Do Long-Term Investors Improve Corporate Decision Making?

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1 Do Long-Term Investors Improve Corporate Decision Making? Jarrad Harford (University of Washington) Ambrus Kecskés (York University) Sattar Mansi (Virginia Tech)

2 Are long-term investors desirable for firms? Examples from the media Bloomberg, , Bezos's behind-the-scenes role in the Washington Post's web growth Long-term orientation from private ownership grows the media firm Economist, , Long-term private equity funds: The Omaha play Many prominent private equity firms are starting up longterm funds Economist, , Management horizons: Quick and dirty Short-term pressure is widespread around the world Motivated the founding of Focusing Capital on the Long-Term (FCLT) by BlackRock, CPPIB, Dow, McKinsey & Co., and Tata Harford, Kecskés, and Mansi 2

3 [F1] Evolution of share turnover and holding periods Mean share turnover / Mean holding period Share turnover (per year) Holding period (in years) Harford, Kecskés, and Mansi 3

4 Are long-term investors desirable for firms? Survey evidence "Companies are most likely to describe their ideal shareholder as having a "long-term investment horizon" Companies want long-term shareholders in particular because it allows them to implement their corporate strategy and make long-term investments without the distraction and short-term performance pressures that come from active traders." (Beyer, Larcker, and Tayan (2014)) Most managers are willing to sacrifice long-term shareholder value for short-term profits (Graham, Harvey, and Rajgopal (2005)) Harford, Kecskés, and Mansi 4

5 The problem and a possible solution Separation of ownership and control in publicly traded firms leads to agency problems (Jensen and Meckling (1976)) Imperfectly informed market participants can lead managers to make myopic investment decisions (Stein (1988) Long-term investors are a monitoring mechanism that counters this tendency (Drucker (1986), Porter (1992) and Monks and Minow (1995)) They are effective because they spread their costs and accrue the benefits of ownership over a long period (Gaspar, Massa, and Matos (2005) and Chen, Harford, and Li (2007)) Harford, Kecskés, and Mansi 5

6 How are long-term investors involved in corporate governance? "Exit": Don't engage with corporate management, instead reveal private information through trading or not (Edmans (2009)) "Voice": Engage with corporate directors and executives, instead of trading Usually privately, rarely publicly Typically coordinated with other governance leaders, e.g., other long-term investors, proxy advisors, activist hedge funds, etc. True for active as well as passive long-term investors Harford, Kecskés, and Mansi 6

7 Our paper Hypotheses Do long-term investors in publicly traded firms improve corporate behavior? Does their influence on managerial decision making improve returns to shareholders of the firm? Harford, Kecskés, and Mansi 7

8 Theory and predictions Clearly, corporate governance should improve and managerial misbehavior should diminish Investment, financing, and payout predictions are unclear (Bebchuk and Stole (1993)) "Empire building" view: Managers overinvest (Baumol (1959) and Williamson (1964)) "Quiet life" view: Managers underinvest (Holmström (1979) and Grossman and Hart (1983)) Investment needs determine financing and payouts (Stulz (1990)) Value should clearly increase, through higher profitability and/or lower volatility Harford, Kecskés, and Mansi 8

9 [F2] Evolution of total institutional ownership and the proportion of long-term investors Harford, Kecskés, and Mansi 9

10 Empirical strategy Large sample of publicly traded U.S. firms (panel of roughly 100K firm-years) Measure investor horizons as the ownership in firms of institutional investors with low portfolio turnover (very persistent at both the investor and firm levels) (e.g., Gaspar, Massa, and Matos (2005) and Chen, Harford, and Li (2007)) Run regressions for a broad range of corporate behavior variables Regression equation: CB i,t =f(ltio i,t,io i,t,controls i,t ) where CB i,t is a corporate behavior variable LTIO i,t is long-term investor ownership IO i,t is institutional ownership Controls i,t are control variables, incl. industry year fixed effects Harford, Kecskés, and Mansi 10

11 Identification Use portfolio indexing by long-term investors Relevant because they can influence corporate managers Private engagements (Carleton, Nelson, and Weisbach (1998), Del Guercio and Hawkins (1999), and Gillan and Starks (2000)) Public interactions through shareholder votes, incl. block voting, vote trading, and advisory voting (Christoffersen, Geczy, Musto, and Reed (2007), Matvos and Ostrovsky (2010), and Appel, Gormley, and Keim (2015)) Exogenous because they cannot control the composition of their portfolio Split long-term investor ownership: Plausibly exogenous indexers / index firms Possibly endogenous non-indexers / non-index firms Similar results regardless of split or side of split Harford, Kecskés, and Mansi 11

12 The effect of long-term investors: Findings Corporate governance Shareholder proposals, board quality, executive turnover Takeover defenses Managerial misbehavior Earnings management, accounting misconduct, financial fraud Harford, Kecskés, and Mansi 12

13 The effect of long-term investors: Findings Investment (-1.8% of TA) Capex, R&D, acquisitions, trade credit, inventory Innovation Counts, citations, generality, originality Financing (-1.2% of TA) Debt, equity, off balance sheet debt, debt maturity Payouts (+0.7% of TA) Dividends, share repurchases Harford, Kecskés, and Mansi 13

14 The effect of long-term investors: Findings Value Abnormal returns (+30 bps/month), excess returns (+1.5 p.p./year) Profitability Realized (+0.4% of TA), unexpected Volatility Earnings (-5.2%), stock returns (-2.5%), extreme returns, covenant violations, defaults, bankruptcies Note: Magnitudes refer to the effect of a onestandard deviation increase in long-term investor ownership Harford, Kecskés, and Mansi 14

15 [F5] Abnormal stock returns by quintiles of investor horizons Harford, Kecskés, and Mansi 15

16 Conclusion and contributions We argue and show that long-term investors improve corporate decision making and thereby generate value for shareholders Long-terms investors are a force for good corporate governance Harford, Kecskés, and Mansi 16