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E-MailVivek Astvansh is an Associate Professor of Quantitative Marketing and Analytics at McGill University’s Desautels Faculty of Management. Tao Chen is an Associate Professor in Finance at Nanyang Business School, Singapore. Jimmy “Chengyuan” Qu earned his Ph.D. in Finance from Nanyang Business School, Singapore. This post is based on their recent paper. Related research from the Program on Corporate Governance includes Index Funds and the Future of Corporate Governance: Theory, Evidence and Policy (discussed on the Forum here) by Lucian A. Bebchuk and Scott Hirst; New Evidence, Proofs, and Legal Theories on Horizontal Shareholding (discussed on the Forum here); and Horizontal Shareholding (discussed on the Forum here) both by Einer Elhauge.
The world is becoming richer. Not in resources but in the stimuli it offers to individuals and organizations. Consequently, we are living in the attention economy—that is, attention is becoming increasingly scarce, and we ought to preserve it, lest we distract ourselves away from events that truly matter.
Our forthcoming research article in PLOS ONE applies this intuition to the context of institutional investors’ concurrent holding of blocks of stocks of multiple companies in the same industry—a phenomenon called institutional cross-blockholding. While academics have shown that institutional cross-blockholding of a company’s stock impacts its financial performance, little is known about whether—and if yes, how and why—cross-blockholding affects the company’s social performance. Our research fills this consequential gap in academics’ and practitioners’ knowledge.
Two competing lines of logic guide our research. First, research has shown that institutional investors prefer to hold stocks of socially responsible companies and engage in their portfolio company’s corporate social responsibility (CSR) activities. Therefore, the larger the institutional cross-blockholding of a company’s stocks, the more motivated the company’s managers should be to keep the investors lest the latter redirect their investments to the focal company’s industry peers. Relatedly, institutional crossblockholding lowers outside pressure on managers, leaving them with more resources to boost their social performance. Lastly, by virtue of holding stocks of companies within an industry, investors become more efficient to govern the portfolio companies’ social performance. Collectively, this line of logic suggests that institutional cross-blockholding of a company’s stock boosts its social performance.
On the other hand, investors’ attention is a limited resource. With an increase in the number of companies in an industry whose stocks investors hold, their per-company attention decreases. Relatedly, investors pay attention to a portfolio company’s multiple activities. Because CSR activities are less tangible (than activities in product or financial markets) and their returns manifest in longer-term, the increase in cross-blockholding may lower investors’ attention to a portfolio company’s CSR activities. That is, institutional cross-blockholding may lead to investor distraction, which may impede a portfolio company’s social performance.
We tested these two lines of reasoning on a sample of 13,112 U.S. public company-year observations from 1995-2014. Regression estimates show that the higher the number of institutional investors that concurrently hold blocks of stocks in a company’s industry peers, the lower the focal company’s social performance rating. That is, the evidence supports distraction hypothesis. Next, we use a quasi-natural experiment to provide causal evidence. We consider mergers between institutional blockholders as an exogenous shock to portfolio companies. Propensity-score matching followed by difference-in-differences regression reports a significantly lower social performance rating in post-merger years for companies affected by the merger, relative to their unaffected peers.
A company’s social performance rating is the net of its goodness and “badness.” Therefore, we separate a company’s social performance rating into its goodness rating and badness rating. We find that cross-blockholding increases a company’s “badness” rating, while not impacting its goodness rating. Next, we decompose badness rating into its five dimensions: workforce diversity, employee relations, product quality, community, and natural environment. Results suggest that the drop in the company’s social performance rating manifests on the first three dimensions and not the last two. This finding is consistent with research that shows that investors are likely to be more punitive if a company’s performance on community and environment dimensions worsens. Therefore, the company’s managers lower their activities that boost the company’s performance on workforce diversity, employee relations, and product quality.
We test our distraction explanation in two ways.
First, we report that following a merger of blockholders, an affected company (versus a comparable unaffected company) receives lower search volume in Securities and Exchange Commission’s (SEC’s) Electronic Data Gathering, Analysis, and Retrieval (EDGAR) database. Further, the decline in search volume is greater for nonfinancial (vs. financial) filings, further supporting our argument that investors pay less attention to the portfolio company’s nonfinancial/social activities.
Second, a company whose stock is cross-blockheld (vs. a comparable company whose stock is not cross-blockheld) receives fewer shareholder proposals for socially responsible investment.
Our research alerts institutional investors of an unintended consequence of cross-blockholding. We also inform managers of portfolio companies that investor distraction may be damaging their social performance. More generally, we remind business stakeholders of the interlinkages between financial stakeholders and social performance.
