Long-term investors improve corporate behavior, increase returns

In a world where leaders of publicly traded firms could choose to maximize their own self-interest over the interests of shareholders, who minds the managers?

Long-term investors do. And quite effectively, according to new research by Jarrad Harford, the Marion B. Ingersoll Professor of Finance at the University of Washington Foster School of Business.

Moreover, in curbing bad corporate behavior, long-term investors ultimately benefit shareholders.

Monitoring the managers

Harford and co-authors Ambrus Kecskés and Sattar Mansi examined corporate behavior and financial performance at a wide array of public companies over the period from 1985 to 2012, isolating the effect of investors who maintain their company shares over a long period of time.

The findings indicate that those buy-and-hold investors play an effective external governance role for a firm.

They appear to reduce earnings management, accounting misconduct, financial fraud and option backdating, among a litany of corporate malfeasances. They also discourage overinvestment while fostering shareholder democracy and encouraging dividend payouts.

“(Long-term investors) affect corporate behavior by occupying the middle ground between voting with their feet and voicing their dissatisfaction with corporate managers,” the authors write in the Harvard Law School Forum on Corporate Governance and Financial Regulation.

Many virtues

Corporate governance is great. But is it also good for shareholders?

Harford, Kecskés and Mansi find evidence that the presence of long-term investors benefits all shareholders by driving higher stock returns, greater profitability and lower risk. They decrease volatility and reduce defaults and bankruptcies. And long-term investors lead to greater diversification along business, industry and geographic lines as well as across customers and products.

“Long-term investors have the means and motive to better monitor corporate managers,” the authors conclude. “As a result, managers are induced to make corporate policy choices that increase shareholder value.”

Do Long-Term Investors Improve Corporate Decision Making?” is the work of Jarrad Harford, Ambrus Kecskés and Sattar Mansi.

Read more in the Harvard Law School Forum.