The Role of Institutional Investors in Corporate Governance: An Empirical Investigation

By Shivram RajgopalMohan Venkatachalam
1997| Working Paper No. 1436

Institutional investors, who now own a significant protion of equity in U.S. firms, are often described as transient and myopic owners with no incentives to involve themselves in governance. We examine the validity of this assertion by examining whether institutional owners curb managerial discretion by constraining earnings manipulation. Specifically, we investigate the relation between institutional ownership and discretionary accounting behavior, as measured by discretionary accruals. Our findings are consistent with institutional monitoring and inconsistent with institutional investors encouraging myopic management behavior. We also perform triangulatory tests that examine the capital market pricing implications of managerial discretion, across different levels of institutional ownership. Results form additional analyses further strengthen our earlier findings. Overall, we find evidence inconsistent with allegations that institutions, due to their transient disposition or otherwise, do not monitor the firms they invest in.