Why do large shareholders adopt a short‐term versus a long‐term investment horizon in different firms?

• Published date: 01 November 2019
• DOI: http://doi.org/10.1111/fire.12198
• Author: Onur Kemal Tosun
• Date: 01 November 2019

DOI: 10.1111/fire.12198

ORIGINAL ARTICLE

Why do large shareholders adopt a short-term

versus a long-term investment horizon in different

firms?

Onur Kemal Tosun

Cardiff Business School, Cardiff University,

Cardiff, UK

Correspondence

Dr.Onur Kemal Tosun,Cardiff Business School,

CardiffUniversity, Cardiff,CF103EU, UK.

Email:TosunO@cardiff.ac.uk

Abstract

I ask why the same large shareholders have different investment

horizons. Using data for 1998–2013, I examine four fundamental

firm policies for their potential influence on blockholders’ invest-

ments with different time horizons. The panel ordinary least squares,

difference-in-difference (using the Sarbanes-Oxley Act), logistic, and

dynamic generalized method of moments regression analyses reveal

that blockholders adopt a short-term horizon in smaller firms with

a less independent board, high leverage, and high dividends while

the same blockholders keep their investments longer in firms with a

moreindependent board and low dividends. Under various economic

conditions, different firm characteristics gain importance in block-

holders’ decision on short-term versus long-term investments.

KEYWORDS

blockholders, firm policies, long-term investment, short-term

investment

JEL CLASSIFICATIONS

C23, G11, G32

1INTRODUCTION

Firms exerta lot of effort to keep the types of large shareholders and institutional investors they feel would give them

a competitive advantage. To investigatethis further, many studies have already looked at the relation between firm

characteristics and large shareholders in last decades. Some of them have investigatedthe impact of blockholders on

various firm policies including dividends, investments, governance, innovation, and operations (e.g., Appel, Gormley,

& Keim, 2016; Becker, Cronqvist, & Fahlenbrach, 2011; Cronqvist & Fahlenbrach, 2009; Holderness, 2003; Santos,

Moreira, & Vieira, 2014; Tribo,Berrone, & Surroca, 2007). A large body of literature has studied the potential influ-

ence of institutional investors on firm value, performance, and stock returns (e.g., Cai & Zheng, 2004; Clifford & Lind-

sey, 2016; Lakonishok,Shleifer, & Vishny, 1992; Shome & Singh, 1995; Sias, Starks, & Titman, 2006; Wermers, 1999).

Interestingly, few studies have considered the opposite directionregarding the relation between firm attributes and

Financial Review.2019;54:763–800. wileyonlinelibrary.com/journal/fire c

2019 The Eastern Finance Association 763

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investors. Dahlquist and Robertsson (2001), Dong, Uchida, and Hou (2014), Mak and Li (2001), and Yan and Zhang

(2009) haveexamined possible effects of firm size, dividends, cash, and board structure on institutional investors. Some

ofthe prior studies have analyzed investor horizons and corporate policies (Derrien, Kecskés, & Thesmar,2013; Gaspar,

Massa, & Matos, 2005; Thanassoulis & Somekh, 2016; Yan & Zhang, 2009). However, to my knowledge, studies have

always focused on investors but not explored the individual investmentsin their portfolios. It is only a generalization

to classify a large shareholder as a short-term or a long-term investor because that blockholder may have both types

of investments in the portfolio. In other words, the same large shareholder can be a short-term blockholder in one firm

while a long-term investor in another one.

Thus,an open question exists for researchers: under what circumstances the same large shareholder adopts a short-

term versus along-term investment horizon in different firms? I believe this is an important question to understand the

factors associated with blockholders’ choice of investmenthorizon. I aim to determine whether certain firm character-

istics and policies may potentially influence the same large shareholder to keep his/her stakes shorter versus longer

in different companies. In particular, I analyze firm characteristics, such as firm size and leverage,as well as policies

on dividend payouts and corporate governance through board independence. I also explorevarious conditions under

which firms operate and provide stylized facts about short-term and long-term blockholding investments. This study

is innovative as I categorize each individual investment rather than investorsas either short term or long term. This has

crucial importance because this method enables me to overcome potential difficulties and misspecification caused by

generalization of all investments associated with one investor.By categorizing individual investments, I can correctly

model and so estimate the relation between firm attributes and the hold and sell decisions of short-term and long-term

blockholding stakes of the same large shareholder. The analyses succeed in passing a battery of goodness-of-fit and

robustness tests addressing potential empirical issues such as endogeneity, survivorship, and omitted variable bias.

Therefore, I can offer robust statistical insights. Particularly, analyzing the connection between blockholder invest-

ments and firm characteristics is challenging, because causality may run from the former to the latter.I try to mitigate

this reverse causality issue by lagging the explanatory variables of firm characteristicsby 1 year. More importantly, I

use a dynamic panel generalizedmethod of moments (GMM) model and also exploit the passage of the Sarbanes-Oxley

(SOX) Act and the associated changes by the Securities and Exchange Commission (SEC) in a difference-in-difference

(DID)model setup to alleviate the reverse causality concerns. Last, I conduct further analyses with specific subsamples

to address potential issues related to identification of investor horizon.

Usingdata for 1998–2013, Iexamine U.S.-based firms and blockholders’ investments in panel ordinary least squares

(OLS), logistic, and dynamic GMM regression analyses. A blockholder is defined as an investor with at least 5% owner-

ship of a particular firm. A blockholding investmenthas short-term (long-term) horizon if it stays with the firm less than

3 (more than 7) years. In the OLS and GMM models, I regress the number of retained blockholding investments with

short-term (long-term) horizon on board independence, dividend ratio, leverage, and firm size. Using firm-investor-

yearobservations in logistic regression analyses, I define a dummy variable that equals 1 for a blockholder with a short-

term (long-term) investment in a particular firm at the end of year t,aswellasyeart+1. I regress this dummy variable

on those four fundamental firm policies and characteristics. Different from the literature, first I consider blockholders

adopting a short-term over a long-term investment horizon. I begin with a surprising insight: board independence is a

deterrentto this type of investment. The results suggest that the same large shareholders adopt a short-term horizon in

firms with a less independent board. This finding favorsthe hypothesis that blockholders have short-term investments

in firms with weak management who are therefore more inclined to acquiesce to and implement the blockholder's

policies. I further find that the same blockholders choose to keep their investments shorter in smaller firms with high

leverage and high dividend payouts.These results could be rationalized by the view that short-term investors like div-

idends as a source of cash flow and they would like to see firms they own increasing firm risk through leveragebefore

they sell out of the stock.

Next,I study under what conditions the same blockholders adopt a long-term horizon in firms. The statistical analy-

sis demonstrates that increasing board independence increases the probability of attractingand retaining such invest-

ments. This suggests that investors planning a long-term investment value an independent board; and this is consis-

tent with the idea that an independent board will be best placed to take value-enhancing decisions into the future.

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Moreover,the same large shareholders keep their stakes in firms longer when these firms are smaller in size, pay less

dividends, and have high leverage.These findings could be explained by the view that long-term blockholders support

growth in leverage as a consequence of an expandingand successful firm, and prefer cash invested in growth projects

as opposed to paid to shareholders.

Thefindings are consistent with the hypothesis that the same blockholders may adopt different investment horizons

based on different firm policies and attributes. Smaller firms with a less independent board, higher than average divi-

dend ratio, and high leverageare more likely to have short-term blockholding investments. This is compatible with the

viewthat blockholders with short-term investments are often “activist,” having stakes in smaller firms with weak gover-

nance that are less resistant to the blockholders changing firm policies. In their short holding period, such investors on

average benefit from high dividend payments as well as profitable share buybacks. Supporting the results, Strobl and

Zeng (2017) show that activist investors usually have a shorter planning horizon. Furthermore, Andreou, Fiordelisi,

Harris, and Philip (2017) suggest that transient institutional investors intervene and exert pressure on managers to

generate immediate high profit. Considering long-term investments, I find that smaller firms with higher than aver-

age board independence, high leverage,and low dividends are more likely to have long-term blockholding investments.

These results support the hypothesis of such investmentsbeing “passive,” and such investors hold shares of firms with

strong governance along with evidenceof growth. Likewise, Appel et al. (2016) also associate long-term investors with

passive shareholders.

This study contributes to the firm policy and large shareholder ownership literature by providing insight into how

fundamental firm policies and characteristicsare related to the decision on a short-term versus a long-term investment

strategyin different firms by the same large shareholders. The paper also reveals which firm attributes gain importance

in blockholding investmentsunder various economic conditions. The other studies in the literature focus on an investor

by considering investmentsin the portfolio altogether to classify that shareholder 's overallinvestment horizon. Unlike

those papers, I use a new classification approach regarding blockholders’ individual investments with different holding

periods in their portfolios. Hence, this paper will present further explanation to the relation between firms and block-

holding stakes.

The external validity of my findings can be tested in further extended research. I consider all investors relying on

electronic data that may not be complete. Hand-collectingdata from various databases will mitigate this potential con-

cern. Also, a cross-country examination may bring further explanationto the relation between firms and investments

by blockholders considering their different investmentagendas under different country-specific conditions.

The rest of the paper proceeds first by discussing the related literature and developingthe hypotheses to be tested

in Section 2. Section 3 describes the data selection and variable construction. The empirical methodology is then

explained in Section 4. There follows the main results in Section 5, then in Section 6 I conduct robustness checks and

further analyses. I conclude in Section 7.

2LITERATURE REVIEW AND HYPOTHESES

2.1 Related literature and hypothesis building

Previous contributions have examined the relation between institutional investors, blockholders, and various firm

attributes. Cronqvist and Fahlenbrach (2009) examinemutual funds and other i nstitutional investorsseparately. They

use a blockholder fixedeffects approach to investigate the influence of blockholders on firm policies and performance.

Becker et al. (2011) instrument the existence of an individual large shareholder via the density of wealthy individu-

als near a firm's headquarters. They study the effect of those instrumented large shareholders on leverage, dividends,

CEO pay, governance,liquidity, investment, and firm performance. Gugler, Ivanova, and Zechner (2014) examine the

determinants and effects of individual investor control in Central and Eastern European countries. In their model,

they consider Tobin's Q, performance, governance, size, leverage, risk, and intangibility in relation to large individ-

ual investors. Cai, Hillier,and Wang (2016) study the cost of multiple large shareholders and suggest that conflicting