Institutional Ownership and Share Prices: Theory and Evidence

Abstract

We develop and test a theory to explain the variation in institutional ownership and share price levels across firms. In our model, institutional owners provide an alternative channel through which firms can disseminate information and create value by monitoring, thus substituting for costly information generation by analysts. We show that both institutional ownership and share price level increase with the extent to which institutional investors are able to positively affect a firm, in contrast to the causal relation between price and institutional ownership that is widely asserted in the literature. We find that the positive association between share prices and institutional ownership persists even after controlling for liquidity and size differences. Our study resolves the apparent conflict between existing rationales for lowering stock prices through splits and the argument in previous studies that institutions prefer higher priced stocks.