The Trading Competition among Multiple Short-term Institutional Blockholders for Corporate Governanc...
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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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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-hanShen

Department of Finance and Managerial Economics

School of Management, SUNY-Buffalo


Short term institutions are bad for corporate governance

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


But good for market efficiency

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


Research question

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


Theoretical foundation

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


Hypotheses

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


Institution classification

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


What types of institutions are short term blockholders

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


How long are short term blockholders interested in the firm

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


Descriptive statistics

Descriptive Statistics

Carl Shen, SUNY-Buffalo


Kee h chung carl hsin han shen department of finance and managerial economics

Firm Value and Number of Short-term Blockholders

Carl Shen, SUNY-Buffalo


Kee h chung carl hsin han shen department of finance and managerial economics

Firm Value and Number of Short-term Blockholders – Bushee’s Classification

Carl Shen, SUNY-Buffalo


Kee h chung carl hsin han shen department of finance and managerial economics

Firm Value and Number of Short-term Blockholders – 2SLS

Carl Shen, SUNY-Buffalo


Kee h chung carl hsin han shen department of finance and managerial economics

  • Effects of Liquidity, Information Acquisition Cost and Manager Incentive on the Monitoring Effectiveness of Short-term Blockholders

Carl Shen, SUNY-Buffalo


Kee h chung carl hsin han shen department of finance and managerial economics

  • Price Efficiency and Number of Short-term Blockholders – Return Autocorrelation Magnitudes

Kee Chung, Carl Shen, SUNY-Buffalo


Kee h chung carl hsin han shen department of finance and managerial economics

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


Kee h chung carl hsin han shen department of finance and managerial economics

  • Mediating Effect of Price Efficiency on the Relationship between Firm Value and Number of Short-term Blockholders

Carl Shen, SUNY-Buffalo


Conclusion

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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