Institutional Investor Cliques and Governance

Alan D. Crane is Assistant Professor of Finance at the Jesse H. Jones Graduate School of Business at Rice University. This post is based on a recent paper by Professor Crane; Andrew Koch, Assistant Professor of Business Administration at the University of Pittsburgh; and Sebastien Michenaud, Assistant Professor of Finance at Kellstadt Graduate School of Business.

Do institutional investors work together to influence firm policies and governance? Researchers often think of owners as independent actors. This leads to the common view that dispersed ownership will result in poorer governance, all else equal, because small owners will not have the incentive to monitor individually (the “free rider” problem). However, in recent years it has become widely acknowledged that some investors do not act independently, but instead share information about their investment decisions and even work together to influence corporate policies in the firms they own (see, for example, Top US financial groups hold secret summits on long-termism,, February 2016).

In our paper, we examine the relationship between ownership structure and firm governance, taking into account investor interactions. We empirically identify groups of investors that are likely to be working together to influence the firms they own. We then examine how the presence of these coordinating owners relates to governance. Our results support a more complex view of the relation between ownership structure, coordination, and governance. Shareholder coordination increases governance via “voice” by overcoming the free-riding problem, consistent with Shleifer and Vishny (1986). At the same time, coordination weakens governance via threat of exit as predicted in Edmans and Manso (2011).

To identify coordinating groups of investors, we turn to recent work in networks. Theoretical and experimental research in networks supports the view that coordination is associated with complete subgraphs, known as “cliques.” Intuitively, these cliques capture groups of network members that are closely connected to all of the other members of that group. Using these insights and techniques borrowed from graph theory, we identify investor cliques in the network of institutional ownership, where network connections between institutions are driven by common equity ownership positions.

We find that there are roughly 20 of these cliques each year. The top institutional clique in each firm has a 13% stake on average. Coordinated groups, in total, own close to 30%. Overall, we find that approximately 35% of institutional investors are members of a clique and membership is persistent. Institutions that belong to cliques are most likely to be dedicated investors and least likely to be quasi-indexers (as classified by Bushee, 1998). Clique members tend to be neither large nor small in terms of assets under management, and on average they hold large stakes in firms. Institutions within the same clique tend be more similar to each other than they are to institutions outside of their clique across a variety of institutional characteristics.

Ownership structure has changed dramatically over time, particularly when taking into account coordinating groups. Despite the increase in overall levels of institutional ownership over the last 30 years, the concentration of institutional investor holdings, when measured while treating each investor as acting independently, has decreased significantly over the sample period. The median stake of a given institutional owner in a firm in recent periods is roughly five times smaller than it was in the early 1980’s. At the same time, we find that ownership by institutional investor cliques has increased significantly over this same time period. Therefore, while institutional ownership has become more dispersed, many of these owners are now more connected to one another.

We also examine proxy voting outcomes as a function of clique ownership. We find that clique members vote together, and especially against proposals that are not in shareholders’ interests. This is true even after controlling for other characteristics of ownership structure, including the overall level of institutional ownership, ownership by blockholders, ownership concentration, and ownership by different types of institutions (quasi-indexers, transient, etc.).

We then explore whether certain cliques tend to focus on specific corporate policies rather than broadly improving governance across all dimensions. We find evidence of clique “specialization” and that the presence of specialized cliques has predictive power for future firm policies. For example, a firm is 5% more likely to initiate a dividend within a year in which it is owned by a clique that specializes in dividend payouts, relative to firms that are not. We find similar results for firms owned by cliques that specialize in acquisitions and divestitures.

One particular concern with our measure of coordination is that institutions in the same clique may not work together to govern, but instead act independently based on similar information (the correlated effects problem as in Manski, 1993). We rule out this alternative by examining governance via the threat of exit. The ability to coordinate should facilitate governance via direct intervention (voice) because coordination helps overcome free-riding. However, instead of intervening, owners may take the “Wall Street walk,” the threat of which acts as a governance mechanism (Admati and Pfleiderer, 2009 and Edmans, 2009). Importantly, coordination among shareholders can have a negative effect for this type of governance. Consistent with this theoretical prediction, we find that the threat of exit is weaker when clique ownership is high, even after controlling for ownership structure and other firm characteristics. We also find that clique ownership is lower among firms with myopic managers, where the threat of exit is likely to be particularly effective.

Overall our results suggest that some investors work together to influence corporate managers. However, there is a tradeoff in the effect of coordination on governance. It improves governance through direct intervention, but it decreases the threat of exit.

The full paper is available for download here.

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