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.

Keywords: Institutional Investors; Investment Efficiency; Monitoring Attention; Agency Problem; Index Switch

JEL Classification: G23; G30; G31; M4