Today we welcome Jonathan O’Brien, the US Bank Distinguished Professor of Business and chair of the Department of Management in the College of Business at the University of Nebraska. O’Brien and co-authors Pengfe Ye, Christina Matz Carnes and Iftekhar Hasan addressed “The Influence of Bondholder Concentration and Temporal Orientation on Investments in R&D” in a recent issue of the Journal of Management. The abstract for the paper appears below, and O’Brien answers some questions about the research further down.
Although innovation can be a critical source of competitive advantage, research has found that debt can erode management’s willingness to invest in R&D. In this article, we employ a stakeholder bargaining power perspective to argue that this effect is most pronounced when the firm’s bonds are concentrated in the hands of bond blockholders. Furthermore, we contend that the temporal orientation of bondholders influences this relationship. Specifically, while it is commonly assumed that bondholders have a limited temporal orientation that induces them to focus on short-term value appropriation, we argue that some bond blockholders adopt a long-term temporal orientation. This orientation, in turn, makes them more inclined to support long-term value creation for the firm in the form of enhanced investments in R&D. Moreover, while agency theory suggests that there is an inherent conflict of interest between shareholders and bondholders, our results suggest that the temporal orientation of investors (i.e., both shareholders and bondholders) matters much more than whether they invested in the firm’s equity or its debt.
What motivated you to pursue this research?
Having worked as a financial analyst for an institutional investor, I knew the research on corporate debt – and bondholders in particular – was not necessarily wrong, but it did paint an incomplete picture. More specifically, the research assumes an arm’s length relationship between the firm and its bondholders that puts short-term pressures on management. While that may indeed be the norm, it is not uncommon for some firms to forge close relationships with “dedicated” bondholders who hold a large amount of their debt. For the firm, this helps ensure that the investor not only holds onto their bonds, but that the investor is also likely to buy into new debt issues (which are common for large firms, as debt is the primary source for external financing and maturing bonds are most commonly just replaced with a new bond issue). In turn, the bondholder enjoys enhanced access to the firm’s top management and timely information on the firm’s strategies and plans. The importance of these relationships is evidenced by the growth in private debt placements, which are the sale of an entire bond issue to one or just a few select institutional investors, who generally commit to buying and holding the security – typically with a relatively long maturity – for the life of the bond. Such deals rarely materialize in the absence of an established relationship between the firm and the investor.
In what ways is your research innovative, and how will it impact the field?
Early research argued that equity investors take a long-term perspective on the firm and its strategies, but that bondholders have a shorter time horizon and are more risk averse, thereby inducing managers to adopt a more short-term perspective. More recently, the literature has acknowledged that equity investors – specifically institutional investors – are heterogeneous: while some are indeed “dedicated investors” and supportive of long-term value creation for the firm, others are “transient investors” that put short-term pressures on management. Despite this, bondholders have still been assumed to be relatively homogenous. Our research shows that some bondholders can also be dedicated investors that are supportive of the firm adopting long-term, value enhancing strategies.
Furthermore, agency theory – the most common theory employed in studying corporate governance – argues that there is an inherent conflict of interest between shareholders and bondholders. However, our results show that when it comes to supporting long-term value enhancing strategies, the temporal orientation (i.e., whether they are dedicated or transient investors) of both shareholders and bondholders matters much more than the type of security they purchased. We contend that this should not be surprising, given that the same institutional investors that hold the firm’s equity also commonly hold their bonds. While typically there are different managers overseeing equity and fixed income (i.e., bond) investments, they do communicate – particularly when they hold large stakes and when they start to establish a relationship with the firm.