Long-term Institutional Investors Research Articles

The association between institutional ownership and audit properties

We are interested in channels through which institutional ownership affects corporate governance and in particular whether financial statement audit is one of them. We hypothesize that institutional investors can influence corporate policy to employ governance mechanisms that reduce their monitoring costs. Our evidence shows that firms are more likely to hire a Big 4 auditor (our proxy for audit quality) when long-term institutional ownership is high, suggesting that long-term institutional investors view high-quality audits as a viable means of improving corporate governance while reducing their direct monitoring costs. We find no association between auditor choice and short-term institutional ownership. Next, we find that auditors charge higher fees (our proxy for audit risk) when short-term institutional ownership is high, consistent with short-term investors creating greater incentives for managers to act myopically. We find no association between audit fees and long-term institutional ownership. Taken together, our evidence suggests that long-term institutional investors demand higher quality audits to enhance corporate monitoring, and that short-term institutional ownership is positively associated with higher audit risk.

Institutional Investors and Firm Efficiency of Real Estate Investment Trusts

This study investigates the effect of institutional ownership on improving firm efficiency of equity Real Estate Investment Trusts (REITs), using a stochastic frontier approach. Firm inefficiency is estimated by comparing a benchmark Tobin’s Q of a hypothetical value-maximizing firm to the firm’s actual Q. We find that the average inefficiency of equity REITs is around 45.5%, and that institutional ownership can improve the firm’s corporate governance, and hence reduce firm inefficiency. Moreover, we highlight the importance of heterogeneity in institutional investors—certain types of institutional investors such as long-term, active, and top-five institutional investors, and investment advisors are more effective institutional investors in reducing firm inefficiency; whereas hedge funds and pension funds seem to aggravate the problem. In sub-sample analysis, we find that these effective institutional investors can reduce inefficiency more effectively for distressed REITs, and for REITs with high information asymmetry, and with longer term lease contracts. Lastly, we find that the negative impact of institutional ownership (except for long-term institutional investors) on firm inefficiency reduces over time, possibly due to strengthened corporate governance and regulatory environment in the REIT industry.

Shareholder Investment Horizons and Payout Policy

We find that institutions with short and long investment horizons have different effects on corporate payout policy. Firms with higher long (short) term institutional holdings are more (less) likely to pay dividends and tend to have larger (smaller) dividend payouts. Although high long-term institutional holdings also lead to more and larger repurchases, long-term institutions tend to prefer dividends to repurchases. In contrast, short-term institutional investors prefer repurchases to dividends. Overall, the results are consistent with long-term institutional investors playing an important monitoring role and with short-term institutional investors trading on their short-term information.

Institutional Investors and Corporate Investment

Using investors’ trading horizons to capture their incentives to collect information and monitor management’s decisions, this paper shows that an increase in the ownership stake held by long-term institutional investors is associated with a subsequent decrease in real investment precisely in firms that invest too much. In support of the monitoring hypothesis, we show that results are driven by the purchases of long-term investors, while quasi-indexers and transient investors have no influence on investment. We address the problem of endogeneity using the inclusion of a firm to the S&P 500 Index as an exogenous shock to institutional holdings. Overall, the evidence indicates that long-term institutional investors influence managers’ decisions and are associated with lower agency conflicts in investment choices.

The Association Between Institutional Ownership and Audit Properties

In this study, we examine how institutional ownership affects the quality and riskiness of the financial statement audit. We hypothesize that institutional investors can influence corporate policy to employ governance mechanisms that reduce their monitoring costs. Our evidence shows that firms are more likely to hire a Big 4 auditor (our proxy for audit quality) when long-term institutional ownership is high, suggesting that long-term institutional investors view high quality audits as a viable means of improving corporate governance while reducing their direct monitoring costs. We find no association between auditor choice and short-term institutional ownership. Next, we find that auditors charge higher fees (our proxy for audit risk) when short-term institutional ownership is high, consistent with short-term investors creating greater incentives for managers to act myopically. We find no association between audit fees and long-term institutional ownership. Taken together, our evidence suggests that dedicated long-term institutional investors demand higher quality audits to enhance corporate monitoring, and that short-term institutional ownership is positively associated with higher audit risk.

Momentum Trading and Performance with Wrong Return Expectations

Many long-term institutional investors use strategic portfolio allocation to maximize net asset value assuming that long-run expected returns are constant. This approach is complemented by tactical asset allocation when an asset class is perceived to offer higher expected returns in the short run. When investment performance is evaluated in the interim, it can be difficult to assess the merit of private beliefs about changing expected returns. The authors examine the annual expected return and dynamic trading under wrong assumptions about time-varying expected returns and show that a misspecified portfolio policy can outperform the correct policy. They also find that the particular assumptions about how expected returns vary through time can be identified from observed rebalancing of a portfolio. The assumption that expected returns are changing implies that momentum trading is optimal under certain conditions. In contrast, contrarian trading is always optimal when prices are assumed to follow a random walk around a constant long-term trend. These results can inform the annual performance evaluation of institutions, such as endowments, pension plans, mutual funds, and hedge funds that have long-term investment objectives. <b>TOPICS:</b>VAR and use of alternative risk measures of trading risk, statistical methods, portfolio construction

Institutional Investors and Corporate Investment

Using investors’ trading horizons to capture their incentives to collect information and monitor management’s decisions, this paper shows that an increase in the ownership stake held by long-term institutional investors is associated with a subsequent decrease in real investment precisely in firms that invest too much. In support of the monitoring hypothesis, we show that results are driven by the purchases of long-term investors, while quasi-indexers and short-term investors have no influence on investment. We address the potential problem of endogeneity using the inclusion of a firm to the S&P 500 Index as an exogenous shock to institutional holdings.

The Rise of Pension Fund Capitalism in Europe: An Unseen Revolution?

The pension funds have become America's new ‘tycoons’ – surely the most unlikely masters any society ever had. They have attained this position without any struggle, any crisis, any major ‘problems...

The Equity Risk Premium and the Risks of Equity Investing

The equity risk premium arises from the link between equities as an asset, and corporate profitability and growth. In this paper, we review the concept and measurement of the equity risk premium against a background of recent practitioner debate concerning the suitability of equities for long-term institutional investors. We consider the competing versions of the equity risk premium that are quoted by academics and practitioners, highlight issues of estimation and consider how they can be addressed robustly. We conclude that equities as an asset class offer a robust return premium over long-dated bonds of the order of 2.5% to 3% per annum globally. This is an estimate which adjusts for the experienced changes in market valuations, and is based on detailed empirical analysis of many equity markets over more than 100 years. Diversified exposure to a basket of global equity markets is most likely to deliver this estimated risk premium over time, rather than a concentrated single-country portfolio. Against the same background, we also revisit the debate over time-diversification i.e. the term-structure of the volatility of asset classes with investment horizon. We conclude that the mean-reversion in equity market valuations drives that of equity returns and this mean-reversion directly ensures that the volatility of equities decreases with longer investor time horizons. Hence, in practice, the 'shortfall' risk of equities is less serious than often thought by investors and especially compared with other assets such as bonds when investing for the long-term i.e. over full business or economic cycles.

The Return of the Recap: Achieving Private Equity Benefits as a Public Company

The private equity wave is now reaching most industries, affecting companies of all sizes and in all geographies. Companies as diverse as TXU, HCA, TDC, Equity Office Properties, Neiman Marcus, and Free scale Semiconductor have opted to go private, delivering sizable returns to their public shareholders in the process. The continued operational and capital restructuring that typically follows public-to-private transactions holds out the promise of sizable returns to the new private owners as well. The large returns generated by private equity firms and their investors have put significant pressure on public companies. Long-term institutional investors, hedge funds, retail investors, and the media are increasingly asking the obvious question: Why can public corporations not deliver similar levels of out performance by using the private equity toolbox? And this leads to a series of follow-up questions: Which aspects of the private equity model can be replicated by public companies? Does it pay to adopt elements of the LBO model as a public company? What types of businesses can enhance shareholder value with higher leverage while retaining their public ownership model?

Institutional investor type, earnings management and benchmark beaters

This paper classifies institutional investors into transient or long-term by their investment horizons to examine the association between institutional investor type and firms’ discretionary earnings management strategies in two mutually exclusive settings – firms that (do not) use accruals to meet/beat earnings targets. The results support the view that long-term institutional investors constrain accruals management among firms that manage earnings to meet/beat earnings benchmarks. This suggests long-term institutional investors can mitigate aggressive earnings management among these firms. Transient institutional ownership is not systematically associated with aggressive earnings management and is evident only among firms that manage earnings to meet/beat their earnings benchmarks. This indicates transient institution-associated managerial myopia may not be as prevalent as posited by critics. This study highlights the importance of explicitly considering the type of institutional investor and the specific setting when investigating the association between institutional ownership and corporate earnings management.

Are Family Firms More Tax Aggressive Than Non-Family Firms?

Taxes represent a significant cost to the firm and shareholders, and it is generally expected that shareholders prefer tax aggressiveness. However, this argument ignores potential non-tax costs that can accompany tax aggressiveness, especially those arising from agency problems. Firms owned/run by founding family members are characterized by a unique agency conflict between dominant and small shareholders. Using multiple measures to capture tax aggressiveness and founding family presence, we find that family firms are less tax aggressive than their non-family counterparts, ceteris paribus. This result suggests that family owners are willing to forgo tax benefits in order to avoid the non-tax cost of a potential price discount, which can arise from minority shareholders' concern with family rent-seeking masked by tax avoidance activities (Desai and Dharmapala 2006). This inference is further strengthened by our finding that family firms without long-term institutional investors (as outside monitors) and family firms expecting to raise capital exhibit even lower tax aggressiveness. Our result is also consistent with family owners being more concerned with the potential penalty and reputation damage from an IRS audit than non-family firms. We obtain similar inferences when using a small sample of tax shelter cases.

An Empirical Examination of Institutional Investor Preferences for Corporate Social Performance

This study investigates the pattern of institutional shareholding in the U.K. and its relationship with socially responsible behavior by companies within a sample of over 500 UK companies. We estimate a set of ownership models that distinguish between long- and short-term investors and their largest components and which incorporate both aggregated and disaggregated measures of corporate social performance (CSP). The results suggest that long-term institutional investment is positively related to CSP providing further support for earlier studies by Johnson and Greening (1999, Academy of Management Journal 42, 564–576) and Graves and Waddock (1994, Academy of Management Journal 37, 1034–1046). Disaggregation of CSP into its constituent components suggests that the pattern of institutional investment is also related to the form which CSP takes. Investigation of the impact of investment screens on the selection of stocks suggests that long-term institutional investors select primarily through exclusion, rejecting those firms which have the worst CSP.

Prudent person rules or quantitative restrictions? The regulation of long-term institutional investors' portfolios

This paper examines the rationale, nature and financial consequences of two alternative approaches to portfolio regulations for life insurers and pension funds, namely prudent person rules and quantitative portfolio restrictions. The argument draws on the financial-economics of investment and the differing characteristics of institutions' liabilities, as well as evidence drawn from major OECD countries. The overall conclusion is that prudent person rules are superior to restrictions, particularly for pension funds, except in certain circumstances that may hold temporarily in emerging market economies.

The impact of portfolio size on the variability of the terminal wealth of real estate funds

AbstractStudies have examined the number of properties required to reduce the risk in a real estate portfolio. This research has concentrated on examining the impact of portfolio size on the reduction in the standard deviation of returns from ex post time‐series data. However, the ex post time‐series standard deviation is not really relevant to long‐term institutional investors, such as insurance companies and pension funds, who are more concerned with the variability of the terminal wealth of their portfolios, from which policy holders and pensioners will derive their benefits. Long‐term investors with specific holding period requirements are less concerned with the within‐period volatility of their portfolios than with the possibility that their portfolio returns will fail to finance their liabilities. The terminal‐wealth standard deviation (TWSD) rather than the time‐series standard deviation (TSSD) has been proposed as the ‘true’ measure of portfolio variability to such investors. This paper compares the potential benefits and limitations of risk reduction, as measured by TWSD and TSSD, in the UK property market using a large sample of actual property returns over the period 1981 to 1996. Copyright © 2002 Henry Stewart Publications

Rebalancing Strategies for Multi-Period Asset Allocation

Alternative investments, such as hedge funds, venture capital, and private equity, can improve portfolio performance, especially for long-term institutional and high net worth individual investors. Difficulties arise when rebalancing a portfolio that includes alternative investments due to the nature of the commitments. Transaction costs can be sizable and money flows are restricted by illiquid markets, covenants, and related restrictions. Following a review of the pros and cons of including alternative investments in a traditional portfolio, the authors show the intrinsic advantages of a multi-period asset allocation strategy and present an optimizing approach for addressing transaction costs.

Are Long-Short Equity Strategies Superior?

(1993). Are Long-Short Equity Strategies Superior? Financial Analysts Journal: Vol. 49, No. 6, pp. 44-49.