3-IJAEBM-Volume-No-1-Issue-No-2-INSTITUTIONAL-SHAREHOLDERS-DIFFERENCES-AND-CORPORATE-PERFORMANCE-071 by ISERP ISERP

Iskandar REBAI - (IJAEBM) INTERNATIONAL JOURNAL OF ADVANCED ECONOMICS AND BUSINESS MANAGEMENT Vol No. 1, Issue No. 2, 071 - 080

INSTITUTIONAL SHAREHOLDERS DIFFERENCES AND CORPORATE PERFORMANCE Iskandar REBAI

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Faculty of Economic Sciences and Management Sfax, Tunisia U.R. GOVERNANCE (ESC Sfax) E-mail: r_iskandar2002@yahoo.fr

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Abstract

However, most studies of institutional investors treat them as a homogenous group [6], [7]. Nevertheless, institutional investors are different from each other. Indeed, three main factors may explain their heterogeneity [15].

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This study has examined the association between institutional ownership and firms' performance. It has investigated this relationship for a sample of 123 US firms. It has examined also the effect of institutional ownership on performance of firms having different information environment (S&P 500 versus non S&P 500). Results have shown that the involvement of pension funds in the firmsâ&#x20AC;&#x2122; capitals improve the corporate performance. However, investment funds and banks have no significant effects on firms' performance. Moreover, the hypothesis of the relevance of the environment information in the explanation of the institutional investorsâ&#x20AC;&#x2122; behavior has been confirmed.

they possess, in 2006, 66.3% of shares of all U.S firms. Towards the end of 2007, they held 76.4% of shares of the 1000 largest U.S corporations (The Conference Board report 2008). In fact, the concentration of capital is a guarantee of the effectiveness of control because the gains resulting from this action will be theirs in large part. In this context, [4] and [5] think that because of the high costs of monitoring; only large investors such as institutional investors in particular can engage in manager's control.

Keywords: Institutional investors, managerial discretion, firms' performance,

I. INTRODUCTION

In the perspective of financial theory, managers use company resources to increase their power and the various benefits that they receive (excess compensation, job security, personal prestige...). Their strategic position within the company allows them to control the information and, in particular, restricting its availability to other agents [1]. Similarly, the strategies developed by managers try to expand their discretionary space using the means at their disposal, such as their human capital but also the assets of the company [2].

However, the involvement of institutional investors in the firms' capitals seems to effect changes. The term "institutional investor" means investors other than individuals who manage money within an institution or on behalf of their clients. Nevertheless, there are two essential characteristics of institutional investors. First, their main function is to manage the funds. According to [3], these investors follow two strategies to increase the value of their holdings. The first is to sell their shares in poorly performing firms and invest in companies making more important performance "Exit". The second is to directly influence corporate management through a disciplinary role on managers "Voice". Then, they are characterized by holding huge shares in companies' capital. Indeed,

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First, their investment horizon can vary from short to long term. We often talk about short-term and long term oriented institutional investors [8]. Thus, according to [9] and [10], the investment horizon of pension funds is long term. However, the investment funds is short term oriented [11], [12].

Then, the structure of the participation of institutional investors in firms' capital. We note that the ownership level is critical in explaining their behavior. Indeed, [13] believe that ownership concentration is associated with an active behavior of investors. Finally, the business relationships that can attach institutional investors with managers. [8] mention the case of banks that are able to play a dual role in the company (shareholder and creditor). The fear of the breakdown of their position as a creditor requires banking institutions to play a passive role in companies of their portfolios. Thus, institutional investors have different investment horizons and motivations [11], [12]. Therefore, their influences on managers are different. A major contribution of this study is that it examines how different types of institutional investors, who have different strategies, influence managerial behaviors and so firms' performance. In addition, we found that previous studies neglect the role of the information environment of firms in explaining the behavior of institutional investors. Our study assumed an influential role of the

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information environment of the firm on the behavior of institutional investors. In fact, companies that belong to the S & P 500 stock index are generally of great size, use the services of highly experienced analysts and are subject to effective supervision by the different stakeholders [14]. Therefore, the behavior of institutional investors appears to be different in these firms [15]. The study of the information environment is an important contribution of our research to the existing literature.

2.2.2. The independent variables Carolyn Brancato, who is the director of central governance of The Conference Board was established in 2007 a report on the changing of institutional ownership. This report is the source of the percentages of institutional participation in the following paragraph.

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Thus, in our study, we pursue the following main objectives. First, identify the relationship between the participation of different institutional investors in the capital and firms' performance. Secondly, testing how the information environment can influence the behavior of institutional investors and therefore their impact on firms' performance. The remainder of the paper is organized as follows. The next section gives the materials and methods used. Section 3 presents results and discussions.

measures of performance such as ROA take into account the current status of the firm's performance. The share market measures of firm's performance cause severe problem. Infact, they do not reflect the actual profits made by the investors on their investments.

II. MATERIALS AND METHODS 2.1. Data

The sample used in our study is composed of data carrying on firms of the American economy detected from the company'sâ&#x20AC;&#x2122; yearly reports distributed by the Security and Exchange Commission. From an initial sample, we eliminated the financial firms and insurance companies as well as firms whose data are missing or the yearly reports are distributed for less than three consecutive years. Our final sample is limited to 123 American firms for the period from 2003 to 2005: 43 firms belonging to the S&P 500 stocks and the others donâ&#x20AC;&#x2122;t belong to the S&P 500 stocks. 2.2. Variables description

2.2.1. The dependent variable: performance

The dependent variable "performance" is measured by net income before interest and taxes divided by total assets. This performance measure has been widely used in finance and accounting literature [16]. The main advantage of this measure is that it covers all activities of the company. According to [17] it is more effective than the measures of stock market performance. Indeed, the accounting

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During the past twenty five years, we notice a change in the participation of U.S. institutional investors. Indeed, this participation grows by 37.2% of the shares of American firms in 1980 to 51.4% in 2000 and 66.3% in 2006. However, focusing on the structure of their participation, we noted that the participation of pension funds increased by 32.6% in 1980 to 38.9% in 2005 of all U.S. stocks. However, the participation of investment funds increased by 2.3% of all U.S. stocks in 1980 to 23.8% in 2005. At the same time, participation of banks and insurance companies fell by 38.8% in 1980 to 11.2% in 2005. Thus, if the structure of the participation of institutional investors has been changed, what will be the impact on the effectiveness of the activism of these institutions? a) Pension funds activism

According to [7], pension funds are encouraged to play an active role in monitoring and communication with the firm's managers. Similarly, [18] and [19] consider that the pension fund activism is the subject of an evolution from the model of control by the market to a political model of control. Indeed, [18] suggests that the political model is preferred to takeover model. It is more flexible in the limitation of some conflicts and mistakes made by the management of the firm. However, it should be noted that managers of pension funds choose one of two solutions when they hold shares of poorly performing firms. They sell these shares "Exit", or they induce firms to change their strategies through voting rights "Voice". However, selling does not appear to be the

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best choice for a pension fund. Indeed, the U.S. public pension funds have adopted the second solution. According to [20], the sale induces a decrease in stock prices and a lack of liquidity. About the effectiveness of the activism of pension funds, [21] and [22] note that the abnormal return is virtually zero after the submission of proposals by these institutions. Indeed, he suggests that pension fund activism does not improve the profitability of the firms targeted.

In this context, [27] argue that investment funds seeking to invest primarily in countries granting more protection to shareholders. Moreover, in these countries, they choose firms with better corporate governance structure. According to [28] investment funds are not influenced by their business relationship with the leaders of firms. Indeed, they find that these funds are able to vote against the managers. Therefore, investment funds do not establish a business relationship with the firm in which they invest their funds. This independence from the firms, incite them to exert important disciplinary role on managers. Thus, agency costs will be lower and performance is improving. [29] report that investment funds vote in favor of proposals that are able to increase shareholder wealth and rights. [4] report abnormal returns after the activism of investment funds. Similarly, [30] argue that these funds have targeted underperforming companies and they came to make profits through their activism. Hence the following hypothesis:

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In this sense [23] provides that control by the pension fund may be ineffective because of agency problems between managers of pension funds and other shareholders of the firm. These problems reduce the ability of these funds to exercise effective control. Indeed, [23] discusses the free rider problem. He believes that some pension funds have a small amount of shares but bear all the costs of activism. While all shareholders benefit from this activism.

Indeed, [25] finds that many investment funds submit shareholder proposals. He believes that investors positively value the investment fund activism. Indeed, these funds are considered capable of restoring the confidence lost by the scandals. He reported that a manager of investment funds has encouraged other shareholders to act after detecting a problem in the firm "Disney". In this sense, [26] argues that "Fidelity", which is a large investment fund in the U.S., restore confidence in the firm "Colt Telecom". Indeed, an employee of "Fidelity" has been appointed as a top manager in the "Colt Telecom" firm.

Nevertheless, the OCDE in its December 2008 issue mentions that the financial crisis facing the U.S. today is partly due to the role played by pension funds. Indeed, the lack of clarity in valuation of assets by these funds is at the root of this crisis. The latter shows the dangers associated with lack of control over the resources invested by pension funds. The OCDE says that these funds have embraced the investments they have to bring high returns. However, they ignore the risk that may result. Therefore, mechanisms must be established to monitor the investments of pension funds and their actions. Hence the following hypothesis: H1: Pension funds ownership doesn't affect firms' performance

b) Investment funds activism

This is the category of institutional investors whose overall growth has been the strongest over the last twenty five years. This dynamic affects all countries. According to [24], investment funds have become the main instrument of investment to individuals. The lower level of the minimum contribution and their clear legal framework increase their attractiveness to small investors. However, after the scandals of firms in 2001 and 2002, investment funds have become more active.

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H2: Investment funds ownership improve firms' performance c) Banks activism The evidence on the relationship between banks shareholders and firm performance is mixed. Indeed, while [31] report a nonlinear relationship, [32] affirm that banks control affects company's profitability negatively. Furthermore, it has been asserted that banks may play a special role in the corporate governance of firms because they can combine debt and equity. Hence, banks can obtain information from their

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lending position of firms. These informations can be used in their control role as shareholders. [33] argue that banks can improve firm performance. In this context, [34], [35] support that banks can effectively monitor and discipline managers and so improve firms' performance. According to [36] banks can enhance firm performance by providing valuable capital and monitoring.



The debt ratio is measured as total debt divided by total assets. Several authors suggest the existence of a positive relationship between leverage and corporate performance [41]. According to [42], debts limit the problem of free cash flow and consequently increase firm performance. Hence, we expect a positive relationship between leverage and performance.

However, the dual role of banks (shareholders and creditors) can weaken the effectiveness of their control on managers. [37] find that banks have no impact on firm value. [38] concludes that for U.S, the impact is never very pronounced. According to [34], banks are more likely to hold shares in companies they lend to. They suggest that there is complementarily between bank equity holding and lending. Moreover, debt holders are risk averse because they face downside risk on their loans. They can use their lending activity as an additional instrument to discipline managers. Nevertheless, the lending relationship can weaken their ability to influence firms' managers. According to [39], if a bank holding equity is primarily interested in ensuring the service of its outstanding debts, this would conflict with shareholders interest. [8] notes that banks may harm their business relationship with the firm. So, they are more supportive of management actions. Hence the following hypothesis:



H3: Banks ownership has no effect on firms' performance

2.2.4. Information environment hypothesis

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Sales growth (CCA) is measured by the rate of sales growth. Under the agency theory, competition in the market for goods and services can discourage managers to manage the firm to the detriment of the interests of shareholders [43], [44]. However, high sales growth is generally associated with weak competition in the market for goods and services. Thus, the leaders will have less incentive to manage efficiently what adversely affects the performance of the firm [45]. So, more the sales growth, more the performance decreases.

2.2.3. The control variables

Managerial ownership is defined as the proportion of capital held by managers. According to agency theory, managers are trying to use company resources to satisfy their own interests. A process that usually causes conflicts of interest between managers and shareholders. However, when the participation of leaders in the capital is important, their interests coincide more with those of the owners of the company. Agency costs decline and performance increases. According to [40], managerial ownership is an excellent way to align the interests of managers and shareholders. Therefore, managerial ownership affects positively the firm performance.



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The size is measured by the logarithm of total assets. Indeed, there is often a category of innovative projects that can be only adopted by large firms because of the huge funds required for these types of investments. Larger firms may be more efficient because they can exploit economies of scale. In addition, they can recruit more experienced managers that lead to better performance. Therefore, more the firm size increase, more the performance will be better. 

[46] as well as [47] show that in opposition to the individual investors, the institutional investors have a preference for the investment in the big firms. [48] stipulate that the positive relation between the institutional involvement and the size of the firms essentially drifts to the legal constraints and the relatively important transparency level in the big business. Nevertheless, these firms are submitted to more of control on behalf of the different taking parts and resort more than the others to financial analyst services. In this order of idea, [49] considers that firms that belong to the S&P 500 stocks have a more elevated stock capitalization and a more important transparency level in contrast with non S&P 500 firms. The informational environment of firms belonging to the S&P 500 stocks is supposed more rigorous in comparison with to the one of the

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other firms. We think that the influence of the institutional investors on managerial latitude concerning firms' performance varies depending on whether the studied firms belong or not to the S&P 500 stocks [15].

Table I Regression results of equation (1) The dependent variable: performance Explanatory Variables Constant PFP PFI PBQ INSD DET CCA LTA Within R 2 = 0.10 Between R 2 = 0.30 Overall R 2 = 0.11

2.3. Estimation method

-0.05 0.05 -0.04 -0.03 0.09 -0.14 0.02 0.07 Hausman = 3.07 Prob = 0.93

-0.55 4.23*** -0.74 -0.50 -0.30 -4.38*** 1.95* 2.21** F = 3.56 Prob F = 0

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We focus on panel data. The study period is from the year 2003 to 2005. One possible estimation methods is the method of least squares (OLS). This estimate assumes that all parameters are identical. The model would be consistent. However, the risk of sample heterogeneity exists, making biased estimates by OLS. So we adopt an estimation based on panel fixed and random effects. ROA = f (INSD, DET, CCA, LTA, PFP, PFI, PBQ, error term) with; • ROA: the level of firms' performance. It is measured by profitability: net income before interest and taxes / total assets; • INSD: managerial ownership; • DET: total debt to total assets; • CCA: the rate growth of sales; • LTA: the logarithm of total assets; • PFP: pension funds ownership; • PFI: investment funds ownership; • PBQ: banks ownership; • α, β, δ: model parameters to estimate; • u, v, w: error terms.

Coefficients

III. RESULTS AND DISCUTIONS

3.1. The impact of different institutional ownership on performance

ROA it = α0 + α1 PFP it + α2 PFI + α3 PBQ + α4 INSD it + α5 DET it + α6 CCA+ α7 LTA it + u it (1) The results of equation (1) regression by the panel random effects method are presented in the following table:

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   

(*) Indicate significance at the 10% (**) Indicate significance at the 5% (***) indicate significance at the 1%

3.1.1. Role of pension funds

The impact of pension fund ownership on firms' performance is positive. Thus, we confirm the assumption that the pension funds exert an important disciplinary role on managers. According to [50], these funds retain often their holding in the company for more than a decade. This orientation for the long term is justified both by the nature of the compensation of fund managers, generally based on salary (not related to the performance achieved) and the need to ensure the pension payments that is spread over a long period [51]. In this sense, [52] stipulate that pension funds have an obligation to protect the capital of the pensioners. To this end, the pension funds are obliged to effectively control the managers of firms in which they invest [9] and [10]. 3.1.2. Role of investment funds The effect of investment funds ownership on firms' performance is insignificant. We therefore reject our hypothesis that investment funds improve firms' performance. The results found seem to be the consequence of short-term horizon of these institutions. Indeed, the limited period of their participation in the capital of firms negatively affects their ability to limit managerial discretion. Consequently they can't improve the firms' performance.

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3.1.3. Role of banks The banks do not exert a significant influence on firm performance. This result manifests the passivity of banking institutions. We support our hypothesis that banks establish business relationships with companies where they invest their funds. Fearing the breakdown of this relationship, the banking institutions do not oppose managerial decisions. Therefore, their passivity inhibits them to improve firms' performance.

Table II Regression results of equation (2) The dependent variable: performance Explanatory Variables Constant PFP PFI PBQ INSD DET CCA LTA Within R 2 = 0.15 Between R 2 = 0.35 Overall R 2 = 0.11

3.1.4. The control variables

-0.01 0.02 -0.01 0.04 -0.02 -0.27 -0.21 0.01 Hausman = 7.94 Prob = 0.44

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The effect of "INSD" variable on firms' performance is insignificant. We therefore reject our hypothesis that the participation of leaders can improve corporate performance. So, it is difficult to conclude on a relationship between the managerial ownership and firms' performance. "DET" affect negatively the firms' performance. This result implies that the disciplinary power of debt on managers is limited. In fact, the increased level of debt seems to amplify the agency costs of debt. An approach usually associated with limiting the level of corporate performance. The sales growth influence positively firms' performance. Similarly, the variable size has a positive effect on firms' performance. We confirm our assumption that large firms have the ability required to enhance their performance. Moreover, this result can be explained by the fact that large firms are generally controlled by several economic agents and in particular by the state, which limits the opportunistic behavior of managers and therefore improves performance.

Coefficients

   

The regression results of equation (3) by the method of panel random effects are presented in the following table: Table III Regression results of equation (3) The dependent variable: performance Explanatory Variables Constant PFP PFI PBQ INSD DET CCA LTA Within R 2 = 0.09 Between R 2 = 0.25 Overall R 2 = 0.14

z (*) Indicate significance at the 10% (**) Indicate significance at the 5% (***) indicate significance at the 1%

ROA it = δ0 + δ1 PFP it + δ2 PFI + δ3 PBQ it + δ4 INSD it + δ5 DET + δ6 CCA it + δ7 LTA it + w it (3)

3.2.1. The firms surveyed belong to the S & P 500 stock index ROA it = β0 + β1 PFP it + β2 PFI + β3 PBQ + β4 INSD it + β5 DET it + β6 CCA it + β7 LTA it + v it (2)

   

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0.45 2.68*** -0.50 2.29** -2.48** -4.41*** 0.1752* 1.36 F = 4.45 Prob F = 0

3.2.2. The firms surveyed are not belonging to the S & P 500 stock index

3.2. The impact of the informational environment on firms' performance

The regression results of equation (2) by the method of panel random effects are presented in the following table:

Coefficients

0.04 -0.06 0.03 -0.06 -0.02 -0.06 0.025 0.02 Hausman = 5.29 Prob = 0.73

0.97 -0.59 -3.61*** -1.11 -0.63 -1.98* 2.76** 0.95 F = 4.09 Prob F = 0

z (*) Indicate significance at the 10% (**) Indicate significance at the 5% (***) indicate significance at the 1%

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3.2.3. The changing of environment results analysis

informational

References [1] W.G. Sanders and M.A. Carpenter, Strategic satisying? A behavioral agency theory perspective on stock repurchase program announcements, Academy of Management Journal, 2003, pp. 160-178. [2] L. Scot, A Stakeholder Approach to Organizational Identity, Academy of Management Review,2000 pp. 43-62. [3] J.C Coffee, Liquidity versus control: the institutional investors voice, Columbia Law Review, 1991, vol.91, pp. 1277-1338. [4] A. Brav, W. Jiang, F. Partony and R. Thomas, Hedge fund activism, corporate governance and firm performance, 2006, Unpublished [5] Y.W. Park and H.H. Shin, Board composition and earnings management in Canada, Journal of Corporate Finance, 2004, pp. 431-457. [6] L. Gillan and L.T. Starks, Corporate governance proposals and shareholder activism: the role of institutional investors, Journal of financial Economics, 2000, pp. 275-305. [7] S. Wahal and J.J. MC Connell, Do institutional investors exacerbate managerial myopia? Journal of corporate Finance, 2000, pp. 307-329. [8] X. Chen, K. Li and J. Harford. Monitoring : which institutions matters?, Journal of Financial Economics, 2007, pp. 279-305 [9] B.J. Bushee, "The influence of institutional investors on myopic R&D investment behavior", Accounting Review, 1998, vol. 73, pp. 305-333 [10] P. David, M.A Hitt, J. Gimeno. â&#x20AC;&#x153;The role of institutional investors in influencing R&Dâ&#x20AC;?, Academy of Management Journal, 2001, vol. 44, pp. 144-157 [11] P.S. Bhattacharya and M. Graham, Institutional ownership and firm performance: evidence from Finland, unpublished, Deakin University, Australia, 2007. [12] L. Tihanyi, R.A. Johnson, R.E. Hoskisson and M.A. Hitt, Institutional ownership differences and international diversification: the effects of boards of directors and technological opportunity, Academy of Management Journal, 2003, pp. 195-211. [13] J.C. Alexandre, S.W. Barnhart, S. Rosenstein. "Do investor perceptions of corporate governance initiatives affect firm value, The case of TIAA-CREF". The quarterly Review of Economics and Finance", 2007, vol. 47, pp. 198-214 [14] S. Mitra and W.M. Cready, Institutional stock ownership, accruals management and information

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The estimated model (2), where firms belonging to the stock index S & P 500 shows different influences of institutional investors on firm performance. Indeed, although investment funds do not exert significant effects, the influence of the pension funds and banking institutions on performance is positive. However, the results found by estimating the model (3) where the companies examined do not belong to the S & P 500 stock index show that only investment funds exert a positive influence on firms' performance. The two other institutions studied do not affect firms' performance. These results seem to be in agreement with our main hypothesis. Furthermore, we confirm our assumption that the information environment of the firms is able to modify the behavior of institutional investors on managerial discretion and therefore corporate performance. Thus, we confirm the results detected by [15].

not belong to this index. Inversely, investment funds improve performance in the two types of firms. Concerning banks, they influence positively firms' performance in the S&P 500 stock index. But they are passive in the non S&P 500 firms. These results prove different behaviors of institutional investors for the two categories of firms (S & P 500 and non S & P 500). Thus the informational hypothesis is verified for the three institutions studied.

3.3. Conclusion

This paper tries to study the relation between institutional ownership and corporate performance. The evidence on a panel of American firms observed during the period 2003-2005, shows different behaviors of institutional investors. Indeed, while pension funds encourage the managers to act in the interest of shareholders and therefore to improve firms' performance, investment funds and banks are passive. The results seem to be in agreement with the assumption that the pension funds exert an important disciplinary role on managers. However, the results are surprising for the case of investment funds. Indeed, these institutions do not establish business relationships with the managers. For banks, their passive role seems to be the consequence of their business relationship with managers. Fearing the breakdown of this relationship, the banking institutions do not oppose managerial decisions.

In addition, we examine the effect of institutional ownership on performance of firms having different information environment (S&P 500 versus non S&P 500). The results show that pension funds enhance firms' performance on S&P 500 stock index. However, they play a passive role in firms that do

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