Short-term institutional investors advocate firm behaviors that are harmful to long-term shareholders, research has shown.
These short-term investors pressure firms to spend less on research and development (R&D), generating earnings surprises that lead to temporarily inflated stock prices, according to the University of Notre Dame Professor Martin Cremers, Rutgers University Assistant Professor Ankur Pareek, and Professor Zacharias Sautner of the Frankfurt School of Finance and Management.
“Short-term investors may pressure executives to reduce R&D to surprise the market with higher earnings, and markets may not be able to immediately determine that these R&D reductions are detrimental to long-term firm value,” they wrote.
By measuring the stock holding duration of institutional investors, Cremers, Pareek, and Sautner showed that under the influence of short-term investors, firms spent less on R&D—investments “whose benefits are likely manifested on in the long-run, while their expenditures depress current earnings.”
As R&D spending is expensed directly on firm income statements, reductions in long-term investments allowed firms to report higher earnings—and in turn boost stock prices in the short term, as investors “misinterpret the positive earnings surprises.”
“As short-term investors move en masse into particular stocks, their equity market valuations increase substantially relative to fundamentals—but only temporarily,” the researchers wrote.
When short-term investors exit a firm, these artificial gains are erased as R&D spending starts up again.
“Short-term investors benefit from temporarily inflated valuations, as their short horizons ensure that they exit the firm shortly afterwards,” Cremeres, Pareek, and Sautner concluede. “As a result, only long-term shareholders eventually suffer from the reduction in investment.”
Read the full report, “Short-Term Investors, Long-Term Investments, and Firm Value.”