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‘An Antidote to Economic Sclerosis’ — Short-Term Investors Aren't All Bad, Study Finds
Investors with shorter time horizons push companies to adapt faster to new environments, according to academic research.
Short-term investors are widely seen as bad for they companies they invest in, because they are likely to focus on immediate changes in stock value — potentially at the expense of the company’s long-term profitability. But new research suggests that there may be times when a short-term focus can actually help companies perform better over the long run.
The study, expected to be published in the scholarly journal Management Science, found that companies with more short-horizon investors — who trade stocks regularly — adapted more quickly when their competitive environments changed “radically.”
“Under these circumstances, firms and economies with disproportionately more short-term investors may appear more dynamic and avoid stagnation, indicating that short-horizon investors perform an important function in the economy,” wrote authors Mariassunta Giannetti (Stockholm School of Economics) and Xiaoyun Yu (Indiana University).
For their study, the duo looked at a specific type of shock: large reductions in industry-level import tariffs, which lead to increased pressure from foreign competitors. “These shocks involve the risk of losing domestic market shares, but they also provide opportunities for expanding in new markets,” Giannetti and Yu wrote. “Firms thus have to quickly react to seize the opportunities and avoid the risks.”
Based on their research, the firms that reacted the most quickly were those with a higher composition of short-term investors — defined in the study as investors with high portfolio turnover.
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Companies with disproportionately more short-horizon investors experienced smaller declines in sales growth compared with other domestic firms in their industries, invested in more diversifying acquisitions, maintained market share by introducing new products, and obtained more trademarks and patents. These companies also had higher executive turnover following the tariff reductions, “suggesting that they search for new skills to adjust their corporate policies,” according to the study.
“Importantly, these changes translate into long-term improvements in profitability and firm value,” the authors said. They concluded that these benefits are important “even in the light of the costs associated with short-termism.”
“The process of globalization and the introduction of more radical innovations increase the incidence of shocks to which the benefits of short-term ownership are associated,” Giannetti and Yu argued. “Firms that fail to adapt may become ‘zombies,’ increasing capital misallocation and dragging down the overall macroeconomic performance… Short-term investors may thus be an antidote to economic sclerosis.”