The downside to investors of a short-term focus

Complaints about the short-term orientation of investors have been legion more many years, but that hasn't stopped investors themselves from shortening their time horizons, turning over their portfolios with increasing velocity, and then demanding that corporate managers listen to their demands for constant outperformance. The litany of malpractice now includes the interim Kay Review published by the UK government, added to the volume that went before it. But what if taking a short-term approach was actually bad for the investors themselves? Might that lead to a greater notion of stewardship in action?

A study by three Harvard scholars suggests that companies with short-term horizon suffer from higher levels of investment risk. "Using conference call transcripts, we measure the time horizon that senior executives emphasize when they communicate with investors," they write. "We show that firms focusing more on the short-term have a more short-term oriented investor base. Moreover, we find that short-term oriented firms have higher stock price volatility, and that this effect is mitigated for firms with more long-term investors." The study also shows that short-term oriented firms have higher equity betas and as a result higher cost of capital, a result which the presence of long-term investors does not mitigate. They conclude: "our evidence suggests that corporate short-termism is associated with greater risk and thus affects resource allocation."

Source document: The working paper "Short-Termism, Investor Clientele, and Firm Risk," by François Brochet, Maria Loumioti and George Serafeim, is a 54-page pdf file.