No, short-term investors are not bad for a company

Short-termism by company management can become a problem because if you manage only to the next couple of quarterly earnings results, the temptation is to use accounting shenanigans or short-term measures like share buybacks to boost the share price at the expense of long-term performance. Sometimes, the blame is pushed back on investors by claiming that it is the short-term nature of investors that requires corporate executives to engage in these actions.

Luis García-Feijóo and Pedro Monteiro would disagree with this. They examined the impact short-term, transitory investors have on the way a company is run.

At first, they did a simple regression on the impact of share buybacks on investments and found that if a company increases share buybacks, long-term investments, in particular research and development investments declined. If true, that would be really worrisome because we know that increased investments in R&D is associated with better long-term share price performance.

But if the researchers added a control variable for short-term investors, something interesting happened. On the one hand, if a company had more short-term investors on its shareholder register, share buybacks tended to increase. But at the same time, a company with more short-term investors on its register also significantly increased its investment activity, presumably to keep these investors happy with news about new growth opportunities.

But if you want to keep short-term investors happy with ever expanding growth opportunities, the risk is high that you overinvest and make inefficient capital allocation decisions.

The pressure to buy back shares counteracts this temptation and the net effect is that once short-term investors are taken into account, share buybacks do not reduce long-term investments. Instead, long-term investments become more efficient and overinvestment in vanity projects or projects with low return on capital is reduced to finance share buybacks. In a sense, short-term investor help make companies more efficient.