[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 examine whether the application of fundamental analysis can yield significant abnormal returns. Using a collection of signals that reflect traditional rules of fundamental analysis related to contemporaneous changes in inventories, accounts receivables, gross margins, selling expenses, capital expenditures, effective tax rates, inventory methods, audit qualifications, and labor force sales productivity, we form portfolios that earn an average 12-month cumulative size-adjusted abnormal return of 13.2 percent. We find evidence that the fundamental signals provide information about future returns that is associated with future earnings news. Moreover, a significant portion of the abnormal returns is generated around subsequent earnings announcements. These findings are consistent with the underlying focus of fundamental analysis on the prediction of earnings. Significant abnormal returns to the fundamental strategy are not earned after the end of one year of return cumulation, indicating little support for the idea that the signals capture information about multiple-year-ahead earnings not immediately impounded in price or about long-term shifts in firm risk. Additional analysis on a holdout sample suggests that the strategy continues to generate abnormal returns in a period subsequent to the introduction of the fundamental signals in the literature, and contextual analyses indicate that the strategy performs better for certain types of firms (e.g., firms with prior bad news).]

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 goats. 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 arid 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 examine whether the application of fundamental analysis can yield significant abnormal returns. Using a collection of signals that reflect traditional rules of fundamental analysis related to contemporaneous changes in inventories, accounts receivables, gross margins, selling expenses, capital expenditures, effective tax rates, inventory methods, audit qualifications, and labor force sales productivity, we form portfolios that earn an average 12- month cumulative size-adjusted abnormal return of 13.2 percent. We find evidence that the fundamental signals provide information about future returns that is associated with future earnings news. Moreover, a significant portion of the abnormal returns is generated around subsequent earnings announcements. These findings are consistent with the underlying focus of fundamental analysis on the prediction of earnings. Significant abnormal returns to the fundamental strategy are not earned after the end of one year of return cumulation, indicating little support for the idea that the signals capture information about multiple-year-ahead earnings not immediately impounded in price or about long-term shifts in firm risk. Additional analysis on a holdout sample suggests that the strategy continues to generate abnormal returns in a period subsequent to the introduction of the fundamental signals in the literature, and contextual analyses indicate that the strategy performs better for certain types of firms (e.g., firms with prior bad news).