Do Institutional Investors Influence Capital Structure Decisions?

Abstract

This paper empirically investigates the relationship between institutional holdings and capital structure. Institutions may affect capital structure through their monitoring and information-gathering roles. At the same time, institutions may gravitate toward firms with specific capital structures, forming leverage-based investment clienteles. Using implied trades generated from mutual fund outflows as an instrument for institutional holdings, and a semi-natural experiment in which addition to the S&P 500 Index provides an exogenous shock to institutional holdings, we find that institutional holdings are a significant determinant of firms' capital structures: A change in institutional holdings causes an opposite change in leverage. Moreover, using dynamic panel estimation, we find that while institutions affect capital structure decisions, changes in leverage do not affect institutional holdings, and there is no evidence of a clientele effect. Finally, we find that firms lower their leverage in response to increased institutional holdings by becoming more likely to issue equity, and less likely to increase debt. While our findings are consistent with models in which institutions substitute for debt by monitoring and reducing information asymmetry problems, further evidence suggests that the effect on asymmetric information dominates.

A Study of the Relationship Between Institutional Ownership and Capital Structure: Evidence From Turkey

“…To sum up, institutional ownership ratio has a significantly negative relation with leverage which is in line with studies of Michaely and Vincent (2012), Tong and Ning (2004) and partial data of Crutchley et al (1999). Tangibility has a significantly negative relation in the sample which is not in line with trade-off theory since increase in tangibility is expected to ease increase in level of debt.…”

“…In other words, as institutional ownership ratio increases, financial leverage decreases. Michaely and Vincent (2012) show similar results and they investigate from both directions. They conclude that "firms in which institutions have a strong presence tend toward low leverage, and firms in which institutions strengthen their presence are associated with lower leverage".…”

“…De Jong, Kabir and Nguyen (2008) find that there is a positive relation at 10% significance level for Turkish companies. Michaely and Vincent (2012) also show positive relationship. Gurunlu and Gursoy (2010) also look for both book and market value leverages.…”

“…There is a significantly positive relation (t-value = 6.07, p < 0.01). Michaely and Vincent (2012), Xuan-Quang and Zhong-Xin (2013), Gurunlu and Gursoy (2010), Sayılgan, Karabacak and Küçükkocaoğlu (2006), Li, Yue, andZhao (2009) andCéspedes, González, andMolina (2010) all find the relation significantly positive parallel to sample's result. Pöyry and Maury (2010) find negative relation but results are insignificant.…”

Investment Horizons and Information

“…6 As such, LIO firms conform more to the pecking order (Myers, 1984;Myers and Majluf, 1984). 9 Michaely and Vincent (2012) refer to this phenomenon as institutional ownership substituting debt. This is again consistent with value-neutral information being less user-specific and more efficiently reflected in security prices: When external equity financing is subject to severe information asymmetry problems (e.g., in an economy with only small investors; (Grossman and Hart, 1980), debt is a valid solution due to its relative non-sensitivity to private information as a pricing factor and its lower associated monitoring costs.…”