean Cleary (Smith School of Business, Queen’s University), Jun Wang (Western University)
Published: International Journal of Managerial Finance (Vol. 13 Issue: 2, pp.186-212, 2017)