Abstract
In this study, we examine the role of monitoring institutional investors in firm innovation. Following Fich, Harford and Tran (2015), we define monitoring institutions as those whose holding value in a firm is among the top 10% of holdings in the institution’s portfolio. We document a positive effect of monitoring institutional ownership on firm innovation after controlling for traditional measures of institutional ownership. The positive effect is more pronounced when monitoring institutions are more diversified. We further find that monitoring institutions enhance firm innovation by: (1) increasing failure tolerance and CEO risk-taking incentives, and (2) reducing intense board monitoring, managerial career concerns, and diversion of corporate resources. Overall, the evidence shows that monitoring institutions are instrumental in promoting firm innovation.
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