Impacts of Long-Term Investors on Over-Investment

Cristina Cella investigates whether institutional investors influence firms’ investment policies. By virtue of their significant ownership stakes and investment horizons, long-term institutional investors should closely monitor management and thus reduce agency costs.

Using a panel dataset of 2,511 U.S. manufacturing firms that went public in 1980-2003 and using several econometric specifications, she find that firms with long-term institutional investors tend to have lower capital expenditure relative to widely-held firms. Further, investment is reduced precisely in those firms that suffer mostly from over-investment. In fact, the presence of a large blockholder is associated with a reduction of capital expenditure in firms that (a) invest too much with respect to their growth opportunities, financing constraints and industry affiliation, (b) have few investment opportunities but large availability of cash-flows.

Most importantly, she finds that reduction in capital expenditure in these firms leads to improvements in firms’ profitability in subsequent years, confirming that institutional investors’ actions aimed at removing over-investment are value-enhancing. Cella concludes that an important area of further research would be to explore the circumstances of when investors prefer to use their voice, and comparing the effectiveness of voice versus exit. (Institutional Investors and Corporate Investment, 2/15/ 2010,  available at SSRN)