Institutional Investors And Firm Performance

Institutional investors had experienced a great development in size, variety and behavior since the first professional investment fund found in UK in1868. Many countries around the world including not only the developed countries but also emerging countries hope that the participation of institutional investors could decrease defects in corporate governance. In China’s capital market, with the strategy of ’Transnormal development of institutional investors’announced, the size and amount of institutional investors developed fast. At the end of2012, professional institutional investors take17.4%of A shares market. With amendments of the Fund Act finished in2013, the government once again pin their hope on institutional investors, expecting them could act as activism, gradually take the responsibility for corporate governance.Although the effect of institutional investors has been approved empirically and theoretically, the research of mechanism is still to be perfected. This paper argues that as owner of large tradable shares, institutional investors are important factor in corporate governance and could not only affect corporate governance through intervention mechanism, but also could use the threat of exit mechanisms. We investigated that whether institutional investors could act as effective governance mechanism to improve corporate performance. We also investigated the effect of changes of liquidity of capital market on this mechanism. The threat of exit, as opposed to actual exit, is difficult to measure directly. However, a crucial property is that the threat of exit is weaker when stock liquidity is lower and vice versa. We use natural experiments of financial crises and reform of non-tradable shares as exogenous shocks to stock liquidity, together with liquidity of the firm itself. Firms with larger institutional investors experience greater declines in firm value when liquidity decrease (and increases when liquidity increase), particularly if the manager’s wealth is more sensitive to the stock price and thus to the threat of exit.This article analysis how institutional investors affect corporate governance thereby affect corporate performance theoretically and empirically. By reviewing the literature, we found that the definition on institutional investors is different, so we first define institutional investors as narrow scope; based on the analysis, we analysis the two mechanism that institutional investors could take when participate in governance and how the threat of exit mechanism affecting corporate governance together with the effect of liquidity. Through theoretical analysis, we propose hypotheses and select private listed companies to make empirical analysis.We found that in private listed companies, institutional investors could affect corporate governance through the mechanism of threat of exit, and the higher the liquidity of market, the more credible the threat of exit, the higher the company’s performance. In addition, the threat of exit mechanism relies on the relationship between the interests of executives with the company’s stock price; that is, if the company’s shares held by executives, threat of exit mechanism will be greater. Therefore, in order to determine the mechanisms of institutional investors are not affected by the intervention, we divided our sample into two groups based on the boundary mid-value of CEO share-holding. The results show that compared to company with lower executives share-holding, the threat of exit mechanism more apparent in higher executives share-holding.Based on theoretical and empirical research, this paper considers that we should improve corporate governance system through macro and micro aspects. Macro aspects include improving financial markets continuously, developing institutional investors, enriching institutional investors group and its structure, as well as guiding investors actively participate in corporate governance. In micro aspects, listed companies should establish long-term equity incentives to reduce the myopia problem and enable them focus on future development, which could prompted institutional investors to better play their own governance. What’s more, under cooperation of government departments, companies and institutional investors, there should achieve a win-win symbiosis.