NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Shareholder Trading Practices and Corporate Investment Horizons

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

NBER Working Paper No. 3638
Issued in February 1991
NBER Program(s):   ITI   ME   IFM

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.

download in pdf format
   (850 K)

email paper

This paper is available as PDF (850 K) or via email.

Machine-readable bibliographic record - MARC, RIS, BibTeX

Document Object Identifier (DOI): 10.3386/w3638

Published: Journal of Applied Corporate Finance, Volume 5, pp. 42-58 Summer 1992 citation courtesy of

Users who downloaded this paper also downloaded these:
Froot and Perold w3498 New Trading Practices and Short-run Market Efficiency
Froot and Obstfeld w3091 Intrinsic Bubbles: The Case of Stock Prices
Stein w8342 Agency, Information and Corporate Investment
Cheng, Hong, and Scheinkman w16176 Yesterday's Heroes: Compensation and Creative Risk-Taking
Hall w3794 Corporate Restructuring and Investment Horizons
 
Publications
Activities
Meetings
NBER Videos
Data
People
About

Support
National Bureau of Economic Research, 1050 Massachusetts Ave., Cambridge, MA 02138; 617-868-3900; email: info@nber.org

Contact Us