Does The Involvement Of Institutional Investors Lead To Higher Financial Performance?

 
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Institutional investors have been a debatable issue and generated various investigations over the years. Research has established that the institutional investors are the dominant holder of assets in companies. However, their being so influential does not necessarily mean that their involvement would lead to higher financial performance by companies. This research paper focuses on the effect of the involvement of institutional investors on the financial performance of the companies. Financial Performance in this research paper is used as a barometer to indicate how a company can administer its assets to either improve or deteriorate its financial health. Higher financial performance of a firm would lead to better investment returns, which is the major interest of investor classes and in particular institutional investors. The research paper will attempt to point out the pros and cons of the influence of institutional investors on firms which have a bearing on financial performances.

Jill Solomon aptly suggests that institutional investors are the connection between shareholders and the companies in which they invest. They play a crucial role in the performance of the financial markets. Economic theory suggests that institutional investors contrast individual investors on the financial markets. UK specific, she points out that institutional investors are organizations that put in huge amounts of money in the shares and other financial assets of companies, home or foreign.[1]

The most important type of institutional investors are Pension funds.[2] The international institutional investors by investing money in companies help in the global movement of money.

Institutional investors differ among each other in their risk taking appetites as well as positioning themselves for maximum planned returns. They deal with enormous volumes of shares and hence, their influence on the movements of stock markets is implied. This paper will mainly focus on pension funds as they have been the most prominent among the institutional investors.[3] In the past thirty years, shareholding has been highly concentrated in institutional investors. Among the institutional investors, the private and public pension funds are highly important.[4]

Institutional investors, as compared to individual shareholders are more influential and have better resources. They relate mostly to firm level performance. They study the portfolio holdings of institutions in firms thereby influencing the corporate performance. Governance at firm level is directly proportional to global institutional investment.[5]

The first part of the research paper describes the increasing influence of the institutional investors over the years. It then discusses the investment patterns of certain types of investors, in order to get a brief view of the various strategies used by the investors. Further, it goes on to the second part, where it tries to prove corporate governance as the link, between institutional investors and financial performance. Over the years this link has become stronger but not necessarily beneficial. The third part deals with the merits and demerits of institutional investors and their inferences. Finally, the paper analyzes the various ways of effective leverage of power by the institutional investors.

PROGRESSIVE INFLUENCE

It has been observed that the recent trend is towards increasing shareholding by institutional investors as opposed to individual shareholders. The influence of institutional investors in UK is self evident, as more than 40% of the worth of shares, in the hands of all institutional investors, is managed by the topmost 25 institutional investors.[6] Section 5 of the Hampel Report stated that: It is generally implicit that the power of share holders in corporate governance mainly concerns institutional investors, this is more prominent in the case of UK institutions. Since institutional investors like pension funds, unit and investment trusts as well as insurance companies, garner major portion of shares in UK companies, i.e. 60%. Of the balance, 40%, 20% are held by individuals, and high net worth individuals and 20% by foreign investors. As is evident by sheer strength of numbers, institutional investors have a greater say. (ss.5.1). Hampel report ss.5.2, amplifies the diversion in the activities of institutional investors, from drawing board policies to active participation in corporate firms .[7]

In the US, there has been a gradual but visible change in asset composition between 1991- 1999. Exponential increase in equity prices are partly a reflection of the value of equity investments, as such in the period from 1991 - 1999 in the US the value of equity investments grew 18% on an average. Bonds registered a growth of 9%, whereas loans showed a modest 3% growth. When seen against volume of assets of institutional investors which grew to $19279 Billion in 1999, which was triple of its value from 1991, hence the shift in asset allocation is evident from the various percentage growths as to the favoured investment engines. Pension funds in the US are the leading institutional investors which recorded an year on year increase of 15% from 1991-99, during this boom period investment companies assets rose from $ 1376 Billion to $6289 Billion.[8]

In the United Kingdom, the role of the institutional investors came to the limelight in 1973 with the Institutional Shareholders Committee. The leading class of institutional investors in the UK is the pension funds. 1994 figures for UK reveled that almost 66 billion pounds of all occupational pension fund assets was managed by mainly five pension funds.[9] Since then pension fund assets have further grown in leaps and bounds.

The work of institutional investors has been applauded as they lead to higher financial performance of firms by using modes such as voting, engagement and dialogue, but at the same time they have also been criticized for emphasis on short-termism. As has been explained in the myopic institutions theory (Hansen and Hill, 1991) that institutional investors in the long run become more short sighted than the individual shareholders. The reason for this is the competition for accounts and their standing on the basis of their performance.[10}

This research paper attempts to give clarity to the influence of the institutional investors (mainly the pension funds) on firms. It lays foundation to the fact that institutional investors wield a greater influence than individual shareholders, in terms of their resources and the ways in which they could influence the firms. These resources if used progressively would definitely strengthen the companies' work ethics and long term strategies, consequently resulting in better governance.

Investment Patterns of Institutional Investors.

Mutual Funds comprise of cross section of investors who contribute to create a common pool of funds investing in securities e.g. stocks, bonds, money market instruments and similar assets. These funds are run competently by qualified fund managers, who strictly follow the norms of investment objectives of their prospectus. The fund managers deploy the funds capital after due diligence with an aim to create capital gains for the investors.[11} While those securities which are profitable but are not actively managed are lapped up by Unit Investment Trusts who in turn sell the shares held by the trusts to potential investors. These UIT are registered investment companies. However, there are certain differences between the Unit Investment Trust and Mutual Fund, the most significant one being the active management of the mutual fund, whereas a Unit Investment Trust is self governing. In the UIT shareholders receive the benefits accrued on the capital, interest and bonus from the trust at the designated periods. The proceeds of the trust would be tax free, in case the trust is investing in only tax free securities. Both risk and return in case of the Unit Investment Trust are usually low. However, sometimes UITs are preferable to mutual funds as their yearly working costs are lower than mutual funds, nonetheless, they frequently charge on sales and have fees for entrance or exit.[12} Then, there are those firms which are created to hold securities of other firms who raise their capital from public issue of shares which are traded on the stock exchanges; these are known as Investment Trusts. These institutional investors issue a fixed number of shares (traded at a discount on their net present value) which are bought by new investors from the existing share holders. These are closed ended funds. In this a unit holder is not a share holder of the unit trust and these units are not shares but qualify the interest of the investor in the unit trust's investment portfolio.[13}

Other high value institutional investors who have deep pockets for investment in the markets are Hedge Funds. These funds are highly flexible and opportunistic. They resort to various investment techniques to ensure high returns. Due to their flexibility they move into safe havens of options or bonds in a volatile market, or play the market by taking long or short positions in trade as well as use arbitrage while also using every opportunity to buy and sell undervalued securities. The main strategy of Hedge Funds is to preserve their capital and ensure positive returns in both uptrend and downtrend in markets. These funds have a very large flow of capital and can deploy large quantities of capital in the markets, they are very informed investors.[14}

Hedge funds have distinctive strategies in their investment appetite; the risk and return level vary for each strategy. For example, a macro hedge fund is volatile but has a higher return potential, they dabble in stock and bond markets, currencies, hoping to profit from global shifts in interest rates and various countries' economic policies. Then there are distressed - securities hedge funds that buy the equity...

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