Institutional Investor Horizons Set the Course for Corporations

Whether institutional investors have a long-term or short-term outlook influences the management principles of the corporations in which they are invested, according to a study.

Institutions with longer investment horizons prompt corporate executives to grapple with the concerns of corporate social responsibility (CSR) and avoid controversial business practices, while institutions with shorter investment horizons prompt corporate executives to disregard the strengths of CSR.

Whether stakeholders’ influence regarding CSR goals hinders a corporation’s financial performance and short-term value or enhances a corporation’s competitive advantage and long-term value has long been argued. Shorter buy-and-hold periods, the rise of high-frequency trading, the shortening of average CEO tenures and the disproportionate focus on quarterly earnings have been cited as symptoms of “short-termism.”

However, a new theory called enlightened value maximization specifies that a corporation’s objective function is to maximize the total long-term market value, allowing for principled decision-making by management.

In the study, higher CSR scores and higher short-term institutional ownership were negatively associated with near-term buy-and-hold returns. Higher CSR and higher long-term institutional ownership were positively associated with long-term buy-and-hold returns. This indicates that institutions with long-term horizons increased CSR and found that it benefited their investment, while institutions with short-term horizons decreased CSR and found that their investments did not benefit from CSR.

Part of the issue is that value is simply considered by some to be the maximization of short-term financial performance. Corporations often suffer under short-term bias because of poorly structured managerial incentives, among other issues, at the expense of stakeholders.

Accordingly, institutional investment managers with low portfolio turnover and concentrated positions outperformed managers without these two characteristics 2.3% to 3.5% per year over 20-plus-year observation periods. However, the average holding period for stocks has fallen to 1.67 years in 2017 from 8.33 years in 1960, showing an increase in short-term investment horizons among investors.

Considering short-termism as a pressure on corporate managers from institutional investors with shorter investment horizons, the study highlights the importance of structuring managerial incentives to align with a long-term view. The study’s authors encourage pension funds to rethink their investment and governance strategies.

Source: “Institutional Ownership Horizon, Corporate Social Responsibility and Shareholder Value,” by Otgontsetseg Erhemjamts and Kershen Huang; SSRN, May 2019.