When it comes to investing, it pays to be patient. Or, in the case of firms, have investors who are.
Finance professor Sattar Mansi co-authored a recent study that examined the effect on corporate decision making of investors with long-term investment horizons — i.e., investors who intend to hold on to their investments for more than a year and trade infrequently.
Specifically, Mansi and his co-authors looked at two questions: whether long-term investors improve a firm’s managerial decision making and, if so, whether this generates better returns for shareholders.
The answer is yes, in both cases: long-term investors help bring about a range of managerial behaviors that increase shareholder value.
Mansi and his co-authors, Jarrad Harford, of the University of Washington, and Ambrus Kecskes, of York University, received the Wharton-WRDS Outstanding Paper Award in June for their work.
Investor commitment has big advantages
“Our paper is the first to show that long-term investors influence a wide range of managerial behaviors in publicly traded firms and thus prevent a significant destruction of shareholder value,” the co-authors wrote.
In a comprehensive study, the researchers find that long-term investors strengthen corporate governance and restrain managerial misbehavior, discourage a range of investing and financing activities, and encourage payouts. Shareholders benefit through higher stock returns, higher profitability, and lower risk.
Previous studies have shown that investors have historically voted with their feet rather than voicing their dissatisfaction with corporate management, Mansi noted.
Influence without hype
“Our findings show that long-term investors affect managerial behavior by occupying the middle ground between exit and voice — i.e., by monitoring behavior.”
Long-term investors, Mansi said, have the capacity and motivation to monitor corporate managers. “In doing so, they help move corporate managers toward policy decisions that increase shareholder value by raising profitability and lowering risk.”
Furthermore, he said, their effect on corporate investment, financing, payouts, and performance “takes place with little publicity or confrontation.”
Sound policies equal higher payouts
Regarding corporate governance, Mansi and his co-authors find that long-term investors strengthen governance by increasing shareholder proposals, board quality, and executive turnover.
“Underscoring their monitoring role, we also find that long-term investors restrain managerial misbehaviors. Specifically, they reduce not only earnings management but also accounting misconduct, financial fraud, and option backdating.”
Looking at the impact on investment and financing, the researchers find that long-term investors cause a decrease in various types of investment activity as well as external financing, but they lead to an increase in payouts to shareholders.
These corporate policies lead to higher investment returns for shareholders that result from both unexpectedly higher profitability and lower risk.
Longer horizons prevent shortsighted decisions
Long-term investors also promote greater diversification, along business, industry, and geographic lines, as well as across customers and products.
Mansi noted that other studies have shown that rather than maximizing the value of their shareholders’ stake in the firm, managers of publicly traded firms who are “left to their own devices” tend to maximize their “private benefits of control” — economic gains that may include perks, salaries, and project resources that accrue to managers or owners who have control of the firm, but not to minority shareholders.
At the same time, Mansi said, managers can also make “myopic” (or short term focused) investment decisions. “Overinvestment, or ‘empire building,’ is one possibility, but managers may instead underinvest, or ‘enjoy the quiet life’; in either case, shareholders lose.”
Longer investor horizons, Mansi said, is one of the most important mechanisms to counter corporate mismanagement. “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.”
The Buffet example
Warren Buffet, Mansi said, is perhaps the best example of the effectiveness and benefits of long-term investors. “He has an investment horizon of forever. His annual return on his stock for the past 50 years is about 20 per cent — beating every major index out there.”
For their study, the researchers used a large sample of firm years, comprising 3,000 publicly traded firms over nearly 30 years.
Mansi, who holds the Wells Fargo Professorship, received Pamplin’s 2015 Research Award. He has focused on issues related to governance and how well companies are run.