Neglected Firm Effect
Categories: Financial Theory
If we were to ask ten people to identify their least favorite management trait, we guarantee that at least one of them would say “micromanagement.” People don’t like to be micromanaged. It’s hard to get stuff done when we’re constantly under a microscope, constantly having to defend and explain our actions, and constantly having to report back to someone on every little thing that happens.
Well, companies aren’t crazy about being under a microscope, either. In fact, if we’ve got two relatively identical companies, and one is always in the spotlight while the other is not, the not-spotlighted company tends to outperform the other one. This is what’s known as the “neglected firm effect,” and it doesn’t just apply when we have super-similar organizations. In general, heavily scrutinized and analyzed firms tend to not perform as well as those who are left alone to handle their biz.
What does this mean for us as investors? It means that neglected firms just might be a better investment bet than those that are constantly in the spotlight. But it bears mentioning that this isn’t always the case, so just as with any investment decision, we should make sure we do plenty of research before sinking our hard-earned coin into some company’s stock just because financial analysts and institutional investors tend to leave them alone.
