Does Institutional Ownership Create Values? the New Zealand Case

Abstract

Introduction As the world has moved into the twenty-first century, institutional investment in public firms has emerged as an important mechanism in monitoring and controlling the functioning of their business operations. Institutional investors have real interest and ability in influencing corporate decisions. Their abilities are significantly stronger than the collective efforts of diverse, small investors' independent board representatives. The purpose of this study is to examine whether institutional investors perform an effective monitoring function and add value to the monitored firms. (1) There are several metrics that could be used to determine whether value is added. We choose improved financial returns as an indicator of added value. This study uses sample firms traded on the New Zealand Stock Exchange to specifically test our hypotheses. The New Zealand market is a small, open, and highly concentrated market. We believe institutional influence is more sensitive to, and hence easily detectable by employing, data from a small open market. The relationship between ownership structure and firm performance has been a focus of academic research as early as Berle and Mean (1932), who hypothesized that an inverse correlation should be observed between the diffuseness of shareholdings and firm performance. Given the significance of this topic in management, economics, and finance, the relationship between ownership structure and firm performance is one that has received considerable attention in empirical studies. Empirical results so far have failed to provide consistent evidence to prove whether the type of ownership does significantly affect firm performance. This failure simply might reflect the various degrees of variability of ownership profiles and percentages across the samples utilized. Corporate ownership also is studied widely via analyses of ownership concentration (Demsetz and Lehn, 1985; Demsetz and Villalonga, 2001) and management agency cost due to interest conflicts (Jensen and Murphy, 1990). There are empirical results supporting the view that ownership concentration and management ownership are important elements to control cost (Shleifer and Vishny, 1986). This proposition is not often tested with data on institutional investors, who have the potential to play a much stronger monitoring function than independent directors. Grossman and Hart (1980) provide an analysis of the incentives for large shareholders such as institutional investors in effectively monitoring and governing corporations. Cornett et al. (2004) examine the relation of institutional ownership and corporate performance and confirm a significant positive relationship between a firm's operating cash flow and both of the institutions' ownership percentage and institutional stockholder number. Additionally, they find that this relation is found only for pressure-insensitive institutional investors, those with no business relation with the firm. In periods of market crises, Baek, Kang, and Park (2004) find that firms that have unaffiliated foreign institutional investors performed better than firms where the institutional investors were tied by other existing relationships to the firms in which they were invested. Hence, the duration of the institutional investment, the level of self-interest, and other firm-level specific factors can affect monitoring performance of institutional investors. In this study we use New Zealand publicly-listed firms and empirically test if there is any relation between the institutional ownership measures and the firms' market value as measured by Tobin's Q and return on equity. New Zealand has experienced a decade of change in its business and financial environment. In particular, the economic deregulation of the mid-1980s paved the way for New Zealand to become a more open economy, especially with regard to international capital markets (Grimes, 1998). …

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