PROPOSAL FOR DOCTORAL DISSERTATION SCHOLARSHIP
By Lianzeng (Edward) Yuan, Ph.D Candidate, Schulich School of Business, York University
The Impact of Institutional Ownership: A New Perspective
In the past several decades, the holdings of institutional investors, including
banks, insurance companies, pension funds, endowment funds, investment firms, etc.,
have increased significantly. As institutional shareholdings get higher, both practitioners
and researchers are engaging in a heated debated on whether or not these investors do
help to improve corporate governance by monitoring and disciplining managers,
especially in this post-Enron era.
Although considerable research has been done on institutional ownership, most of
the previous literature focuses on its impact on the equity side, such as operation
performance, firm value and major corporate decisions, and no consensus has been
reached. This is not surprising given the noisiness of the equity market, the endogeneity
problem plaguing any attempt to discern the relationship between equity holders and
equity performance. Therefore it might be helpful to switch the angle and investigate this
problem from another perspective: corporate debt.
Compared to the equity, debt has a shorter maturity and its pricing is well
specified; in addition, debt is less subject to endogeneity problem as institutional
investors may exert immediate impact on the equity, but it is less likely that changes in
corporate debt will cause institutional holdings quickly. Despite these advantages, there is
a paucity of studies on the relationship between institutional ownership and corporate
debt. In this study we attempt to fill this gap by examining the impact of institutional
ownership on the cost of loans. By doing so, we can examine whether institutional
investors help reduce risk level in borrowing firms through effective monitoring.
Loans are the most important source of external financing for companies.
According to Thomson Financial, the total proceeds from the syndicated loan market
world wide amounted to US $ 3,079,467.70 million in 2004; in comparison, the total
proceeds from all equity was US $ 844,769.20 million in the same period. Given the
important role of loans in firm-level financing, an understanding of how institutional
ownership affects the cost of loans is undoubtedly necessary.
In this study, we will empirically test the two major arguments prior studies have
made regarding institutional investors: active monitors versus inactive monitors. If these
investors actively monitor and discipline managers in their portfolio companies, they can
reduce the risk level of these firms, and consequently, these companies will pay a lower
cost on their loans, ceteris paribus. Therefore, this argument implies a negative
relationship between institutional ownership and the cost of loans. If these investors do
not actively monitor, they will not have any impact on the risk level of the borrower;
resulting in no significant relationship between institutional ownership and the cost of
loans.
Meanwhile, due to the conflict of interest between shareholders and debt holders,
as institutional ownership increases, lenders might raise the cost of loans to cover
additional risk exposure arising from the fact that shareholders have the incentive to take
riskier projects to take advantage of their limited liability. So not only does this approach
provide us with a novel framework to analyze the role of institutional investors in
corporate governance, it also allows us to test another possible effect associated with
institutional investors, namely a higher agency cost of debt, something always neglected
in prior studies.
The time frame of completing the dissertation is from April 2005 to June 2007.