New academic research claims that long-term investors help prevent “corporate misbehavior” as well as helping to boost profits and lower risk as part of their “monitoring role”.
“We find that long-term investors prevent corporate misbehavior and facilitate greater investor influence on management,” write the researchers.
“We also find they cause a decrease in various types of investment activity as well as external financing, but they lead to an increase in payouts to shareholders. As a consequence of these corporate policies, shareholders earn higher returns on their investment as a result of both higher profitability and lower risk.”
“Our overarching conclusion is that long-term investors lead to a range of corporate behaviors that increase shareholder value,” concludes the paper.
The 64-page research – Do Long-Term Investors Improve Corporate Decision Making – has been put together by Jarrad Harford of the University of Washington, Ambrus Kecskes of the Schulich School of Business at York University and Sattar Mansi at the Virginia Polytechnic Institute and State University.
It studies a “wide swath” of corporate behaviors and uses portfolio turnover as a way to define investors’ investment horizons.In practice, it is index investors that are identified (“we establish causality based on the ownership of long-term investors that index their portfolios”).
“We find that long-term investors reduce not only earnings management but also accounting misconduct, financial fraud, and option backdating. Underscoring their monitoring role, we find that long-term investors promote shareholder proposals and greater executive turnover,” write Harford, Kecskes and Mansi. Other benefits include lower earnings volatility as well as a “lower rate of defaults and bankruptcies”.
“In summary, long-term investors increase shareholder value by raising profitability and lowering risk.”
Such investors are “an additional force for good governance”. Interestingly, the researchers find that the long-term investors they identify affect corporate behavior by “occupying the middle ground between exit and voice” (divestment and activism) – taking place “with little publicity or confrontation”.
It’s an argument put forward recently by new PRI signatory Vanguard, the $3trn indexing giant. “As indexers, we are permanent shareholders,” the firm’s Chairman and CEO William McNabb told the University of Delaware’s John Weinberg Center for Corporate Governance in October.