Costly Trading, Managerial Myopia, and Long-Term Investment

Abstract

The costly trade theory predicts that it is much more difficult to exploit long-term private information than short-term. Thus, there is less long-term information impounded in prices. The managerial myopia theory predicts that a variety of short-term pressures, including inadequate information on long-term projects, cause asymetrically-informed corporate managers to underinvest in long-term projects. The introduction of long-term options called LEAPS provides a natural experiment to jointly test both theories, which are otherwise difficult to test. We conduct an event study around the introduction of LEAPS for a given stock and test whether corporate investment in long-term R&D/Sales increases in the years following the introduction. We find that over a two year period of time LEAPS firms increase their R&D/Sales between 23% and 28% ($125-$152 million annually) compared to matching non-LEAPS firms. The difference depends on the matching technique used. Two other proxies for long-term investment find similar increases. We find that the increase is positively related to LEAPS volume. We also find that the increase is larger in firms where R&D plays a larger and more strategic role. These results provide both statistically and economically significant support for the costly trade and managerial myopia theories.

Keywords: Trading, Myopia, Investment, LEAPS, R&D

JEL Classification: G14, G31