Motivated monitors: The importance of institutional investors׳ portfolio weights

Abstract

a b s t r a c tStudies of institutional monitoring focus on the fraction of the firm held by institutions. We focus on the fraction of the institution's portfolio represented by the firm. In the context of acquisitions, we hypothesize that institutional monitoring will be greatest when the target firm represents a significant allocation of funds in the institution's portfolio. We show that this measure is important in reconciling mixed findings for total institutional ownership in the prior literature. The results indicate that our measure of institutional holdings leads to greater bid completion rates, higher premiums, and lower acquirer returns. This empirical evidence provides support for theories predicting a beneficial effect of blockholders in monitoring the firm in general and in enhancing the gains to takeover targets in particular.

Motivated monitoring by institutional investors and firm investment efficiency

“…First, institutional investors are not homogeneous: their monitoring roles are related to institution type, their investment horizon, and their preference for trading (Bushee, 1998;Chen, Harford, & Li, 2007;Schmidt & Fahlenbrach, 2017). Second, it is not optimal for institutional investors to equally monitor all the firms held in their portfolios, because their capacity to monitor is not unlimited (Kempf, Manconi, & Spalt, 2017); 1 the motivation of institutional monitoring would rationally depend on the relative importance of an individual stock in their portfolios (Fich, Harford, & Tran, 2015). Previous studies have focused on the heterogeneity of institutional investors, and how their institutional characteristics might affect firm performance.…”

Investor heterogeneity and trading

“…Bushee and Goodman (2007) link an investor's big bet on a particular firm to superior information. In the context of returns around mergers and acquisitions (M&As), a recent study finds that institutions engage in more extensive monitoring when the target accounts for a significant share of the institution's portfolio (Fich et al, 2015), consistent with the notion that institutions with concentrated positions have stronger information and monitoring incentives.…”

“…Baik, Kang, and Kim (2010) show that local institutional ownership predicts returns, particularly for firms with high information asymmetry. Fich, Harford, and Tran (2015) show that a larger weight of a security in institutional investor portfolios results in more intense scrutiny by institutional investors. Gompers and Metrick (2001) link institutional ownership to future stock returns and show that the relation is driven by demand shocks caused by a shift in ownership composition towards institutions.…”

Frenemies: How Do Financial Firms Vote on Their Own Kind?

“…To address this potential endogeneity issue, we use the fuzzy regression discontinuity design approach as in Schmidt (2012) and Fich, Harford, and Tran (2015). When the Russell 1000 and 2000 indices are reconstituted each June, fund management companies tracking these indexes are forced to change their holdings accordingly.…”

“…If the proportion averages more than 0.7 over two consecutive years, the following year the firm enters our sample. Schmidt (2012) and Fich, Harford, and Tran (2015). Holding stake is the proportion of the value of the institution's portfolio represented by the portfolio firm's shares.…”