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Kee H. Chung Carl Hsin-han Shen Department of Finance and Managerial Economics

The Trading Competition among Multiple Short-term Institutional Blockholders for Corporate Governance Mechanism. Kee H. Chung Carl Hsin-han Shen Department of Finance and Managerial Economics School of Management, SUNY-Buffalo. Short-term Institutions are “bad” for corporate governance….

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Kee H. Chung Carl Hsin-han Shen Department of Finance and Managerial Economics

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  1. The Trading Competition among Multiple Short-term Institutional Blockholders for Corporate Governance Mechanism Kee H. Chung Carl Hsin-hanShen Department of Finance and Managerial Economics School of Management, SUNY-Buffalo

  2. Short-term Institutions are “bad” for corporate governance… • Bushee (1998): “transient” institutions drive managers to cut R&D investment in order to meet short-term earnings targets. • Gaspar, Massa, and Matos (2005): in M&A deals, target firms with a higher short-term institutional ownership enjoy lower target premiums; and bidders with higher short-term institutional ownership suffer from more negative market reactions upon the announcements. • Burns, Kedia, and Lipson (2010): short-term institutional ownership increases the likelihood of financial misreporting. Kee Chung, Carl Shen, SUNY-Buffalo

  3. But “good” for market efficiency • Recent studies show short-term institutions have advantageous private information • Ke and Petroni (2004): transient institutions (as defined by Bushee) can predict the break in a series of consecutive quarterly earnings increases. • Yan and Zhang (2009): the predictive power of institutional ownership on future stock returns is almost entirely driven by the ownership of short-term institutions. • In particular, Yan and Zhang do not find long-term price reversals, indicating the higher return predicted by short-term institutions is not due to the firms’ myopic policies for boosting short-run share price. • Wang and Zhang (2009): transient institutional equity ownership reduces information asymmetry and thus reduces credit spread. Kee Chung, Carl Shen, SUNY-Buffalo

  4. Research Question • The price efficiency brought about by short-term institutions seems to stand in stark contrast to the unfavorable corporate governance effects brought about by them. • With the help of their information advantage, can short-term institutions contribute to enhance corporate governance? • In this paper we explore the hypothesis that the presence of multiple short-term institutional blockholders serves as a corporate governance device that disciplines managers through trading. Kee Chung, Carl Shen, SUNY-Buffalo

  5. Theoretical Foundation • Edmans and Manso (2011) (EM) predicts that exit governance would work particularly well when there are trading competition among non-interventionist blockholders. • EM shows the fast incorporation of private information to price improves price efficiency and strengthens the discipline effect on managers. • We suggest that, due to their specialty in trading and arguably low interests in intervention, short-term institutional blockholders are proper candidates for the non-interventionist blockholders in EM’s model. Kee Chung, Carl Shen, SUNY-Buffalo

  6. Hypotheses • Firm value increases in the number of short-term institutional blockholders, not in the aggregate block ownership • The positive association between firm value and number of short-term institutional blockholders is stronger for firms with better market liquidity, lower information acquisition costs, and higher equity-based executive compensation. • Stock price efficiency increases in the number of short-term institutional blockholders • Firms with more short-term institutional blockholders exhibit smaller magnitudes of return autocorrelations. • The future earnings are reflected in current stock prices to a greater extent if there are more short-term institutional blockholders in the firm. • The number of short-term institutional blockholders generates impacts on firm value through price efficiency. Kee Chung, Carl Shen, SUNY-Buffalo

  7. Institution Classification • Institutions are classified as short-term, medium- or long-term institutions based on the institutions’ portfolio churn rates. • Institution k’s churn rate for quarter t is then defined as: • For each quarter, we rank the institutions into three tertiles based on their churn rates. • The institutions in the top tertile are classified as the short-term institutions; the institutions in the medium or bottom tertiles are classified as the medium/long-term institutions Kee Chung, Carl Shen, SUNY-Buffalo

  8. What types of institutions are short-term blockholders? • We hypothesize that short-term institutional blockholders have incentives to monitor the managers, it would be contradicting to our hypothesis if many of short-term institutional blockholders are “passive” institutions. Kee Chung, Carl Shen, SUNY-Buffalo

  9. How long are short-term blockholders interested in the firm? • If short-term institutions only heavily invest a firm for a short period of time, it seems far-fetched to argue that short-term institutions would spend the resources on information gathering and monitoring. Kee Chung, Carl Shen, SUNY-Buffalo

  10. Descriptive Statistics Carl Shen, SUNY-Buffalo

  11. Firm Value and Number of Short-term Blockholders Carl Shen, SUNY-Buffalo

  12. Firm Value and Number of Short-term Blockholders – Bushee’s Classification Carl Shen, SUNY-Buffalo

  13. Firm Value and Number of Short-term Blockholders – 2SLS Carl Shen, SUNY-Buffalo

  14. Effects of Liquidity, Information Acquisition Cost and Manager Incentive on the Monitoring Effectiveness of Short-term Blockholders Carl Shen, SUNY-Buffalo

  15. Price Efficiency and Number of Short-term Blockholders – Return Autocorrelation Magnitudes Kee Chung, Carl Shen, SUNY-Buffalo

  16. Price Efficiency and Number of Short-term Blockholders – Future Earnings Response Coefficient Rt = α + β1 Et+1 +β2 Et+1×NSB + β3 Et+1×NMLB + β4 Et+1×OwnSB + β5 Et+1×OwnMLB + β6 Et + β7 Et×NSB + β8Et×NMLB + β9Et×OwnSB + β10Et×OwnMLB + β11 Et-1 +β12 Et-1×NSB + β13 Et-1×NMLB + β14 Et-1×OwnSB + β15 Et-1×OwnMLB + β16 Rt+1 +β17 Rt+1×NSB + β18 Rt+1×NMLB + β19 Rt+1×OwnSB + β20 Rt+1×OwnMLB + β21 NSB + β22 NMLB + β23OwnSB + β24OwnMLB + εt. Kee Chung, Carl Shen, SUNY-Buffalo

  17. Mediating Effect of Price Efficiency on the Relationship between Firm Value and Number of Short-term Blockholders Carl Shen, SUNY-Buffalo

  18. Conclusion • In this paper, we hypothesize that short-term institutional blockholders actually can benefit invested firms by disciplining the managers through trading. • First, we document a robust positive association between firm value (proxied by industry-adjusted Tobin’s q) and the number of short-term blockholders. • Second, we document that stock prices of firms with more short-term blockholders exhibit higher levels of efficiency. • Lastly, we show that the trading competition among short-term blockholders indeed increases firm value through price efficiency. • In sum, in contrast to the unfavorable images of short-term institutions depicted in previous studies, in this study we provide evidence that short-term institutions actually can add values to the invested firms by exerting exit governance. Kee Chung, Carl Shen, SUNY-Buffalo

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