71 Pages Posted: 10 Oct 2009 Last revised: 18 Mar 2010
Date Written: December 2008
This paper demonstrates the existence of different institutional investor preferences for equity characteristics, and makes the link between these preferences and firm value. We show that transient institutional investors (those that trade frequently with a view to maximizing short term gains) possess superior information to other market participants and actively seek out situations in which they can exploit this informational advantage. Their presence, particularly under conditions where firm-level information quality is poor, is associated with both higher returns and higher subsequent firm values. We also find that dedicated (long term) and quasi-indexing (passive with broad holdings) institutional investors are attracted to firms that enable them to engage in monitoring activities. Although there is some evidence to suggest that the arrival of dedicated institutional investors enhances firm transparency, the presence of both dedicated and quasi-indexer investors is of limited importance in determining overall firm value when other features of the firm‟s contracting environment (such as corporate governance provisions, information precision and free cash flows) are fully considered. These results are robust to both a fixed effects and an instrumental variables procedure that mitigates the endogeneity problem. Therefore, the previously documented linear relationship between institutional holdings and Tobin's Q is almost entirely driven by the trading actions of active investors who do not engage in monitoring in the conventional sense.
Keywords: Ownership structure, Institutional investors, Tobin's Q, Firm performance
JEL Classification: G12, G30, G32
Suggested Citation: Suggested Citation