Portfolio Firms Research Articles

How Do Institutional Investors Perceive Mandatory ESG Disclosure: Evidence From SEC’s Mandatory Climate Change Disclosure Proposal

This study examines how institutional investors perceive the SEC’s mandatory climate change disclosure proposal, announced on March 21, 2022. The findings show that investors of US public firms with higher institutional ownership react less negatively to the proposal despite overall negative market reactions. Additional tests show that the main results hold even if an endogeneity concern and greenhouse gas contributors’ effect were tested with the cross-sectional regression models. This research sheds light on the lack of consensus on the impact of institutional investors on ESG disclosure for US public firms, providing evidence that institutional investors contribute to the long-term sustainability and value creation of portfolio firms.

Common institutional ownership and corporate cost stickiness —Evidence from China

This study examines the impact of common institutional ownership (CIO) of firms on their degree of cost stickiness. Taking the data of China's A-share listed companies during the period 2007–2022 as sample, we find that firms with common institutional ownership (CIO) have a lower degree of cost stickiness. Mechanism test find that CIO mitigate the degree of cost stickiness by improving the governancing and monitoring efficiency and by promoting the transfer of information among portfolio firms. Heterogeneity tests provide evidence that the positive relation is stronger among non-state-owned firms and firms in monopolistic industries.

How Portfolio Disclosure Impacts Monitoring Spillovers Between Competing Asset Managers

Fund managers can monitor portfolio firms to improve returns, but their incentives to engage depend on other investors' monitoring, e.g., via free riding or collaboration. In this paper, we examine how portfolio disclosure affects monitoring spillovers between competing asset managers. In our model, informed and uninformed funds use monitoring investments to compete with each other over fund flows from investors. We provide conditions for when informed and uninformed fund monitoring are strategic complements, leading to monitoring of the same firms, or strategic substitutes, leading to monitoring of different firms. We then highlight several disclosure implications of our model. Interestingly, disclosure of the informed fund's holdings facilitates monitoring complementarities across funds, above and beyond disclosure providing information to investors and firms. Overall, our results inform the debate on asset managers' incentives to invest in monitoring, and highlight the key role played by portfolio disclosure.

Institutional Investors and the Fight Against Climate Change

ABSTRACTResearch Question/IssueThis article examines the role of institutional investors in the fight against climate change. We explain the institutional context, provide evidence highlighting institutional investors' bright and dark sides in this fight, and develop multiple ideas for future research.Research Findings/InsightsWe show that climate change has a significant impact on institutional investors. Simultaneously, we demonstrate that institutional investors can have a significant positive impact on fighting climate change, particularly if they actively engage with portfolio firms to reduce carbon emissions. For risk management reasons, this is in their own interest, and it is also in the interests of society.Theoretical/Academic ImplicationsWe highlight possible future research avenues on the link between institutional investors and climate change, emphasizing issues related to environmental, social, and governance (ESG) rating agencies, greenwashing, and the risk of a loss of trust in ESG products. Climate change constitutes one of the grand challenges of our time, and substantially more research on the role of finance is required.Practitioner/Policy ImplicationsClimate change imposes financial risks on institutional investors' portfolio firms, which must be actively addressed in the investment process. Nascent evidence indicates that markets have begun pricing these risks. Institutional investors can positively influence climate change by engaging portfolio firms on their emissions and simultaneously reducing climate transition risks.

Can long-term institutional owners improve market efficiency in parsing complex legal disputes?

Long-horizon institutional investors can help mitigate information asymmetries around securities class action (SCA) lawsuits. We find that the machine readability of SCA complaint filings can predict the outcome and duration of class actions. Long-term institutional investor ownership leads to a more positive post-SCA announcement price reaction and increases the volatility ratio of prices as a measure of price informativeness. Furthermore, there is a significant interaction effect between long-term institutional ownership and SCA complexity on price informativeness consistent with a superior information processing ability about complex corporate events affecting portfolio firms.

Political sentiment and abnormal accruals

ABSTRACT Firms exhibiting high political sentiment can be desirable for investors as a hedging tool, which increases the demand for their stocks due to the mispricing related to manger’s sentiment and intertemporal hedging demand. A long-short portfolio of firms corresponding to the quintiles of political sentiment has a positive alpha spread. We document a positive relationship between political sentiment and abnormal accruals, which implies that corporate executives who engage in accruals-based earnings management also discuss political risk more frequently during earnings calls. Some managers tend to portray their firms as politically sensitive to mitigate the risks of high accruals. Indeed, our distance-to-default analyses suggest that political sentiment ameliorates the negative effects of high accruals. Double-sorted portfolios on political sentiment and abnormal accruals earn significant positive alphas in the month/quarter of earnings call.

How does corporate diversification affect earnings management? A path analysis approach

We examine whether and how corporate diversification affects earnings management. We find that diversified firms exhibit lower earnings management than comparable portfolios of single-segment firms and that the magnitude of reduction in earnings management increases with greater diversification. Using path analysis, we find that diversification decreases earnings management by reducing both earnings volatility and the need for external financing and by increasing the propensity to pay dividends. Our results are robust to using different measures of diversification and earnings management and continue to hold when we account for endogeneity using both the Heckman two-stage model and propensity score matching.

Private captive fund providers and the likelihood of achieving successful venture capital exits

ABSTRACT We analyze the impact of the relationship between private captive venture capital firms (VCFs) and their parent investors on the likelihood of achieving successful exits in investee firms. We argue that the differences in strategic goals and the way venture managers are appointed and incentivized may affect the exit way achieved by different types of captive VCFs. In particular, we focus on private captive VCFs solely funded by a corporation or a financial institution, as well as on semi-captive VCFs jointly funded by several entities. We find that captive VCFs backed by corporations show a higher likelihood of exiting their portfolio firms more successfully than those backed by financial institutions and semi-captive VCFs. VCFs backed by corporations seem to have strategic goals that are compatible with the maximization of portfolio return, and their venture managers may contribute with valuable specific industry knowledge. Conversely, the managers of VCFs wholly owned by financial institutions rarely contribute with industry and technology knowledge and are even more affected by the lack of adequate compensation packages.

Material ESG Alpha: A Fundamentals-Based Perspective

ABSTRACT Using SASB’s materiality framework, prior research finds alpha for the portfolio of firms with improving ratings on material ESG issues. We replicate this finding and provide a fundamentals-based perspective on why the materiality portfolio outperforms. Our basic premise is that changes in material ESG issues reflect fundamental firm characteristics. More financially established firms—firms with larger size, lower growth, and higher profitability relative to their sector—are more likely to not only create material strengths but also resolve material weaknesses in their ESG scoring. This fundamental link dictates that one should comprehensively control for fundamental determinants of stock returns before attributing portfolio outperformance to improving material ESG scores. Indeed, we find that the materiality portfolio does not generate alpha after we account for its exposure to profitability and growth factors. Our evidence underscores the issue of correlated omitted fundamental factors in the debate of ESG alpha. Data Availability: Data are available from the sources cited in the text. JEL Classifications: G11; G12; G14; M14; M41; Q51.

Risk Characterization of Firms with ESG Attributes Using a Supervised Machine Learning Method

We examine the risk–return tradeoff of a portfolio of firms that have tangible environmental, social, and governance (ESG) attributes. We introduce a new type of penalized regression using the Mahalanobis distance-based method and show its usefulness using our sample of ESG firms. Our results show that ESG companies are exposed to financial state variables that capture the changes in investment opportunities. However, we find that there is no economically significant difference between the risk-adjusted returns of various ESG-rating-based portfolios and that the risk associated with a poor ESG rating portfolio is not significantly different than that of a good ESG rating portfolio. Although investors require return compensation for holding ESG stocks, the fact that the risk of a poor ESG rating portfolio is comparable to that of a good ESG rating portfolio suggests risk dimensions that go beyond ESG attributes. We further show that the new covariance-adjusted penalized regression improves the out-of-sample cross-sectional predictions of the ESG portfolio’s expected returns. Overall, our approach is pragmatic and based on the ease of an empirical appeal.

Estimating Spillover Effect from International Oil Market to Stock Market: Evidence from Korean Portfolio-Level Analysis

Using a diagonal BEKK model, this paper estimates a spillover effect from the international crude oil market to the Korean stock market. Empirical results suggest that shocks and volatility in Dubai oil prices are significantly transmitted into twenty portfolios of the Korean stock market. Also, it was found that these spillover effects dramatically rose during the year 2020, when the threat of COVID-19 was the most serious. More specifically, oil-oriented portfolios, such as the power and gas firms’ portfolio and chemical firms’ portfolio, had a greater spillover effect from the international crude oil market rather than other portfolios. Further, compared to larger-capitalization firm portfolios, small-capitalization firm portfolios had a relatively greater spillover effect. Several implications and important avenues for further research are identified.

Do ESG funds engage in portfolio pumping to gain higher flows? An application of Benford's Law

AbstractPortfolio pumping is identified as an ‘illegal’ trading practice that involves inflating quarter‐ and year‐end portfolio returns. Utilizing U.S. domestic equity mutual fund daily return data, we examine whether environmental, social, and governance (ESG) funds engage in portfolio pumping to generate higher flows. Our findings reveal that, on average, ESG funds attract 0.4% higher flows than other funds. However, they engage in portfolio pumping and achieve returns that are 5.3 basis points (bps) higher at quarter ends compared to their returns during the rest of the year. This practice does not result in additional fund flows. Notably, compared to other funds, ESG funds exhibit a significant 4 bps reduction through portfolio pumping. This implies that, on the last day of the quarter, ESG funds earn approximately 4 bps lower returns compared to other funds. Portfolio pumping is costly for both investors and financial markets since it leads to trading activities that cause stock prices to deviate from their fundamental values. ESG funds engage less in portfolio pumping than other funds, which indicates that their primary focus is to maximize fund flows rather than enhance or create a positive social impact on the underlying firm portfolio. Investors seem to understand this goal, particularly when ESG funds engage in portfolio pumping and avoid investing in ESG funds.

Oil price uncertainty and excess value of diversification

PurposeThis study examines the value implications of oil price uncertainty for investors in diversified firms using a sample of 922 USA firms from 2001 to 2019.Design/methodology/approachOur study employs a panel dataset to examine the value implications of oil price uncertainty for diversified firm investors. We consider several alternative specifications to account for unobserved factors and measurement errors that could potentially bias our results. In particular, we use alternative measures of the excess value of diversified firms and oil price uncertainty, additional control variables, fixed-effects models, the Oster test, impact threshold for confounding variable (ITCV) analysis, two-stage least square instrumental variable (2SLS-IV) analysis and the system-GMM model.FindingsWe find that the excess value of diversified firms, relative to a benchmark portfolio of single-segment firms, increases with high oil price uncertainty. The impact of oil price uncertainty is asymmetric, as corporate diversification is value-increasing for diversified firm investors only when the volatility is due to positive oil price changes and amidst supply-driven oil price shocks. The excess value increases irrespective of diversified firms’ financial constraints and oil usage. Diversified firms become conservative in their internal capital allocations with high oil price uncertainty. Such conservatism is value-increasing for diversified firm investors, as it supports higher performance in response to oil price uncertainty.Originality/valueOur study has three important implications: first, they are relevant to investors in understanding the portfolio value implications of oil price uncertainty. Second, they are helpful for firm managers while comprehending the value-relevant implications of internal capital allocations. Finally, our findings are policy relevant in the context of the future of diversified firms in developed markets.

R&D investments in emerging market firms: the role of institutional investors and board interlocks

Despite the increase in institutional investor shareholdings in emerging market firms, their impact on R&D investments has received scant attention in the literature. By integrating agency and resource dependence perspectives, we examine the role of different types of institutional investors and their interactions with board interlocks in shaping their preference for R&D investment in their portfolio firms. We test our hypotheses on a sample of 2,478 Indian firm‐year observations from 2005 to 2019, using various estimation techniques. Our results indicate that different categories of institutional investors have distinct preferences for R&D investment. Specifically, we find that ownership by both foreign institutional investors and mutual fund investors negatively impacts R&D investments in firms. While board interlocks positively moderate the impact of institutional investors such as banks and financial institutions and foreign institutional investors on R&D investments in firms, this moderation is negative in the case of mutual fund investors and R&D investments in firms. We contribute to the understanding of the determinants of R&D investments in emerging market firms, with a specific focus on institutional investor ownership and add to the nascent literature on the interaction between two forms of governance, i.e., ownership and board characteristics, in shaping this firm strategy.

Common ownership and creative destruction: evidence from US consumers

Abstract How does common ownership affect creative destruction? What are the underlying mechanisms? Do the effects of increased common ownership vary among different customer segments? Using product-level data, we show that, on average, firms with greater common ownership introduce new products at a faster rate and discontinue existing products at a similar pace. The observed economic impacts intensify over time, reflecting the gradual nature of knowledge spillovers and the learning curve. Subsequent to an increase in common ownership, portfolio firms tend to both add and drop products that are dissimilar to those of their rival firms, with the net effect of decreasing between-firm product dissimilarity. We also find that the effects are more relevant for product modules with greater technological likeness, lower barriers to market entry, and greater numbers of product market players. Product variety is substantially greater in product lines catering to higher-income households. Overall, the result highlights the procompetitive effects of increased common ownership.

Venture capital and corporate financialization: Evidence from China

We examine whether and how venture capital investors (VCs) affect corporate financialization in post-IPO stages using China’s A-share non-financial listed firms from 2007 to 2019. We find that the presence of VCs reduces the level of corporate financialization. The negative relationship is more pronounced in VCs with private ownership and portfolio firms with poor corporate governance. Further evidence shows that the negative effect of VCs on corporate financialization is driven by VCs through stronger corporate governance engagement, indicating a monitoring channel. We also find that VCs exhibit a high level of failure tolerance and innovation promotion by decreasing the sensitivity of CEO turnover to compensation performance, and promoting R&D investment in firms with a stronger arbitrage incentive, suggesting another innovation channel.

Restructuring of Poorly Performing Family-Owned Portfolio Firms: The Role of Socioemotional Wealth

How do owners of family firm portfolios restructure poorly performing firms? To answer this question, we conducted an in-depth qualitative case-study analysis of six poorly performing family portfolio firms, on the basis of 39 interviews, 117 pieces of archival data, and observations we gathered over 2 years. Drawing upon the socioemotional wealth (SEW) perspective and escalation-of-commitment literature, we suggest that family firm owners initially show refraining behaviors toward restructuring their poorly performing portfolio firms. Subsequently, they exhibit escalating behaviors by first investing and then reshuffling assets, to safeguard firm-level SEW. Yet, when retaining these poorly performing firms threatens the existence of the remaining portfolio and, thus, portfolio-level SEW, family firm owners exhibit de-escalating behaviors by divesting. Preferably, they attempt a sale and, when a sale is no longer an option, a liquidation. We developed a model that contributes to a more granular theoretical understanding of the family firm’s restructuring behavior, in the context of portfolio entrepreneurship.

Same owner, different impact: How responses to performance feedback differ across a private equity investor's portfolio firms

AbstractResearch SummaryPrivate equity (PE) investors invest in a portfolio of firms, setting new, ambitious performance aspirations and providing monitoring and value‐adding services to help management attain these aspirations. Integrating a behavioral theory of the firm and corporate governance perspective, this study investigates how portfolio firms respond to performance feedback, considering heterogeneity in PE investors' incentives and influence toward a given portfolio firm's strategic actions. Using unique data from a PE investor including direct aspirations measures, we find that (1) portfolio firms' performance relative to aspirations, and (2) the PE investor's relative investment amounts and experience of PE‐appointed board members, interact to affect the distinct growth strategies (i.e., internal capital investments or external acquisitions) its portfolio firms pursue.Managerial SummaryA PE investor may guide its portfolio firms differently. Incentives to intervene should be larger in case of larger investments, and influence should be more extensive in case of more senior PE board representatives. In this study, we examine how a PE investor's varying incentives and influence affect how PE‐backed firms strategically react to underperformance and overperformance. We find that a PE investor pushes for capital investments but deters acquisitions as performance shortfalls increase in a portfolio firm, when they have made larger investments and appointed more senior board members. In case of overperformance, a PE investor pushes toward acquisitions (and against capital investments) when they have invested more. Surprisingly, the opposite holds in case of more senior board members.

Market Discipline in the Direct Lending Space

Abstract Using the exclusion of business development companies (BDCs) from stock indexes, this paper studies the effectiveness of market discipline in the direct lending space. Amid share sell-offs by institutional investors, a drop in BDCs’ valuations limits their ability to raise new equity capital. Following this funding shock, BDCs do not adjust their capital structure. At the same time, they are reducing the risk exposure of their portfolios. We document a greater reduction in risk for BDCs subject to stronger market discipline from their debtholders. BDCs pass through the capital shock to their portfolio firms by reducing their investment intensity.

Female venture capitalists on boards and firm innovation in China

ABSTRACT This paper empirically examines the representation of female venture capitalists (VCs) on boards and how they exert substantial influence on firm innovation performance in China. We first identify a positive association between female VCs’ board participation and firm innovation, implying that Chinese female VCs contribute to growing resource commitments and greater success in innovation through quality board services in portfolio firms. We then show that firms with female VC board directors exhibit a lower adverse effect of managerial myopia, capital market pressure, and product market competition on innovation activities. These results are robust to the use of instrumental variable (IV) estimations, subsamples, and alternative variable definitions.