Institutional Investors, Monitoring, and the Transformation of Underperforming Firms

Abstract

We focus on chronically underperforming firms and assess the roles of institutional investors in either facilitating asset redeployment or entrenching managers. We find that, in aggregate, institutions exhibit a flight to quality, selling shares in firms that subsequently fail. For underperforming firms that survive, institutional holdings are associated with improved performance, but abnormal returns are still negative and return on assets and Tobin’s Q are still low. Our evidence suggests that many of the findings in previous research of positive relationships between institutional holdings and abnormal returns, return on assets, and Tobin’s Q may be entirely explained by flight to quality combined with the distressed firm anomaly. We find no evidence that holdings of traditional activist public pension funds lead to improved performance. Nor do performance results support positive roles for institutions with long-term holdings. However, activist hedge funds are different in that they significantly increase holdings in firms that are subsequently acquired. Also, short-term holdings by institutions are associated with positive subsequent performance. Results for institutional blockholders are mixed, reflecting their heterogeneity. The distinction between independent and non-independent (gray) institutions does not appear to matter. We contrast the results to those for consistently overperforming firms; the analysis points to a more limited governance role of institutions for firms that are performing well.