Corporate Finance
Applied Microeconomics

Corporate Finance
Applied Microeconomics
Microeconomic Theory

(Oral) Microeconomic Theory and Financial Economics
(Written) Macroeconomic and Microeconomic Theory

Which Institutional Investors Monitor: Empirical Evidence from Corporate Acquisition Activity and Theory

Professor Arturo Bris
Professor Judith Chevalier (Chair)
Professor Stephen Morris
Professor Matthew Spiegel

May 2004

Ph.D., Economics, Yale University, Expected May 2004
M.Phil., Economics, Yale University, December 2002
M.A., Economics, Yale University, May 2001
A.B., Bryn Mawr College, May 1999
     major in Economics, minor in Mathematics, magna cum laude, Honor in the major

Yale Dissertation Fellowship, Fall 2003
John Perry Miller Fellowship, Graduate School of Arts and Sciences, Yale University, 2002
Cowles Prize, Cowles Foundation for Economic Research, Yale University, 2000
Yale University Graduate Fellowship, 1999-2003
Laura Estabrook Romine Fellowship, Bryn Mawr College, 1999
Full scholarship, Bryn Mawr College, 1996-1999

Introductory Microeconomics (undergraduate)
Intermediate Microeconomics (undergraduate)

Research Assistant, Professor Matthew Spiegel, School of Management, Yale University, Summer 2001

"Which Institutional Investors Monitor? Evidence from Acquisition Activity," September 2003 [job market paper]

"Managerial Reputation Concerns, Outside Monitoring, and Investment Efficiency," working paper

"Who Wants Dividends?" work in progress

"Long-term Industry Effects in Initial Public Offerings", (with Gerard Hoberg), work in progress

Institutional investors hold more than half of all U.S. publicly traded equity. Some of them, especially public pension funds, have been active in submitting shareholder proxy proposals on corporate governance topics. However, prior studies on the effectiveness of institutional investor activism have found only inconclusive results. Managers of public pension funds may be politically motivated and their actions do not necessarily enhance shareholder value. Other types of institutions may remain passive due to legal constraints or conflict-of-interest resulting from existing business ties with portfolio companies. This dissertation contributes to the ongoing debate on the effectiveness of institutional investor activism by examining whether institutional ownership is associated with reductions in value-reducing corporate merger and acquisition (M&A) activity. I document that public pension funds are the only class of institutions whose presence is associated with a reduced likelihood of future M&A activity. This reduction is greater for potentially harmful M&A activities.

The study employs a collection of datasets. Firm financials are from COMPUSTAT. Stock information is from CRSP. Insider ownership data is from Execucomp. Institutional ownership data is from Thomson Financial. Merger and acquisition data is from SDC. The firm-level governance index is obtained from Gompers, Ishii, and Metrick (Quarterly Journal of Economics, 2003). The final dataset includes 6,693 observations on 1,363 firms over eight years (1992-1999).

The first chapter of the dissertation utilizes a random effect logistic regression model. Concerns for ownership endogeneity necessitate the use of instrumental variables. The model allows for firm-level unobserved heterogeneity in merger and acquisition decisions, and utilizes both the time-series dimension and the cross-sectional dimension of the data. The specification also controls for firm-level governance provision, managerial incentives, firm characteristics, and industry characteristics.

Different classes of institutional investors exhibit different impacts on corporate merger and acquisition activity. Public pension fund ownership is negatively associated with M&A likelihood, while insurance company and investment company ownership is positively associated with M&A likelihood. Public pension fund ownership is also negatively associated with deal sizes (conditional on completed deals) in the future 12 months, while investment company ownership is positively associated with deal sizes (conditional on completed deals).

The negative association between public pension fund ownership and M&A likelihood is not a result of public pension funds seeking out non-acquisitive firms. Prior corporate M&A activity does not appear to affect public pension fund ownership. In addition, estimates using the negative binomial regression model suggest that the negative association between public pension fund ownership and M&A likelihood is sustained in the long-run.

Among low Q firms (firms with few positive NPV projects), the reduction of M&A associated with public pension fund ownership is greater for cash rich firms, which are identified in existing literature as the group with higher agency costs. Public pension fund ownership is also negatively associated with the likelihood of "buying-growth" M&A, which is also previously identified as value-reducing for bidder shareholders.

Although public pension fund ownership is not significantly correlated with bidder abnormal announcement stock returns, it is positively and significantly associated with bidder long-term abnormal stock returns (for 12 months including the announcement month) and post-M&A  improvement in asset turnover rates.

The overall results are supportive of the argument that public pension funds play an important and unusual role as monitors for corporate governance.

The second chapter of the dissertation develops a theoretical model of outside monitoring. It can be shown that given uncertainty of investment profitability and uncertainty of manager type, an outside monitor with limited punishment capability can improve investment efficiency in a two-period setting. This improvement can be limited, and is characterized by a mixed-strategy equilibrium. The model suggests that managerial reputation concerns play an important role in facilitating effective monitoring. It also suggests that in the worst-case scenario, when a bad manager has a high initial reputation, the monitor may decide not to monitor. Thus, the model provides a rationale for the recent advocacy that institutional investors should capture the boards.

In the third chapter, I investigate whether institutional investors affect a firm’s non-acquisition financing/cash distribution policies, such as dividend payout, repurchase, capital expenditures, and debt reduction. In this chapter, I utilize the technique of systems of simultaneous equations. Preliminary estimation results again demonstrate the existence of heterogeneity among different classes of institutions.