Are Passive Institutional Investors Engaged Monitors or Risk-Averse Owners? Both!

Abstract

We differentiate the effects of passive institutional investors on firms’ innovation activities and innovation strategies. With larger passive institutional ownership, while firms’ countable innovation activities increase, they shift their innovation strategies by focusing more on exploitation of existing knowledge rather than exploration of new technology. Enhanced monitoring by passive institutional investors through active votes could explain their positive effects on firms’ innovation activities. Increasing risk aversion by passive institutional investors appears the underlying force that drives firms’ shift to incremental innovation. Our paper uncovers a subtle relation between institutional investors and innovation, which is largely ignored by earlier studies.

Keywords: Passive Institutional Investors, Innovation, Exploitation, Exploration

JEL Classification: G23, G30, O16, O31