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Payout Policy Choices and Shareholder Investment Horizons
Abstract
This paper examines how shareholder investment horizons influence payout policy choices. The authors infer institutional shareholders'
investment horizons using the churn rate of their overall stock portfolios prior to the payout decision. The authors find
that the frequency and amount of repurchases increases with ownership by short-term investors to the detriment of dividends.
They also find that the market reacts less positively to repurchase announcements made by firms held by short-term institutions.
These findings are consistent with a model in which undervalued firms signal their value through repurchases, but firms held
by short-term investors make repurchases more often because those investors care mostly about the short-term price reaction.
Hence, the market rationally discounts the signal provided by such repurchases. Our findings suggest that shorter shareholder
investment horizons might be one contributing factor to the increasing popularity of buybacks.
... Over the past three decades, how institutional investors' holdings affect corporate financial policies has been examined both theoretically and empirically. In particular, recent studies have focused on institutional heterogeneity, such as different institutional investment horizons, in the relation between shareholder ownership and corporate finance decision (Chen et al., 2007;Gaspar et al., 2005Gaspar et al., , 2012Attig et al., 2012). They argue that short-term institutional investors are weak monitors, and independent institutions with long-term investments specialize in monitoring and influencing efforts rather than in trading. ...
... Second, we supplement existing literature by considering corporate governance in the relation between foreign investment horizons and payout policy. Previous literature has mostly focused on the direct relation between institutional investment horizons and their monitoring roles in the stock market (Chen et al., 2007;Gaspar et al., 2005;Gaspar et al., 2012). They do not consider corporate governance, which is one of the efficient ways to monitor and reduce agency costs. ...
... Assuming that institutions are better monitors (Allen et al., 2000), these theories imply that the larger the institutional investment, the higher the payouts and lower agency costs. Meanwhile, recent studies focus on institutional heterogeneity, such as different institutional investment horizons, in the relation between shareholder ownership and corporate finance decision (Chen et al., 2007;Gaspar et al., 2005;Gaspar et al., 2012). Gaspar et al. (2005) argue that short-term institutional investors are weak monitors. ...
This paper examines whether long-term foreign investors may force firms to use a costly dividend to mitigate inefficient managerial behavior. The authors also hypothesize that the relation between foreign investment horizons and payout policy depends upon the extent of the corporate governance. The authors find that firms held by long-term foreign investors make dividend more often in the subsequent years. The authors also find that foreign investors with long-term investments do not cause firms to pay dividends when firms have strong corporate governance. It suggests that long-term foreign investors serve as a substitute for strong corporate governance with respect to controlling agency conflicts.
... In contrast, LTIOs believe more in relationship-building with companies and specialize in monitoring managers due to superior informational advantages and longterm goals for value creation rather than trading in crisis times (Chidambaran & John, 1998;Attig et al., 2012). These attributes indicate that when it comes to ESG issues, LTIOs are more rationally inclined to relationship-building than STIOs and are more cautious about long-term value creation by ensuring adequate monitoring and working with the company, especially when equity market reacts negatively due to ESG-related concerns (Bushee, 1998;Chen et al., 2007;Gaspar et al., 2013;Gillan & Starks, 2000). ...
... Third, our study adds to the literature on the effectiveness of LTIOs as a tool for monitoring risk factors. The literature on LTIOs has investigated many corporate aspects such as valuation (Döring et al., 2021), innovation (Aghion et al., 2013;Bushee, 1998), control (Gaspar et al., 2005), employment decisions (Ghaly et al., 2020), corporate cash holdings (Harford et al., 2012), investment cashflow sensitivity (Attig et al., 2012), market shocks (Cella et al., 2013), decision-making (Derrien et al., 2013), corporate payout policies (Gaspar et al., 2013), credit ratings (Driss et al., 2021), CEO incentives (Cadman & Sunder, 2014), firm lifecycles and innovation patterns (Barrot, 2017), long-term value creation (Bena et al., 2017), corporate ESG profiles , the cost of capital (Attig et al, 2013;Lin et al., 2019), CSR (Kim H. D. et al., 2019;Gloßner, 2019), IPO underpricing (Massa & Zhang, 2021), bank risk-taking (Pathan et al., 2021), disclosure policies (Cadman et al., 2023), and environmental costs . We add the unique perspective of the CCN Beta to this literature. ...
... Share repurchases have emerged as an alternative method of returning cash to shareholders. Early dividend literature by Lintner (1956), Miller and Modigliani (1961), and Black (1976) did not consider stock repurchases, which gained prominence in the 1980s and have since grown substantially, particularly in the United States (Fama and French 2001;Julio and Ikenberry 2004;Brav et al. 2005;Skinner 2008;Gaspar et al. 2013). Although Chay and Shuh (2009) observed that fewer firms repurchase shares in countries like Australia, France, Germany, and the United Kingdom compared to the United States, von Eije and Megginson (2008) noted a rising trend in share repurchases across Europe. ...
... Share repurchases have emerged as an important means of payout, gaining prominence in the 1980s. Since then, repurchases have grown substantially, especially in the United States, and are now seen as an alternative to cash dividends Julio and Ikenberry 2004;Brav et al. 2005;Gaspar et al. 2013). Indeed, recent studies (e.g., King and Teague 2022;Bonaime and Kahle 2023;Jakob and Valta 2023;Boubaker et al. 2024;Gopal et al. 2024) have shown that US firms have shifted from paying dividends to repurchasing as their primary method of cash disbursement. ...
We investigate the perceptions of corporate managers of non-dividend-paying firms listed on the London Stock Exchange (LSE) to identify the factors and explanations leading to a zero cash dividend policy. Our survey evidence shows that the main reasons for not paying dividends involve poor profitability, the firm’s life cycle stage and profitable growth opportunities. Managers consider shareholder preferences when setting a zero cash dividend policy, but neither taxes nor share repurchases (as substitutes for cash dividends) explain this policy. High insider ownership and transaction costs also do not explain why some UK companies pay no cash dividends. However, respondents confirm that the cost of raising new external funds (debt) is an important factor in not distributing cash dividends. Our results are inconclusive on the potential signaling effect of not paying dividends. Finally, the findings indicate that the COVID-19 pandemic did not affect the decision to follow a zero cash dividend policy in the United Kingdom.
... Past research also suggests that at a firm level, stock repurchase improves capital structure, by helping companies decrease their equity and achieve optimal leverage ratio (Chen et al., 2015;Dittmar, 2000;Opler and Titman, 1996). Further, stock repurchases result in a tax advantage (Gaspar et al., 2013;Isagawa, 2000), because there are lower taxes for capital gains than other income, and only the part of stock repurchase that is a capital gain is taxed (Dittmar, 2000). Stock repurchases also increase acquisition price because repurchased stocks have low reservation values (Bagwell, 1991), and can effectively serve as a takeover deterrent (Bagwell, 1991;Dittmar, 2000), as they can increase the price of stocks and decrease the stocks outstanding. ...
... There is extensive literature that has studied the antecedents or drivers of stock repurchase and its effects on different stakeholders, including investors (Grullon and Michaely, 2004), top management (Ikenberry and Vermaelen, 1996), corporate financial managers (e.g. Chen et al., 2015;Gaspar et al., 2013). Yet, the perspective of one important stakeholder has been relatively neglected in the literature, namely the marketing department, likely because most of the work on stock repurchases has been conducted in the finance literature. ...
Purpose
This study aims to investigate the effect of stock repurchase – firms buying back their own stocks – on firm performance, focusing specifically on the role of marketing capability. The authors also investigate the moderating influence of competitive intensity on this effect. This research sheds light on how marketing capability explains the negative effect of stock repurchase on firm performance, and how this effect varies in different competitive intensity environments.
Design/methodology/approach
The authors test their hypotheses using US firm-level longitudinal data collected from a sample set of firms obtained from the Compustat database for the 1989–2015 period. The authors specify a panel data regression model to test the hypotheses.
Findings
The authors find that adoption of stock repurchase ultimately results in a decrease in firm performance, through a decrease in marketing capability. The authors also find that the indirect effect of stock repurchase on firm performance is moderated by firm competitive intensity, such that at higher levels of competitive intensity, the negative relationship between stock repurchase and marketing capability will become amplified and at lower levels of competitive intensity, the negative relationship between stock repurchase and marketing capability will get attenuated.
Research limitations/implications
This study indicates that the risk from stock repurchase is the diversion of funds from other beneficial activities such as marketing budgets, leading to lowered marketing capability.
Practical implications
This study's results will help managers improve their understanding of the dark side of the stock repurchase strategy and help take corrective action.
Originality/value
The present study empirically tests the effects of stock repurchase on marketing capability and firm performance.
... Short-term investors tend to trade on temporary signals (Yan and Zhang 2009), liquidity needs (Da et al. 2011), or behavioral biases (Cremers and Pareek 2015). The investment horizon of institutional investors matters for corporate policies (Harford et al. 2018;Derrien et al. 2013), cost of equity (Attig et al. 2012), the amplification of market shocks (Cella et al. 2013), bank debt financing (Cline et al. 2020), firm valuation (Cremers et al. 2020), payout policy (Gaspar et al. 2013), SEOs (Hao 2014), and corporate social responsibility (Nguyen et al. 2020), and equity returns (Yan and Zhang 2009). Given the growing importance of the role of the investment horizon of institutional investors, it is a crucial question to examine the relationship between the investment horizon of institutions and economic policy uncertainty. ...
... Investors ranked in the bottom quartile are classified as long-term institutional investors. Finally, we define long-term (short-term) institutional ownership (hereafter LIO and SIO) as the ratio of the number of shares held by long-term (short-term) institutional investors to the total number of shares outstanding (Yan and Zhang 2009;Gaspar et al. 2013;Harford et al. 2018;Cline et al. 2020; Wang and Wei 2021). ...
Existing literature has extensively discussed the impact of economic policy uncertainty (EPU) on firm-related activities, but there is sparse evidence of its impact on the behavior of institutional investors. Using quarterly U.S firm-level data for 1980Q1-2020Q4, we find heterogeneous responses of institutional investors to EPU shocks to different horizons. Specifically, long-term institutional investors respond positively to EPU shocks, while short-term institutional investors reduce their holdings during periods of uncertainty. We posit that different expectations about the future of firms between long- and short-term investors may account for the heterogeneous responses. We test this hypothesis by investigating how firm growth opportunities, volatility, and investment activity influence the relationship between EPU and institutional investor horizons. The results show that the positive (negative) effect of EPU on long-term (short-term) institutional investors becomes stronger for firms with higher growth opportunities, higher volatility, and more investment. Our paper has important economic implications that the countercyclical behavior of long-term institutional investors improves firm value and liquidity during uncertain periods.
... In the past three decades, the share repurchase activity of U.S. corporations has experienced extraordinary growth (Gaspar et al., 2013). Repurchases are now an important form of payout of US firms, and the long-term trend in payout choices points toward a lower proportion of firms paying dividends and replacing them with repurchases (Fama and French, 2001;Gaspar et al., 2013). ...
... In the past three decades, the share repurchase activity of U.S. corporations has experienced extraordinary growth (Gaspar et al., 2013). Repurchases are now an important form of payout of US firms, and the long-term trend in payout choices points toward a lower proportion of firms paying dividends and replacing them with repurchases (Fama and French, 2001;Gaspar et al., 2013). However, stock repurchases are very pro-cyclical, while dividends increase steadily over time. ...
Purpose
The purpose of this paper is to investigate the relationship between dividend policy and the life cycle of firms in India. In addition, this study intends to examine the variation in dividend behaviour over the life cycle of a firm. The study anticipates that a firm's dividend behaviour varies over its life cycle.
Design/methodology/approach
To scrutinize the validity of the proposition, the authors classify 1968 non-financial industrial firms listed at Bombay Stock Exchange (BSE) into growth, mature and stagnant firms over the period 2000–20. Additionally, to check the robustness of the results, they use an array of techniques such as analysis of variance, pooled ordinary least squares, fixed effects models and random effects models.
Findings
The empirical findings suggest that dividend behaviour varies over a firm's life cycle. Specifically, stagnant firms are paying significantly higher dividends than growth firms. Mature firms are paying significantly higher dividends than growth firms. The results are consistent after controlling the effects of firm's size, profitability, leverage, operating risk, systematic risk and growth opportunities.
Research limitations/implications
The findings are useful for corporate decision makers in establishing an appropriate dividend policy conditional on firms' life cycle stage and for shareholders in making investment decisions.
Originality/value
The relation between dividend policy and firm life cycle has not been examined before in the context of Indian stock market. Thus, this research bridges this gap in the literature.
... Crane et al. (2016) demonstrate a positive correlation between institutional ownership and dividend payouts, particularly in firms with higher expected agency costs. Gaspar et al. (2013) explore the influence of shareholder investment horizons on payout policies, finding that short-term investors tend to favor share repurchases over dividends, with market reactions reflecting this preference. Di Giuli et al. (2021) investigate the impact of common ownership on dividend policies, revealing a convergence toward the dividend strategies of existing portfolio firms. ...
Managerial ability plays a key role in the development and performance of a business and, implicitly, in corporate financing decisions and dividend opportunities. This study builds on the contradictory literature arguments related to dividend policies and analyses the influence of managerial ability and financial constraints on cash dividends, considering a comprehensive perspective of dividends expressed as both accounting and market measures of payout, yield, and growth in the context of the Chinese financial market. Alternative empirical estimations on a sample of 18,011 firm-year data of Chinese A-share listed companies between 2010 and 2019 indicate that managerial ability has a positive influence over cash dividend distribution, enhancing shareholders’ returns and the attractiveness of the companies on the financial market. The effect of managerial ability is challenged by the financial constraints’ conditions and state ownership. These results contribute to corporate and regulatory dividend policies, illustrating the importance of understanding the role of managerial influence on dividend decisions.
... In contrast, institutional investors with a short-term investment horizon possess less incentives to actively monitor corporate managers as they are interested in short-term earnings even if it comes at the expense of the long-term prosperity of the firm (Jiang and Anandarajan, 2009;Gaspar et al., 2013). According to Froot et al. (1992), short-term institutional investors hinder the ability of corporate managers to impose long-term managerial discipline. ...
Purpose- While there is some evidence of a relationship between earnings quality and information asymmetry, there is limited evidence on the moderating role of institutional investors in this relationship. To fill this gap, this study aims to examine how institutional ownership affects the relationship between earnings quality and information asymmetry, with a focus on the impact of different investment horizons.
Design/methodology/approach- This study employs a sample of listed European firms from 2000 to 2022. Earnings quality is measured using the McNichols (2002) modification of the Dechow and Dichev (2002) model. The analysis examines the moderating effect of institutional ownership on the relationship between earnings quality and information asymmetry.
Findings- We find that the relationship between earnings quality and information asymmetry is more pronounced in firms with a higher percentage of institutional ownership. We find that the monitoring role of long-term institutional investors is more effective than that of short-term institutional investors. The study also finds that the influence of institutional investors is more significant in firms with incentives to engage in earnings management.
Practical implications- Our findings provide evidence suggesting that institutional investors are an important class of investors in terms of exercising an effective monitoring role to mitigate information asymmetry and demand higher earnings quality from their investee firms. These findings are informative for many financial reporting participants, including investors, analysts, regulators, and managers.
Originality/value- Our study extends the existing research examining the relationship between earnings quality and information asymmetry (e.g., Affleck-Graves et al., 2002; Ascioglu et al., 2012; Bhattacharya et al., 2013; Jayaraman, 2008; Liu and Elayan, 2015) by examining the moderating effect of institutional ownership on this relationship. It further contributes to the literature by distinguishing between long-term and short-term institutional investors and their respective monitoring roles. Additionally, the study broadens the geographical scope of the research by using cross-country data from European firms, providing evidence that country-specific factors do not uniformly affect the relationship between earnings quality and information asymmetry.
... as well as to pressure companies into maximizing short-term earnings growth and resell their stock at a profit compared to investors that have a short-term focus (Bushee 2001;Bolton et al. 2006;Gaspar et al. 2013). Hassan et al. (2021) indicate that myopic investors are likely to use shareholder litigation as a tool to pressure management into taking actions that can reduce short-term price risk. ...
This paper investigates whether and how shareholder litigation infuences income smoothing. Using the ruling of the Ninth Circuit Court of Appeals in 1999 as an exogenous shock to the threat of litigation, we fnd that the increasing difculty of class action lawsuits decreases income smoothing. This fnding is robust to diferent model specifcations. We also show that such an efect is stronger for frms that are more likely to face greater pressure from the threat of shareholder litigation risk. Overall, our fndings extend the literature on investigating how class action lawsuits can afect the motivation of income smoothing.
... Finally, my paper is broadly related to the investor horizon and managerial (myopic) actions (Borochin and Yang (2017), Bushee (1998), Bushee (2001), Chen et al. (2007), Gaspar et al. (2005, Gaspar et al. (2012), andHarford et al. (2018)), but shed more light on the channel, how passive (long-term) institutions affect managerial behavior to focus on longterm goals. Few papers have documented the relation between investor horizon and CEO incentive horizon. ...
A one-standard-deviation increase in passive ownership leads to a 25% increase in the compensation duration. I find proxy voting is the channel through which passive investors affect incentive horizons. Since the passage of the Dodd-Frank Act, passive funds tend to vote more against Say-on-Pay (SOP) proposals, and SOP proposals are less likely to pass with higher passive ownership. Moreover, passive ownership is associated with a greater number of shareholder-sponsored compensation proposals and an increased likelihood of these proposals passing. The overall findings indicate that passive institutions work to lengthen CEO compensation to align incentive horizons, and proxy voting is the mechanism through which they exert influence.
... as well as to pressure companies into maximizing short-term earnings growth and resell their stock at a profit compared to investors that have a short-term focus (Bushee 2001;Bolton et al. 2006;Gaspar et al. 2013). Hassan et al. (2021) indicate that myopic investors are likely to use shareholder litigation as a tool to pressure management into taking actions that can reduce short-term price risk. ...
This paper investigates whether and how shareholder litigation influences income smoothing. Using the ruling of the Ninth Circuit Court of Appeals in 1999 as an exogenous shock to the threat of litigation, we find that the increasing difficulty of class action lawsuits decreases income smoothing. This finding is robust to different model specifications. We also show that such an effect is stronger for firms that are more likely to face greater pressure from the threat of shareholder litigation risk. Overall, our findings extend the literature on investigating how class action lawsuits can affect the motivation of income smoothing.
... As a measure for ESG reputational risk, we use RepRisk's CurrentRRI index to capture a company's current exposure to ESG-related issues. In addition, following the extant literature on payout determinants (Almeida, Fos and Kronlund, 2016;Arena and Julio, 2023;Bens et al., 2003;Blouin, Raedy and Shackelford, 2011;Bonaimé, Hankins and Harford, 2014;Dittmar, 2000;Gaspar et al., 2013;Herdhayinta, Lau and Shen, 2021;Jensen, 1986;Oswald and Young, 2008;Rozeff, 1982), we include in our regression a rich set of control variables. In line with Jensen's (1986) free cash flow theory, we control for free cash flows (FreeCash-Flows). ...
This study explores the relationship between ESG reputational risk, corporate payouts and firm value. Using a sample of 2021 US-listed firms between 2007 and 2019, we provide robust evidence that ESG reputational risk relates to higher payouts, and that free cash flows amplify this relationship. Turning to payout composition, we document that ESG reputational risk associates with a payout mix comprising a higher analogy of share repurchases versus dividends; and that this relationship is more pronounced under financial constraints. Furthermore, we show that the market places a premium on payouts from high ESG reputational risk firms. Our findings are in line with the notion that ESG reputational risk represents agency problems and raises financial risk, inducing firms to disgorge cash via a more flexible payout regime. Results are robust to several estimation techniques that address endogeneity, self-selection, and censored observations.
... Finally, we add to the literature linking investment horizon to corporate behavior, such as capital structure (Boubaker et al, 2019), corporate innovation and R&D investment (Barrot, 2017;Bushee, 1998), corporate social responsibility (Boubaker et al, 2017), corporate payout policy (Amin et al, 2015;Gaspar et al., 2013), mergers and acquisitions (Gaspar, Massa, and Matos, 2005), firm's performance (Elyasiani and Jia, 2010), and investment to cash flow sensitivity (Attig et al. 2012). As noted by Hartzell and Starks (2003), though long-term investors could affect corporate policies by active monitoring, short-term investors could affect corporate policies through their trading strategies and preferences. ...
We examine the relation between the probability of future stock price crash and investors’ investment horizons. Using negative skewness as a proxy for firm-specific crash risk, we document a positive association between institutional ownership and stock price crash risk. The relation is, however, driven by short-term institutional investors, while the presence of long-term institutional investors has a negative effect on stock price crash risk. In addition, we find that the presence of short-term institutional investors induces corporate risk-taking behavior. Our results are robust to alternative model specifications, endogeneity concerns, and different measures of crash risk and proxies of investors’ horizons.
... Rank issue modes based on wealth transfers corporate decisions. 15 For example, tax clientele effects are known to be an important determinant in firms' payout policies, including dividends and share repurchases (see, e.g., Bhat and Pandey 1993;Lie and Lie 1999;Gaspar et al. 2013) and incorporation decisions (Babkin, Glover and Levine 2017). Anecdotal evidence indicates that some shareholders oppose a share issue because it would considerably dilute their holdings. ...
We analyze rights and public offerings when informed shareholders strategically choose to subscribe. Absent wealth constraints, rights offerings achieve the full information outcome and dominate public offerings. When some shareholders are wealth constrained, rights offerings lead to more dilution of their stakes and lower payoffs, despite the income from selling these rights. In both rights and public offerings, there is a trade-off between investment efficiency and wealth transfers among shareholders. When firms can choose the flotation method, either all firms choose the same offer method or high and low types opt for rights offerings, while intermediate types select public offerings. (JEL G32)
Received September 23, 2021; editorial decision June 8, 2022 by Editor: Andrew Ellul.
... SDReturn and SDCF are included to be consistent with the flexibility hypothesis, where firms use their discretion over the number and timing of shares to buy back ( Bargeron et al., 2011 ;Bonaimé et al., 2016 ). BlockOwn, OfficerOwn , and ForeignOwn are included because prior studies find a relationship between ownership structure and repurchaserelated variables ( Wu, 2012 ;Gaspar et al., 2012 ). Finally, given that Massa et al. (2007) find that firms initiate OMRs to mimic their industry peers, we include Mimic to account for industry trends. ...
This paper extends the signaling hypothesis by investigating the signal strength adjustment behavior with respect to the announcement of an open market repurchase (OMR). Given that an OMR is a non-binding commitment for the repurchasing firm, the stock market would likely scrutinize the credibility of the undervaluation signal from the OMR announcement of the firm. This may compel the manager to engage in various mechanisms in order to strengthen the undervaluation signal of the OMR announcement. This paper investigates whether managers of repurchasing firms would modify the terms of the OMR program when the simultaneous announcements of bad news threaten the credibility of the signal from the OMR announcements. Consistent with our signal strength adjustment hypothesis, we find that managers of repurchasing firms increase (shorten) the repurchase plan size (period) with the magnitude of bad news in the simultaneous announcements. Our results also show that the stock market reacts positively to the signal strength adjustments, indicating that they are informative to the market. These results hold after using various techniques to control for sample selection bias.
... Cella et al. (2013) show that stocks held by more long-term investors are more resilient to market downturns. Gaspar et al. (2013) find that shareholder investment horizons influence payout policy choices. Cremers et al. (2020) find that an increase in short-horizon investors is associated with cuts to long-term investment and increased short-term earnings. ...
... Other contributions indicate that the effects of short-term investors extend beyond R&D. For example, firms with more short-term investors perform worse in corporate takeovers, both as targets and acquirers (Gaspar et al., 2005;Chen et al., 2007), exhibit more fraud and empire building (Harford et al., 2018), and use share buybacks more frequently to payout out more to shareholders (Gaspar et al., (2013). ...
We provide a comprehensive overview of the role of institutional investors in corporate governance with three main components. First, we establish new stylized facts documenting the evolution and importance of institutional ownership. Second, we provide a detailed characterization of key aspects of the legal and regulatory setting within which institutional investors govern portfolio firms. Third, we synthesize the evolving response of the recent theoretical and empirical academic literature in finance to the emergence of institutional investors in corporate governance. We highlight how the defining aspect of institutional investors – the fact that they are financial intermediaries – differentiates them in their governance role from standard principal blockholders. Further, not all institutional investors are identical, and we pay close attention to heterogeneity amongst institutional investors as blockholders.
... Second, employee satisfaction fosters productivity and efficiency, also leading to higher profits (Edmans, 2011;Edmans, 2012). Third, corporate social responsibility can attract a shareholder base that has long-term investment goals, reducing pressure on management to generate short-term profits and allowing for investments that yield returns over a longer time horizon (Gaspar et al., 2013). Fourth, improved governance standards indicate better management practices and result in higher future performance (Ferrell et al., 2016). ...
We study behind-the-scenes investor activism promoting environmental, social, and governance (ESG) improvements by means of a proprietary dataset of a large international, socially responsible activist fund. We examine the activist’s target selection, forms of engagement, impact on ESG performance, drivers of success, and effects on the targets’ operations and value creation. Target firms are typically large and visible, perform well, and have high liquidity (stock turnover) and low ESG performance. Engagement induces ESG rating adjustments: firms with poor ex ante ESG ratings experience a ratings increase after complying with the activist’s demands, whereas firms with high ex ante ESG ratings experience a ratings decrease following the revelation of their ESG problems. Activism that is focused on environmental and social issues is more likely to succeed if targets are ESG-sensitive (i.e., they have a strong ex ante ESG profile). Successful engagements boost targets’ sales. Risk-adjusted excess stock returns (with four-factor adjustment and relative to a matched sample of non-engaged firms) of successful engagements outperform those of unsuccessful engagements by 2.7%. Results are especially strong for firms with low ex ante ESG scores. Specifically, targeted firms in the lowest ex ante ESG quartile outperform matched peers by 7.5% in the year after the end of the engagement. Our results thus suggest that the activism regarding corporate social responsibility generally improves ESG practices and corporate sales and is profitable to the activist. Taken together, we provide direct evidence that ethical investing and strong financial performance, both from the activist’s and the targeted firm’s perspective, can go hand-in-hand together.
... One important distinction refers to their investment horizons. In recent studies, Gloßner (2019), Kim et al. (2019a) and Oikonomou et al. (2020) distinguish between the impacts of short-and long-term investors on firms' ESG performance because different investment horizons may affect the incentive to monitor and, in turn, affect various corporate decisions and practices (Bushee 1998;Chen et al. 2007;Gaspar et al. 2013). Another separation pertains to content-driven, socially responsible investing (Majoch et al. 2017;Alda 2019). ...
In light of current climate change discussions, this paper analyzes the effect of ownership structure on a firm’s environmental performance with a subsequent focus on corporate emission reduction. Based on a cross-national European sample consisting of 7,384 firm-year observations between 2008 and 2017, this study explores the relationship between sustainable institutional investors and environmental performance. In line with prior research and embedded in an agency theoretical framework, the nature of institutional investors may act as a stimulating driver towards green business practices. Sustainable institutional investors are defined based on their signatory status to the UN Principles for Responsible Investment and their (long-term) investment horizons. The first classification stems from a content-driven sustainability perspective, while the second is derived from temporal sustainability. The results indicate that sustainable institutional ownership is positively associated with a firm’s environmental performance. Further investigations reveal that sustainable institutional investor ownership is also positively associated with firms’ willingness to respond to the Carbon Disclosure Project. These results indicate a higher carbon-risk awareness in firms with greater sustainable institutional investor ownership. Our paper significantly contributes to prior empirical research on institutional ownership and environmental performance and offers useful theoretical and practical implications. It focusses on a still-underdeveloped research area, namely organizations and their relationships with the natural environment, including institutional equity ownership as a driver towards greener practices on a corporate level.
... However, special dividends are preferred for firms where the shareholder heterogeneity is even lower than open market repurchase. Gaspar et al. (2012) discuss the amount of repurchase and its frequency increases for firms held by short-term investors over dividend payment. ...
The paper aims to identify the variables contributing to special payouts considering open market repurchase, tender offer repurchases, and special dividends. A multinomial logit model has been used to investigate the choice of payout out of 754 payout announcements made between 2004 and 2017 in India. The study investigates agency cost, shareholder heterogeneity, clientele effect, distribution size, misvaluation, and takeover threat. The MNL results suggest that open market repurchase is chosen when the takeover threat is high, firms are significant, or in case of undervaluation of firms. Tender offer repurchase is preferred in high agency cost, high takeover threat, low shareholder heterogeneity, and undervaluation. The study further investigates the nature of ownership in terms of a business group affiliated and standalone firms. The result of the study suggests the nature of ownership impacts the choice of dividend payout choice. Group affiliated firms are driven by clientele effect and distribution size, and in standalone firms’ agency and shareholder heterogeneity holds. The Bayesian approach which is based on the combination of previous information and the current data available is used in the study for MNL. The findings suggest that payout choices of open market repurchase and tender offer repurchase over special dividends are based on misvaluation and shareholder heterogeneity.
This study examines how firms’ socially responsible behavior relates to the timing of their share repurchases, considering share mispricing and the resulting wealth transfer between sellers and ongoing shareholders. We hypothesize that firms with a stronger commitment to societal goals prioritize the interests of all stakeholders more equally than those with a weaker commitment. Therefore, their managers are less likely to take advantage of the wealth transfer from selling to ongoing shareholders, which occurs when the firm is undervalued. Our results show that firms with higher corporate social responsibility (CSR) engagement, ceteris paribus, announce repurchases during periods of lower undervaluation. Additional analyses show that this effect is more pronounced when investor protection is stronger at the country level. Moreover, higher institutional ownership increases the relevance of undervaluation in buyback decisions and the distribution of excess cash is a relatively more important reason for share repurchases when firms display higher CSR engagement. Overall, our findings demonstrate that firms that generally act in a socially responsible manner also refrain from exploiting sellers for the benefit of ongoing investors.
JEL classification: G15, G35, M14
Les actions de fidélité sont perçues par certains comme un encouragement à une détention actionnariale de long-terme, tandis qu’elles ne sont pour d’autres qu’un outil d’enracinement des actionnaires contrôlants. Cet article contribue à ce débat en analysant l’impact de la Loi Florange qui fait des actions de fidélité à droit de vote double la règle de droit par défaut tout en offrant la possibilité d’y déroger par un vote en assemblée générale. Les entreprises qui rejettent (adoptent) le droit de vote double enregistrent des réactions boursières négatives (positives). La comparaison des entreprises dont les statuts prévoyaient des actions de fidélité à vote double avant la Loi Florange – environ 2/3 des firmes françaises – et des nouveaux adoptants suggère que les coûts et bénéfices de ces actions dépendent des caractéristiques des entreprises.
This study examines how changes in tick size and the differential between short-term and long-term capital gain tax rates affect the market response to the announcement of stock distributions. Prior research finds that a stock distribution increases the volatility of the stock, which in turn increases the value of the stock’s tax-timing option. We show that the minimum tick size established by the exchange where the stock is traded affects a stock’s volatility and, therefore, the value of the tax-timing option and the market response to the stock distribution. We document a stronger relation between the market response and changes in volatility among large distributions than among small distributions. We also find a positive relation between the market response and the tax rate differential, although it is only significant for small distributions. Finally, we show that the relationship between the market response and changes in both volatility and tax rate differential is primarily driven by tax-sensitive institutional investors in the distributing firm.
Purpose
Although investigating the factors influencing technological diversification is essential to understanding research and development (R&D) strategies, studies from the perspective of corporate ownership structure are limited. This study examines the effect of heterogeneous institutional investors on technological diversification strategies.
Design/methodology/approach
The sample consists of 33,124 firm-year observations of USA manufacturing firms from 1981 to 2008. Data were extracted from US Patent Data, Thomson Reuters' 13f and the Compustat database. A panel regression analysis was used to test the hypothesis. Moreover, the two-stage least squares (2SLS) approach using instrumental variables (IVs) and generalized method of moments (GMM) were also applied to address the endogeneity issue.
Findings
The empirical findings indicate that short-term (long-term) institutional investors positively (negatively) affect technological diversification. That is, short-term institutional ownership hampers R&D diversification, suggesting that firms are forced to make myopic investments to meet short-term goals instead of diversifying corporate R&D projects. Meanwhile, long-term institutional ownership enhances technological diversification to achieve long-term value.
Research limitations/implications
By differentiating between institutional investment horizons, the authors produce empirical evidence that institutional investors with short-term and long-term perspectives have different views on technological diversification. This study is based on data between 1981 and 2008, due primarily to patent data availability and data on institutional investors. However, this limitation does not diminish the importance of the empirical findings, as the study's focus is on discovering antecedent evidence of corporate technological diversification rather than addressing recent trends in firm decisions.
Practical implications
In finding that long-term institutional investors are likely to encourage technological diversification at firms, the paper carries an important practical implication that can help inform decision-making by policymakers and investors.
Originality/value
This research contributes to a more comprehensive understanding of institutional investors' role in technological diversification strategies. Additionally, by challenging the assumption that all institutional owners share the same perspective, this study is the first to confirm the existence of heterogeneous effects of institutional investors on technological diversification strategies.
Purpose
This study aims to examine the impact of board gender diversity on company greenhouse gas (GHG) performance, the influence of a critical mass of women on boards on carbon performance (CP) score and its three components separately (Scope 1, Scope 2 and Scope 3). This study examines the presence of institutional investors as a contingent factor that intensifies the effectiveness of the critical mass of female directors on CP.
Design/methodology/approach
Using a sample of the US companies listed on Securities and Exchange Commission for the period 2011–2018 and making a total of 2416 observations. This study shows that reaching a critical mass of female board members enhances the level of CP. In addition, this study finds that the presence of institutional investors positively moderates this relationship.
Findings
The main results suggest that there is a nonlinear relationship between a critical mass of women directors and CP, and that institutional investors play a strategic role in shaping this relationship. The effect of institutional investors on the three components of CP is also analyzed.
Research limitations/implications
This research is characterized by the methodology adopted for a quantitative variable for measuring CP. Indeed, other research the proxies related to carbon measurements are often used as a simple binary variable. This study verifies the harmony of the theory of critical mass measuring diversity within the board of directors, the presence of institutional investors on GHG emissions (Scope 1, Scope 2 and Scope 3), unlike previous studies (Tingbani et al. , 2020; Nuber and Velte, 2021) which only focus on the two measures of carbon emissions (Scope 1 and Scope 2).
Originality/value
This study shows identically that gender diversity on the board must reach a critical mass of three women directors to motivate and influence CP. We fill the gap in previous research regarding the role played by the institutional environment of the firm in improving CP. Third, this study highlights the relevance of having a critical mass of pressure-resistant female directors on boards due to their engagement in climate change issues and CP.
We study the role of state controlling shareholders in corporate payout policy. The State Capital Operation Program in China requires parent central state-owned enterprises (CSOEs) to contribute part of their consolidated income to a new fiscal fund. We find that listed CSOEs, partially controlled by parent CSOEs, experience significant reductions in dividend payouts as the income-contribution ratio increases. The dividend reductions are concurrent with increases in intragroup resource transfers— listed CSOEs’ loans to, and commercial trades with, group peers. The program yields adverse consequences for listed CSOEs’ investment and employment, yet being mitigated by group-level dividend reductions.
We study whether languages are related to corporate dividend policies around the world. Users of languages with a weak future time reference (FTR), such as Japanese and Finnish, do not need to grammatically distinguish future and current events, while users of strong-FTR languages such as French and Italian do. Chen (2013) shows that people who use weak-FTR languages may perceive the future to be nearer and have less precise perceptions of the timing of future events than users of strong-FTR languages. We argue that these perceptions may result in a lower discount rate and a higher valuation of future dividends, leading to a weaker preference and demand for a dividend today. Using a large sample of firms from 19 markets, we find supporting evidence that firms in weak-FTR language markets pay lower dividends than firms in strong-FTR language markets. The results remain robust after a battery of robustness tests, including using a single market with multiple languages and using a difference-in-differences approach in a market with a change of official languages. Further evidence shows that weak-FTR languages are related to a lower implied cost of equity capital and stronger market reactions to dividend changes. Our results offer a new explanation for cross-country differences in dividend policies and add to the research on culture and financial markets.
We propose a conceptual framework to illustrate that when three conditions hold, institutional investors moderate a positive relation between corporate financial performance (CFP) and corporate environmental performance (CEP). We explore heterogeneities across institution types to demonstrate the importance of each condition. The moderating effect works through the channels of expert consulting and effective monitoring. Our results have important policy and practical implications given the global trend of ownership concentration in institutional investors and the projection that by 2025, one out of three dollars under professional management will be invested in corporate social responsibility (CSR) assets. This article is protected by copyright. All rights reserved.
This paper examines how a manager uses voluntary disclosure to influence corporate control by a short-term shareholder. Because a short-term shareholder intervenes excessively, the manager’s disclosure strategy is determined by the trade-off between excessive and insufficient intervention. In equilibrium, when shareholder short-termism is not too high, the manager discloses both good and bad news and withholds intermediate news. Alternatively, when shareholder short-termism is high, the manager only discloses good news and withholds bad news. In both equilibria, withholding information is value-enhancing for the nondisclosing firms. We also show that the likelihood of disclosure weakly decreases as the shareholder is more short-term-oriented. Moreover, nondisclosing firms are more likely to face shareholder intervention than disclosing firms.
This paper was accepted by Brian Bushee, accounting.
This paper examines whether sustainable institutional investors promote corporate social responsibility (CSR)‐contingent components (e.g., environmental or social aspects) in senior executive compensation in order to align top management interests in the promotion of sustainability with their own. Empirical analyses of a sample of 5979 firm‐year observations from European firms over the 2010–2017 period showed that the presence of sustainable institutional investors positively predicts the likelihood of firms offering CSR‐contingent compensation contracts. This paper significantly contributes to prior empirical research, which predominantly focuses on the effectiveness of CSR‐contingent components within compensation structures. Sustainable institutional investors as a potential driver of CSR‐contingent components have not yet been examined. We specifically investigate institutional investors that have either a substantial or a time‐dependent belief in CSR. Our results indicate that sustainable institutional investors represent a central external corporate governance mechanism and tend to align top management preferences with their own via compensation structures.
We examine the relationship between institutional ownership and bank capital. Using a large sample of U.S. banks, we show that banks with greater institutional ownership operate with substantially higher capital ratios. The results are robust to controlling for standard determinants of bank capital structure, including market- and accounting-based risk measures. The results hold both for indexers and non-indexers, indicating that the effect of institutional ownership on bank capital cannot be explained by self-selection. We further address endogeneity concerns using an instrumental variable strategy based on the inclusion of banks in the S&P index. We find supporting evidence that the superior monitoring abilities of institutional investors, which reduce the severity of agency costs, is the main explanation for our results.
We develop a model to study the impact of corporate governance on the investment decisions of firms and competition in an industry populated by publicly owned firms. A bargaining process between firm’s stakeholders determines the optimal allocation of financial resources between real investments in R&D and financial investments in shares buybacks. We characterize the relation between governance and investment strategy and we study how different governance structures shape technical progress and competition over the industrial life cycle. Numerical simulations of a calibrated set-up of the model show that pooling together industries characterized by heterogeneous governance structures generate the well-documented inverted-U shaped relation between competition and innovation.
Purpose
This paper investigates stakeholders' perspectives of share buybacks in the context of time-horizons of investment decisions and strategy.
Design/methodology/approach
We use in-depth interviews with stakeholders from eight listed UK firms as well as examine their publicly available data.
Findings
Findings suggest that share buybacks involve a wide range of stakeholders' rational interests and long-term management perspectives as they enable firms to strategise operational plans towards their long-term corporate goals.
Research limitations/implications
The findings are based on interviews with a small number of share buyback firms and the findings, therefore, may not be generalised to all firms.
Practical implications
The results show that share buybacks may be part of the long-term interests of firms and not necessarily used as part of short-term EPS increases as suggested in the extant literature.
Originality/value
The findings contribute to the literature on corporate pay-out policies in the context of short-term financial objectives vs long-term strategic objectives of stakeholders. They show that share buybacks can be an important part of firms' long-term strategic considerations.
I examine the role of institutional investors in hedge fund activists’ target selection. I argue that the coordination power and the investment horizon of institutional investors are important factors in explaining target selection. I find that hedge fund activism is higher in firms that institutional investors with long-term horizons invest as well as firms where coordination ability among existing shareholders is less pre-intervention. However, coordination ability increases after the intervention. Furthermore, hedge fund demands and success rates differ with the coordination ability and investment horizon of investors. Firms with investors that have long-term investment horizons and increased coordination ability are more likely to receive demands on board representation, value maximization and corporate governance improvements. Firm performance improvements are the most visible where institutional investors have a long horizon and where coordination among existing institutional investors increases. Overall, the results suggest that coordination ability and investment horizon of existing institutional shareholders are important factors in explaining target selection and strategies explored by hedge fund activists as well as their effects on firm value. The findings support the notion of coordination and collaborative monitoring role of long-term institutional investors with and hedge fund activists.
Farre-Mensa, Michaely and Schmalz (2018) document that many firms issue new equity to finance their payouts to shareholders, despite the substantial cost of equity issuance. We find that equity-financed payouts are related to institutional investors’ horizon. Specifically, firms with a larger ownership by short-horizon institutions are more likely to have equity-financed discretionary payouts, and firms with equity-financed discretionary payouts tend to cut down their investments in the following years. Our results suggest that investor short-termism has significant effects on firms’ payout, financing and investment policies.
Donald Trump’s 2016 election and his nomination of climate skeptic Scott Pruitt to head the Environmental Protection Agency drastically downshifted expectations about U.S. policy toward climate change. Joseph Biden’s 2020 election shifted them dramatically upward. We study firms’ stock-price movements in reaction to these changes. As expected, the 2016 election boosted carbon-intensive firms. Surprisingly, firms with climate-responsible strategies also gained, especially those firms held by long-run investors. Such investors appear to have bet on a “boomerang” in climate policy. Harbingers of a boomerang appeared during Trump’s term. The 2020 election marked its arrival. (JEL G14, G38, G41)
Received November 10, 2019; editorial decision May 4, 2021 by Editor Andrew Ellul. Authors have furnished an Internet Appendix, which is available on the Oxford University Press Web site next to the link to the final published paper online.
This study exploits the staggered adoption of universal demand (UD) laws, which place significant obstacles to derivative lawsuits and thus, undermine shareholders’ rights by 23 states in the United States (U.S.) from 1989‒2005 as a quasi-natural experiment to examine the effects of shareholder litigation rights on corporate payout policy. Weakened litigation rights for shareholders materially increase firms’ payout ratios. The effect is more pronounced for firms exposed to higher shareholder litigation risk ex-ante, firms with higher institutional holdings, and ones financially unconstrained. Overall, the findings are consistent with lower shareholder litigation threats motivating firms to increase dividend payouts.
This paper examines the role of the “Big Three” (i.e., BlackRock, Vanguard, and State Street Global Advisors) on the reduction of corporate carbon emissions around the world. Using novel data on engagements of the Big Three with individual firms, we find evidence that the Big Three focus their engagement effort on large firms with high CO2 emissions in which these investors hold a significant stake. Consistent with this engagement influence being effective, we observe a strong and robust negative association between Big Three ownership and subsequent carbon emissions among MSCI index constituents, a pattern that becomes stronger in the later years of the sample period as the three institutions publicly commit to tackle Environmental, Social, and Governance (ESG) issues.
We find that firms in the growth and maturity stage generally have higher levels of institutional ownership, higher Tobin’s Q ratios, and are more likely to remain in their life cycle stage over the subsequent six-year period. Further analysis indicates a feedback effect between domestic and foreign institutional ownership. Finally, we find that the impact information transmission of foreign institutional ownership is faster than that of domestic institutional ownership. We conclude that Taiwan’s government has been successful in its efforts over the last 20 years to increase economic growth, strengthen corporate governance, and improve the country’s capital markets.
We investigate new institutional investors that do not receive initial public offering (IPO) allocations but invest in the newly public firms after IPOs. We find that many institutions buy the stocks of IPO firms in the post‐IPO secondary market over time. In contrast to retail investors who chase hot IPOs, these new institutions invest in IPO firms with lower valuations at offerings and better fundamentals. These results suggest that new institutional investors' post‐IPO investment decisions are driven by publicly available information on firm fundamentals instead of investor sentiment. Long‐term performance tests confirm that this trading strategy helps institutions identify better quality IPOs.
This article is protected by copyright. All rights reserved.
This study documents that the stability of institutional ownership plays an important role in determining the cost of debt. After controlling for other determinants of the cost of debt, and correcting for the endogeneity of institutional ownership stability, three major results are uncovered. First, there is a robust negative relationship between the cost of debt and institutional ownership stability. Second, institutional ownership stability plays a bigger role in determining the cost of debt, than the institutional ownership level commonly used in the literature. Third, institutional ownership stability affects the cost of debt to a greater extent for firms that are subject to more severe information asymmetry and greater agency costs of debt.
Open-end equity funds provide a diversified equity positions with little direct cost to investors for liquidity. This study documents a statistically significant indirect cost in the form of a negative relation between a fund's abnormal return and investor flows. Controlling for this indirect cost of liquidity changes the average fund's abnormal return (net of expenses) from a statistically significant −1.6% per year to a statistically insignificant −0.2% and also fully explains the negative market-timing performance found in this and other studies of mutual fund returns. Thus, the common finding of negative return performance at open-end mutual funds is attributable to the costs of liquidity-motivated trading.
We examine long-run firm performance following open market share repurchase announcements, 1980–1990. We find that the average abnormal four-year buy-and-hold return measured after the initial announcement is 12.1%. For ‘value’ stocks, companies more likely to be repurchasing shares because of undervaluation, the average abnormal return is 45.3%. For repurchases announced by ‘glamour’ stocks, where undervaluation is less likely to be an important motive, no positive drift in abnormal returns is observed. Thus, at least with respect to value stocks, the market errs in its initial response and appears to ignore much of the information conveyed through repurchase announcements.
Stock repurchases by U.S. companies experienced a remarkable surge in the 1980s and ‘90s. Indeed, in 1998, the total value of all stock repurchased by U.S. companies exceeded for the first time the total amount paid out as cash dividends. And the U.S. repurchase movement has gone global in the past few years, spreading not only to Canada and the U.K., but also to countries like Japan and Germany, where such transactions were prohibited until recently.
Why are companies buying back their stock in such amounts? After dismissing the popular argument that stock repurchases boost earnings per share, the authors argue that repurchases serve to add value in two main ways: (1) they provide managers with a tax-efficient means of returning excess capital to shareholders and (2) they allow managers to “signal” to investors their view that the firm is undervalued. Returning excess capital is value-adding for two reasons: First, it helps prevent companies from pursuing growth and size at the expense of profitability and value. Second, by returning capital to investors, repurchases (like dividends) play the critically important economic function of allowing investors to channel their investment from mature or declining sectors of the economy to more promising ones.
But if stock repurchases and dividends serve the same basic economic function, why are repurchases growing more rapidly? Part of the explanation is that, because repurchases are taxed as capital gains and dividends as ordinary income, repurchases are a more tax-efficient way of distributing excess capital. But perhaps even more important than their tax treatment is the flexibility that (at least) open market repurchases provide corporate managers-flexibility to make small adjustments in capital structure, to exploit (or correct) perceived undervaluation of the firm's shares, and possibly even to increase the liquidity of the stock, which could be particularly valuable in bear markets.
For U.S. regulators, the growth in open market stock repurchases raises some interesting issues. Perhaps most important, companies are not required to (and rarely do) furnish their investors with details about a given program's structure, execution method, number of shares repurchased, or even its duration. Policy regulators (and corporate executives as well) should consider some of the benefits provided by other systems, notably Canada's, which provide greater transparency and more guidelines for the repurchase process.
Theories of corporate payout policy do not explain the observed form of distributions to shareholders. Although open-market repurchases appear to have tax advantages, cash dividends are overwhelmingly chosen. We argue that there are costs associated with open-market-repurchase programs, since they provide managers with opportunities to use inside information to benefit themselves at stockholders' expense. We offer evidence suggesting that bid-ask spreads widen around repurchase announcements, as predicted by our analysis. Since these costs of repurchases do not arise with cash dividends, our analysis implies that repurchases do not dominate cash dividends for making distributions to shareholders.
This paper shows that over time, expected market illiquidity positively affects ex ante stock excess return, suggesting that expected stock excess return partly represents an illiquidity premium. This complements the cross-sectional positive return–illiquidity relationship. Also, stock returns are negatively related over time to contemporaneous unexpected illiquidity. The illiquidity measure here is the average across stocks of the daily ratio of absolute stock return to dollar volume, which is easily obtained from daily stock data for long time series in most stock markets. Illiquidity affects more strongly small firm stocks, thus explaining time series variations in their premiums over time.
This chapter reviews developments to improve on the poor performance of the standard GMM estimator for highly autoregressive panel series. It considers the use of the 'system' GMM estimator that relies on relatively mild restrictions on the initial condition process. This system GMM estimator encompasses the GMM estimator based on the non-linear moment conditions available in the dynamic error components model and has substantial asymptotic efficiency gains. Simulations, that include weakly exogenous covariates, find large finite sample biases and very low precision for the standard first differenced estimator. The use of the system GMM estimator not only greatly improves the precision but also greatly reduces the finite sample bins. An application to panel production function data for the U.S. is provided and confirms these theoretical and experimental findings.
This paper investigates whether institutional investors influence firms’ investment policies. By virtue of their significant ownership stakes and investment horizons, long-term institutional investors should closely monitor management and thus reduce agency conflicts in investment choices. Using a panel dataset of 2,511 U.S. manufacturing firms that went public between 1980 and 2003, I find that firms with long-term institutional investors tend to have lower capital expenditure than widely-held firms. Investment is reduced precisely in firms that are more exposed to the danger of over-investment: (a) firms that invest too much after controlling for their growth opportunities, financing constraints and industry affiliation, and (b) firms that have few investment opportunities but large cash flows. Most importantly, a reduction in capital expenditure in these firms leads to higher subsequent firm profitability and stock market performance, confirming that institutional investors’ actions aimed at removing over-investment are value-enhancing.
This paper examines whether institutional investors exhibit preferences for near-term earnings over long-run value and whether such preferences have implications for firms' stock prices. First, I find that the level of ownership by institutions with short investment horizons (e.g., "transient" institutions) and by institutions held to stringent fiduciary standards (e.g., banks) is positively (negatively) associated with the amount of firm value in expected near-term (long-term) earnings. This evidence raises the question of whether such institutions myopically price firms, overweighting short-term earnings potential and underweighting long-term earnings potential. Evidence of such myopic pricing would establish a link through which institutional investors could pressure managers into a short-term focus. The results provide no evidence that high levels of ownership by banks translate into myopic mispricing. However, high levels of transient ownership are associated with an over- (under-) weighting of near-term (long-term) expected earnings, and a trading strategy based on this finding generates significant abnormal returns. This finding supports the concerns that many corporate managers have about the adverse effects of an ownership base dominated by short-term-focused institutional investors.
This paper measures the growth in open market stock repurchases and the manner in which stock repurchases and dividends are used by U.S. corporations. Stock repurchases and dividends are used at different times from one another, by different kinds of firms. Stock repurchases are very pro-cyclical, while dividends increase steadily over time. Dividends are paid by firms with higher “permanent” operating cash flows, while repurchases are used by firms with higher “temporary”, non-operating cash flows. Repurchasing firms also have much more volatile cash flows and distributions. Finally, firms repurchase stock following poor stock market performance and increase dividends following good performance. These results are consistent with the view that the flexibility inherent in repurchase programs is one reason why they are sometimes used instead of dividends.
August 1987, Revised October 1987
ABSTRACT Two easily measured variables, size and book-to-market equity, combine to capture the cross-sectional variation in average stock returns associated with market {3, size, leverage, book-to-market equity, and earnings-price ratios. Moreover, when the tests allow for variation in {3 that is unrelated to size, the relation between market {3 and average return is flat, even when {3 is the only explanatory variable. THE ASSET-PRICING MODEL OF Sharpe (1964), Lintner (1965), and Black (1972)
This paper investigates the effect of institutional investors on firms’ investment policies in the presence of sub-optimal investments associated with agency conflicts.Using investors’ trading horizons to capture their incentives to collect information about fundamental values and monitor management’s decisions, this paper shows that an increase in the ownership stake held by long-term institutional investors is associated with a subsequent decrease (increase) in real investments precisely in firms that exhibit over- (under-) investment problems. On the contrary, short-term institutional investors are not found to influence firms’ investment policies. Importantly, changes in investment following an increase in the stake held by long-term investors are associated with higher firm’s stock returns. Overall, the evidence indicates that long-term institutional investors influence managers’ decisions and are associated with lower agency conflicts in investment choices.
This paper examines whether institutional investors create or reduce incentives for corporate managers to reduce investment in research and development (R&D) to meet short-term earnings goals. Many critics argue that the frequent trading and short-term focus of institutional investors encourages managers to engage in such myopic investment behavior. Others argue that the large stockholdings and sophistication of institutions allow managers to focus on long-term value rather than on short-term earnings. I examine these competing views by testing whether institutional ownership affects R&D spending for firms that could reverse a decline in earnings with a reduction in R&D. The results indicate that managers are less likely to cut R&D to reverse an earnings decline when institutional ownership is high, implying that institutions are sophisticated investors who typically serve a monitoring role in reducing pressures for myopic behavior. However, I find that a large proportion of ownership by institutions that have high portfolio turnover and engage in momentum trading significantly increases the probability that managers reduce R&D to reverse an earnings decline. These results indicate that high turnover and momentum trading by institutional investors encourages myopic investment behavior when such institutional investors have extremely high levels of ownership in a firm; otherwise, institutional ownership serves to reduce pressures on managers for myopic investment behavior.
We show that the positive relation between institutional ownership and future stock returns documented in Gompers and Metrick
(2001) is driven by short-term institutions. Furthermore, short-term institutions' trading forecasts future stock returns. This
predictability does not reverse in the long run and is stronger for small and growth stocks. Short-term institutions' trading
is also positively related to future earnings surprises. By contrast, long-term institutions' trading does not forecast future
returns, nor is it related to future earnings news. Our results are consistent with the view that short-term institutions
are better informed and they trade actively to exploit their informational advantage.
We investigate the timing of open market share repurchases and the resultant impact on firm liquidity. Using the Stock Exchange of Hong Kong's unique disclosure environment, we identify the exact implementation dates for more than five thousand equity buybacks. We find that managers exhibit substantial timing ability. Consistent with the information-asymmetry hypothesis, bid–ask spreads widen and depths narrow during repurchase periods. We decompose bid–ask spreads and show that adverse selection costs increase substantially as market participants respond to the presence of informed managerial trading. Our findings provide additional insight into how markets process information and have significant implications for corporate payout and disclosure policies.
This paper examines the effect of institutional investors? investment duration on the efficiency of stock prices. Using a new duration measure based on quarterly institutional investors? portfolio holdings, the presence of short-term institutional investors can help explain many of the best-known stock return anomalies, possibly because these investors are affected by behavioral biases like overconfidence. Specifically, we find that both momentum returns and subsequent returns reversal are much stronger for stocks with greater proportions of short-term institutional investors. The accruals and share issuance anomalies are also stronger for stocks held primarily by short-term institutional investors. Finally, short-term institutional investors do not seem to recognize the benefits of significant R&D increases, as they tend to under-react to these increases.
This paper investigates whether the tax disadvantage of dividends results in a relation between institutional portfolio allocations and dividend yield. I analyze the holdings of tax-exempt and taxable institutional investors. Controlling for size, performance, and risk, I find that taxable institutional owners prefer low yield stocks while tax-exempt investors do not exhibit a preference for either high or low yield securities. In addition, I find that the magnitude of the stock price reaction to the announcement of a dividend change is negatively related to the ownership level of taxable institutional investors. This evidence is consistent with the hypothesis that firms with greater taxable investor ownership have smaller price reactions to dividend changes because the information in the dividend change is offset by an increase or decrease in dividend yield. These findings are broadly consistent with the existence of tax-induced dividend clienteles.
I investigate the relation between the structure of CEO compensation and the investment horizons of a firm's institutional investors and find results consistent with the assertion that short-sighted institutions' focus on short-term earnings leads firms to grant more options with higher sensitivity to stock price. In contrast, the percentage holdings of long-term investors are negatively correlated with the use of options and the sensitivity of total CEO equity incentives to changes in stock price. Further results suggest that firms with higher short-term institutional ownership are more concerned about a negative earnings surprise and that when determining annual bonuses, they punish their CEOs more severely. In total, the analyzes provide evidence that the investment horizon of institutional investors is associated with firms' CEO compensation policies.
This paper examines the role of corporate governance for payout policy design from the perspective of pre-commitment. We test the effect of external and internal corporate governance on the design of payout policy and use of pre-commitment, level and structure of cash distributions, and firm dividend and repurchase behavior. We argue that firms use pre-commitment to dividend payments to mitigate the agency conflict due to poor governance. We argue that there is an important distinction between dividends and repurchases from the perspective of pre-commitment. Managers that deviate from the chosen dividend policy incur a cost due to a strong negative market response, which reinforces the pre-commitment role of dividends. On the other hand, the market treats share repurchases as more flexible, irregular payouts made at the manager's discretion, which makes repurchases less effective at mitigating the agency conflict. Therefore, a standalone repurchase policy is not sufficient to mitigate the governance failure, introducing the need for dividend pre-commitment as part of payout policy. Empirically, we find that weak governance is associated with a greater emphasis on dividend pre-commitment in total payout composition. Firms with weak governance are also significantly less likely to use standalone repurchase policies as opposed to a dividends - only or a mixed dividends - repurchases payout policy. Costly dividend pre-commitment presents few benefits to well-governed managers. Instead, they either store excess cash in the firm or distribute it through repurchases. We find that the type of monitoring mechanism is relevant for predicting discretionary payouts. Given the generally strong investor protection level in the US, poorly monitored managers are not immune from firing and they will follow a costly dividend policy. Consistent with the proposed explanation, we find that firms with weak corporate governance on average pay higher dividends. The relation between dividends and governance is stronger for firms with high free cash flow. Managers faced with a high takeover threat (external monitoring) are more likely to repurchase and tend to repurchase more on average. On the other hand, strong internal governance (board, institutional blockholder) allows more accurate following of managerial actions and is associated with fewer cash distributions of any kind, including repurchases.
Accelerated share repurchase (ASR) programs, an innovative way of repurchasing shares, have become increasingly popular in recent years. In this paper, we analyze firms’ rationale for undertaking ASRs rather than the traditional open market repurchase (OMR) programs. Using a hand-collected sample of ASR announcements, we test eight hypotheses regarding firms’ rationale for conducting ASR programs: the distribution of excess cash hypothesis, the target leverage-ratio hypothesis, the takeover avoidance hypothesis, the employee stock option dilution hypothesis, the managerial opportunism hypothesis, the liquidity reduction hypothesis, the EPS manipulation hypothesis, and the signaling or undervaluation hypothesis. We find that firms undertaking ASR programs are significantly larger than those undertaking OMR programs, and that ASR programs have a larger median dollar amount of deal values than OMR programs. Further, ASR firms have significantly smaller cash holdings, higher dividend payout ratios, higher pre-announcement industry-adjusted leverage ratios, and similar probabilities of being takeover targets compared to OMR firms, and ASR firms grant fewer stock options (scaled by sales) to their employees than OMR firms. Option exercise by executives does not increase following buyback announcements in either ASRs or OMRs. Stock liquidity increases following both ASRs and OMRs. Although our univariate tests reveal that ASR firms are more likely to tie the CEO bonus to EPS, our multivariate analysis does not find that EPS manipulation is a significant factor in firms choosing an ASR over an OMR program. Finally, firms undertaking ASR programs have lower pre-announcement market valuations, greater positive announcement effects, and better post-announcement operating and stock return performance, compared to those announcing OMR programs. Overall, our results are consistent with the predictions of the signaling/undervaluation hypothesis but inconsistent with those of the other seven hypotheses.
We find that institutions with short and long investment horizons have different effects on corporate payout policy. Firms with higher long (short) term institutional holdings are more (less) likely to pay dividends and tend to have larger (smaller) dividend payouts. Although high long-term institutional holdings also lead to more and larger repurchases, long-term institutions tend to prefer dividends to repurchases. In contrast, short-term institutional investors prefer repurchases to dividends. Overall, the results are consistent with long-term institutional investors playing an important monitoring role and with short-term institutional investors trading on their short-term information.
This paper provides new evidence on the existence of dividend clienteles for institutional investors. We directly examine individual institutions' preferences for dividend paying stocks based on the characteristics of stocks held in their portfolio. Many institutions follow persistent investment styles, maintaining relatively high or low dividend yield portfolios over time. Institutions which hold portfolios of higher yielding stocks are significantly more likely to increase their holdings in response to a dividend increase or sell their stock in response to a decrease. For a subset of institutions, we directly observe the proportion of their portfolio managed on behalf of taxable clients. Consistent with tax-induced dividend clienteles, institutions with more taxable clients are less likely to increase their holdings in response to a dividend increase. Finally, we show that stock price reactions to announcements of dividend increases are related to characteristics of the institutions holding the stock. Our results suggest that tax status as well as other factors are important in explaining observed clientele behavior.
This paper shows that during episodes of market turmoil, 13F institutional investors with short trading horizons sell their
stockholdings to a larger extent than 13F institutional investors with longer trading horizons. This creates price pressure
for stocks held mostly by short-horizon investors, which, as a consequence, experience larger price drops, and subsequent
reversals, than stocks held mostly by long-horizon investors. These findings, obtained after controlling for the withdrawals
experienced by the investors, are not driven by other institutional investors' and firms' characteristics. Overall, the evidence
indicates that investors with short horizons amplify the effects of market-wide negative shocks by demanding liquidity at
times when other potential buyers'capital is scarce.
Anecdotal and empirical evidence suggest that price is an important determinant in firms’ share repurchase decisions. We investigate a factor that could affect a firm’s stock price around a repurchase and thus the number of shares a firm repurchases. Using unique data on the tax-sensitivity of a sample of institutional investors, we find that the tax overhang that results from taxable investors “locking in” their capital gains and demanding compensation for taxes owed upon realization is negatively related to a firm’s decision to repurchase shares and the number of shares repurchased.
This paper investigates whether a firm's disclosure practices affect the composition of its institutional investor ownership and, hence, its stock return volatility. The findings indicate that firms with higher AIMR disclosure rankings have greater institutional ownership, but the particular types of institutional investors attracted to greater disclosure have no net impact on return volatility. However, yearly improvements in disclosure rankings are associated with increases in ownership primarily by "transient" institutions, which are characterized by aggressive trading based on short-term strategies. Firms with disclosure ranking improvements resulting in higher transient ownership are found to experience subsequent increases in stock return volatility.
This paper investigates whether the quality of a firm's disclosure practices affects the composition of a firm's institutional investor base and whether this association has implications for a firm's stock return volatility. The findings indicate that firms with higher disclosure quality, as measured by AIMR rankings, have greater institutional ownership, but the particular types of institutional investors that are attracted to disclosure quality tend to have no net impact on firms' stock return volatility. In contrast, improvements in disclosure quality are shown to produce contemporaneous increases in ownership primarily by transient-type institutions. Such institutions can be characterized as having a short-term investment focus along with a propensity to trade aggressively. The findings indicate that firms with disclosure quality improvements resulting in higher transient institutional investor ownership experience subsequent increases in stock return volatility.
We investigate whether a firm's accruals quality is affected by its transient and dedicated institutional ownership. Measured as the absolute value of accrual estimation errors, accruals quality is found to be negatively associated with transient institutional ownership and positively associated with dedicated institutional ownership. Causality tests further suggest that transient institutional investors indeed provide managers with incentives to exacerbate accruals quality and that dedicated institutional investors effectively monitor managers in terms of accruals quality. In addition, we find similar results when we measure accruals quality by the standard deviation of accrual estimation errors.
This paper examines whether institutional investors exhibit preferences for near-term earnings over long-run value and whether such preferences have implications for firms' stock prices. First, I find that the level of ownership by institutions with short investment horizons (e.g., “transient” institutions) and by institutions held to stringent fiduciary standards (e.g., banks) is positively (negatively) associated with the amount of firm value in expected nearterm (long-term) earnings. This evidence raises the question of whether such institutions myopically price firms, overweighting short-term earnings potential and underweighting long-term earnings potential. Evidence of such myopic pricing would establish a link through which institutional investors could pressure managers into a short-term focus. The results provide no evidence that high levels of ownership by banks translate into myopic mispricing. However, high levels of transient ownership are associated with an over- (under-) weighting of near-term (long-term) expected earnings, and a trading strategy based on this finding generates significant abnormal returns. This finding supports the concerns that many corporate managers have about the adverse effects of an ownership base dominated by short-term-focused institutional investors.
This paper explains why some firms prefer to pay dividends rather than repurchase shares. When institutional investors are relatively less taxed than individual investors, dividends induce “ownership clientele” effects. Firms paying dividends attract relatively more institutions, which have a relative advantage in detecting high firm quality and in ensuring firms are well managed. The theory is consistent with some documented regularities, specifically both the presence and stickiness of dividends, and offers novel empirical implications, e.g., a prediction that it is the tax difference between institutions and retail investors that determines dividend payments, not the absolute tax payments.
In the early 1900's American financial institutions were active participants in U.S. corporate governance but the enactment of securities laws in the 1930's limited the power of financial intermediaries and thus their governance role. The consequence of such laws and regulations was a progressive widening of the gap between ownership and control in large U.S. public companies. In 1942, SEC rule changes allowed shareholders to submit proposals for inclusion on corporate ballots. Since that time, shareholder activists have used the proxy process, and other approaches, to pressure corporate boards and managers for change. In particular, during the mid-1980s, the involvement of large institutional shareholders increased dramatically with the advent of public pension fund activism. At the heart of shareholder activism is the quest for value, yet the empirical evidence suggests that effects of such activism are mixed. We review the evidence on activism and, while some studies have found positive short-term market reactions to announcements of certain kinds of activism, there is little evidence of improvement in the long-term operating or stock-market performance of the targeted companies. A recent increase in hedge fund activism appears to be associated with dramatic corporate change, however, the research in this area is still somewhat nascent and the long-term effects are still unknown.
The proportion of U.S. firms paying dividends drops sharply during the 1980s and 1990s. Among NYSE, AMEX, and Nasdaq firms, the proportion of dividend payers falls from 66.5% in 1978 to only 20.8% in 1999. The decline is due in part to an avalanche of new listings that tilts the population of publicly traded firms toward small firms with low profitability and strong growth opportunities—the timeworn characteristics of firms that typically do not pay dividends. But this is not the whole story. The authors' more striking finding is that, no matter what their characteristics, firms in general have become less likely to pay dividends.
The authors use two different methods to disentangle the effects of changing firm characteristics and changing propensity to pay on the percent of dividend payers. They find that, of the total decline in the proportion of dividend payers since 1978, roughly one-third is due to the changing characteristics of publicly traded firms and two-thirds is due to a reduced propensity to pay dividends. This lower propensity to pay is quite general—dividends have become less common among even large, profitable firms.
Share repurchases jump in the 1980s, and the authors investigate whether repurchases contribute to the declining incidence of dividend payments. It turns out that repurchases are mainly the province of dividend payers, thus leaving the decline in the percent of payers largely unexplained. Instead, the primary effect of repurchases is to increase the already high payouts of cash dividend payers.
When shareholders have different plans to sell their shares, they will, in general, have different preferences concerning the firm's decision to pay out cash using dividends or share repurchase. We illustrate these different preferences and explore a model of payout policy that highlights the adverse selection costs of repurchases when managers have superior information about the value of the firm. We show that, in the absence of fixed costs to repurchasing shares, there is a separating equilibrium in which managers use taxable dividends to signal the quality of the firm, with better firms paying lower dividends, using repurchases for the remainder of the payout. With fixed costs to repurchasing, small payouts are made via dividend and large payouts are divided between repurchases and dividends, as in the no-fixed cost case. In both cases, the percentage of shares repurchased increases with the size of the payout and larger repurchases are better news.
This paper investigates how the investment horizon of a firm's institutional shareholders impacts the market for corporate control. We find that target firms with short-term shareholders are more likely to receive an acquisition bid but get lower premiums. This effect is robust and economically significant: Targets whose shareholders hold their stocks for less four months, one standard deviation away from the average holding period of 15 months, exhibit a lower premium by 3%. In addition, we find that bidder firms with short-term shareholders experience significantly worse abnormal returns around the merger announcement, as well as higher long-run underperformance. These findings suggest that firms held by short-term investors have a weaker bargaining position in acquisitions. Weaker monitoring from short-term shareholders could allow managers to proceed with value-reducing acquisitions or to bargain for personal benefits (e.g., job security, empire building) at the expense of shareholder returns.
We value a firm that pays its cash flows to equity through share repurchases in a dynamic environment where personal taxes are paid on capital gains upon realization. The cost of capital is reduced by approximately 0.8% through the use of repurchases relative to dividends. We use the empirical distribution of pre-tax free cash flows in Fama and French (1999) to evaluate the tradeoffs between the costs of financial distress, the personal-tax advantages of equity, and the corporate-tax advantage to debt. The optimal capital structure is interior with a 3% bankruptcy cost.
This paper employs heterogeneity in institutional shareholder tax characteristics to identify the relation between firm payout policy and tax incentives. Analysis of a panel of firms matched with the tax characteristics of the clients of their institutional shareholders indicates that “dividend-averse” institutions are significantly less likely to hold shares in firms with larger dividend payouts. This relation between the tax preferences of institutional shareholders and firm payout policy may reflect dividend-averse institutions gravitating towards low dividend paying firms or managers adapting their payout policies to the interests of their institutional shareholders. Evidence is provided that both effects are operative. Plausibly exogenous changes in payout policy result in shifting institutional ownership patterns. Similarly, exogenous changes in the tax cost of institutional investors receiving dividends results in changes in firm dividend policy.
We examine how corporate payout policy is affected by managerial stock incentives using data on more than 1,100 nonfinancial firms during 1993–97. We find that management stock ownership is associated with higher payouts by firms with potentially the greatest agency problems – those with low management stock ownership and few investment opportunities or high free cash flow. We also find that management stock options are related to the composition of payouts. We find a strong negative relationship between dividends and management stock options, as predicted by Lambert et al (1989), and a positive relationship between repurchases and management stock options. Our results suggest that the growth in stock options may help to explain the rise in repurchases at the expense of dividends.
Within a cost–benefit framework, we hypothesize that independent institutions with long-term investments will specialize in monitoring and influencing efforts rather than trading. Other institutions will not monitor. Using acquisition decisions to reveal monitoring, we show that only concentrated holdings by independent long-term institutions are related to post-merger performance. Further, the presence of these institutions makes withdrawal of bad bids more likely. These institutions make long-term portfolio adjustments rather than trading for short-term gain and only sell in advance of very bad outcomes. Examining total institutional holdings or even concentrated holdings by other types of institutions masks important variation in the subset of monitoring institutions.
We hypothesize that firms choose dividend increases to distribute relatively permanent cash-flow shocks and repurchases to distribute more transient shocks. As predicted, we find that post-shock cash flows of dividend increasing firms exhibit less reversion to pre-shock levels compared with repurchasing firms. We also examine whether the stock market uses the announcement of the payout method to update its beliefs about the permanence of cash-flow shocks. Controlling for payout size and the market's expectation about the permanence of the cash-flow shock, the stock price reaction to dividend increases is more positive than the reaction to repurchases.
This paper examines how stock options affect the decision to repurchase shares. Firms announce repurchases when executives have large numbers of options outstanding and when employees have large numbers of options currently exercisable. Once the decision to repurchase is made, the amount repurchased is positively related to total options exercisable by all employees but independent of managerial options. These results are consistent with managers repurchasing both to maximize their own wealth and to fund employee stock option exercises. The market appears to recognize this motive, however, and reacts less positively to repurchases announced by firms with high levels of nonmanagerial options.
We examine the impact of stock market liquidity on managerial payout decisions. We argue that stock market liquidity influences payout policy through a first-order effect on the share repurchase decision, and a second-order or residual effect on the dividend decision. Managers compare the tax and flexibility advantages of a repurchase against its liquidity cost disadvantage. All else equal, higher market liquidity encourages the use of repurchases over dividends. Our empirical results confirm that stock market liquidity plays a significant role in repurchase and dividend initiations, as well as in recurring payout decisions. Unlike previous studies that measure liquidity changes following the repurchase decision, we examine liquidity levels prior to the payout decision. We show that managers condition their repurchase decision on a sufficient level of market liquidity, consistent with Barclay and Smith's [Barclay, M.J., Smith, C.W. Jr., 1988. Corporate payout policy: cash dividends versus open-market repurchases. Journal of Financial Economics 22, 61–82.] theoretical analysis and Brav et al.'s [Brav, A., Graham, J.R., Campbell, R.H., Michaely, R., 2005. Payout policy in the 21st century. Journal of Financial Economics 77, 483–528.] CFO survey results. Repurchases have recently become the payout decision of choice in part because of rising stock market liquidity.
Aggregate real dividends paid by industrial firms increased over the past two decades even though, as Fama and French (J. Financial Econ. 60, 3) (2001a) document, the number of dividend payers decreased by over 50%. The reason is that (i) the reduction in payers occurs almost entirely among firms that paid very small dividends, and (ii) increased real dividends from the top payers swamp the modest dividend reduction from the loss of many small payers. These trends reflect high and increasing concentration in the supply of dividends which, in turn, reflects high and increasing earnings concentration. For example, the 25 firms that paid the largest dividends in 2000 account for a majority of the aggregate dividends and earnings of industrial firms. Industrial firms exhibit a two-tier structure in which a small number of firms with very high earnings collectively generates the majority of earnings and dominates the dividend supply, while the vast majority of firms has at best a modest collective impact on aggregate earnings and dividends.