Motivated monitoring by institutional investors and firm investment efficiency

Abstract

We find that motivated monitoring by institutional investors mitigates firm investment inefficiency, estimated by Richardson's (2006) approach. This relation is robust when using the annual reconstitution of the Russell indexes as exogenous shocks to institutional ownership during the period 1995–2015 and after classifying institutional ownership by institution type. We also show that closer monitoring mitigates the problem of both over‐investing free cash flows and under‐investment due to managers’ career concerns. Finally, we document that the effectiveness of the monitoring by institutional investors appears to increase monotonically with respect to the firm's relative importance in their portfolios.

The Impact of Business Strategy between Corporate Ownership and Investment Efficiency

“…The negative association of institutional ownership with investment efficiency is consistent with Cook et al (2019), who argue that institutional ownership has a negative relationship with under-investment and a positive association with overinvestment, which shows the inefficiency of investment. Ward et al (2020) argued that institutional ownership characteristics are not homogenous. Their monitoring role depends on the institution's type, investment horizons, and trading preferences.…”

“…It was also observed that, in the case of institutional ownership, the firm could eliminate financial constraints. Rare opportunities for investment tend to overinvest, consequently failing to achieve the optimal investment level or efficiency (Ward et al, 2020).…”

“…Previous studies explored how a firm ownership structure influences investment and investment efficiency in the context of information asymmetry and agency conflict (Ward et al, 2020). However, ownerships types have different effects on investment efficiency.…”

“…Moreover, the majority of the investigations mentioned above were done in developed nations like US (Ward et al, 2020), China (He et al, 2019;Jiang et al, 2018;Wang et al, 2021), which differ from developing and emerging countries. Pakistan is an emerging market in which corporate ownership structure is unique than developed countries in context of culture, governance, and law (Din et al, 2021).…”

Heterogenic institutional investors and their influence on corporate innovation: Evidence from a transition economy

“…One of those factors is the lack of firm-specific information in less developed economies (Ebrahimnejad & Hoseinzade, 2019), making it hard to evaluate the true longterm significance of that company (Porter, 1992). Institutional investors' capabilities are limited to monitoring each firm in their portfolios' capabilities and monitoring each firm in their portfolios (Ward, Yin, & Zeng, 2020). Therefore, institutions use information related to firm performance and current corporate earning that is easily accessible.…”