This thesis analyses several aspects of institutional investor influence in the corporate governance of UK firms. Chapter 1 introduces the thesis, and Chapter 2 provides a literature survey. The main original empirical research findings are presented in Chapters 3 to 5.Chapter 3 explores the key firm characteristics related to institutional investors. We show that institutional shareholdings, particularly those institutions with a large shareholding, are positively related to the proportion of outside directors on the board; with stock returns and with volatility. Institutional shareholdings are negatively related to the shareholdings of inside directors and firm size. Interestingly institutional shareholdings are positively related to CEO age but negatively related to the number of CEO’s years in office. This seems contradictory but it is consistent with institutional investors wanting experienced CEOs but not those individuals who have become entrenched. None of the measures proxying for the Cadbury recommendations for board structure, such as number or proportion of non-executive directors, CEO duality, or outside chair, has a significant relationship with institutional shareholdings. Chapter 4 analyses the relationship between institutional shareholdings and CEO cash-based remuneration. Uniquely to this field of research we also consider the different elements of remuneration separately to account for the timing differences relating to their award and performance criteria. First, we find that the presence of a large institutional shareholding, or high concentration of institutional shareholdings, does significantly reduce the magnitudes of salary and bonuses but they do not reduce the magnitude of benefits. However, the presence of an institutional investor, regardless of the size of their shareholding, has no relationship with the magnitude of any of the remuneration variables. Second, we find that institutional shareholdings significantly increases the positive relationship between bonus remuneration and firm performance, but that they do not have such a noticeable effect on the relationship between salary and benefits and firm performance. Third, we find that the presence of a large institutional shareholding, or high concentration of institutional shareholdings, reduces the rates of increase in salary, benefits and bonuses. Fourth, we find that the past practice of modelling salary and bonuses together can produce misleading results. We suggest that salary and bonuses should be modelled separately because they are payments for different reasons and relate to different periods of firm performance. Chapter 5 explores the influence that institutional investors have over CEO turnover. We show that the likelihood of a CEO being forced from office is negative and significantly related to firm performance and positive and significantly related to the presence of a large institutional shareholding or high concentration of institutional shareholdings. The findings in this thesis are robust to variations in research design. The conclusions are that the internal control mechanisms do work, that institutional investors are not the ‘passive’ investors often portrayed by some practitioners and early academic research and that institutional investors go to some lengths to ensure that their investee firms are properly governed.

Thesis advisor: Thomas Chemmanur / My dissertation is comprised of three chapters. In this first chapter, I study the effect of social connections on mutual fund investors' information production and accuracy of their signals. While connected investors have access to information in their social network (information diffusion effect), social connections also reduce their incentives to acquire costly information, since they can free ride on connected peers ("free riding on friends" effect). I find this negative "free riding on friends" effect of social connections dominates information diffusion effect in the mutual fund industry, using fund managers' connections built upon their prior career experiences. First, I find that connected funds are more likely to hold the same stocks and to trade in the same direction, relative to unconnected funds. Second, I find that funds with lower network centrality earn higher alphas, even after controlling for other fund and manager characteristics. A one-standard-deviation increase in eigenvector centrality predicts a decrease of 29-37 basis points in annualized fund alphas. Third, when I define a stock-level variable PMC (Peripheral minus Central) as the difference in average portfolio weights between peripheral funds and central funds, I find that stocks with higher PMC have significantly higher abnormal stock returns. A one-standard-deviation increase in PMC predicts an increase of 1.48%-1.52% in the next quarter risk-adjusted returns (annualized). Finally, I find that PMC predicts firms' future earnings surprises. In the second chapter, co-authored with Thomas Chemmanur, Yingzhen Li, and Jie Xie, we propose a "noisy signaling" hypotheses of open market share repurchase (OMSR) programs, where the equity market equilibrium that prevails after OMSR program announcements is a partial pooling rather than a fully separating equilibrium. We argue that two complementary mechanisms, namely, actual share repurchases by firms and information production by institutions, serve to reduce the residual equity market information asymmetry facing firms subsequent to OMSR program announcements. We test the implications of this noisy signaling hypothesis using transaction-level data on trading by institutions and by a subsample of identified hedge funds, and find strong support for the above hypothesis. In the third chapter, co-authored with Thomas Chemmanur, and Jiekun Huang, we analyze how the geographical locations of institutions affect their investments in IPOs and various characteristics of the IPOs that they invest in. We argue that institutions geographically close to each other may free-ride on each other's information when evaluating IPOs, resulting in IPOs dominated by geographically clustered institutions reflecting less accurate information signals compared to those dominated by geographically dispersed institutions. We find that the equity holdings of institutions in IPOs are influenced more by the investments made by neighboring institutions. We show that an increase in the geographical dispersion of the institutions investing in an IPO is associated with higher IPO price revisions, higher firm valuations at offering and secondary market, larger IPO initial returns, greater long-run post-IPO stock returns lower information asymmetry facing an IPO firm in the equity market. Finally, the predictive power of institutional trading post-IPO for subsequent long-run stock returns and earnings surprises for the first fiscal-year end after the IPO is greater for geographically isolated institutions compared to those that are geographically clustered. / Thesis (PhD) — Boston College, 2017. / Submitted to: Boston College. Carroll School of Management. / Discipline: Finance.

Thesis advisor: Edith Hotchkiss / Chapter one of this dissertation provides new evidence on the existence of dividend clienteles for institutional investors. We directly examine individual institutions' preferences for dividend paying stocks based on the characteristics of stocks held in their portfolio. Many institutions follow persistent investment styles, maintaining relatively high or low dividend yield portfolios over time. Institutions which hold portfolios of higher yielding stocks are significantly more likely to increase their holdings in response to a dividend increase or sell their stock in response to a decrease. For a subset of institutions, we directly observe the proportion of their portfolio managed on behalf of taxable clients. Consistent with tax-induced dividend clienteles, institutions with more taxable clients are less likely to increase their holdings in response to a dividend increase. Finally, we show that stock price reactions to announcements of dividend increases are related to characteristics of the institutions holding the stock. Our results suggest that tax status, as well as other factors are important in explaining observed clientele behavior. Chapter two explores the determinants of heterogeneity in institutional investor portfolio preferences and the relationship between institutions and the clients they serve. I find that the characteristics of an institution's clients and the characteristics of the institution itself are both important determinants of portfolio preferences and trading behavior. Specifically, I find that institutions traditionally subject to prudent investor laws are more likely to invest in high quality stocks, although, institutions sub-managing money for pension funds are less prudent than pension managers themselves. In addition, I find that institutions with taxable clients are likely to avoid unnecessary dividend taxation and turn over their portfolios less frequently. More generally, institutions exhibit systematic shifts in their exposure to common risk factors that may be explained in part by the levels and changes in client composition. While evidence for a causal link between client shifts and institutional preferences is limited to mutual funds, contemporaneous changes in clients and portfolio characteristics suggest that the dynamics of institutional investment are closely related to the nature of the clients served. / Thesis (PhD) — Boston College, 2007. / Submitted to: Boston College. Carroll School of Management. / Discipline: Finance.

The objective of this dissertation is to investigate the impact of important market participants such as Mutual Funds, Hedge Funds and the Federal Reserve Bank on the equilibrium equity premium, risk free rate and asset volatility and to analyze the effect of these institutions on risk shifting, portfolio allocation and financial stability. Specific features of institutional investors and central banks as well as their role in financial markets are reviewed and analyzed in Chapter 1. In Chapter 2, it is shown that the competitive pressure to beat a benchmark may induce institutional trading behavior that exposes retail investors to tail risk. In our model, institutional investors are different from a retail investor because they derive higher utility when they outperform the benchmark. This forces institutions to take on leverage to over-invest in the benchmark. Institutions execute fire sales when the benchmark asset experiences negative shocks. This behavior increases market volatility, raising the tail risk exposure of the retail investor. Nevertheless, ex-post, tail risk is only short lived, all investors survive in the long run under standard conditions, and the most patient investor dominates in the sense that she has the highest consumption wealth ratio. Ex-ante, however, benchmarking is welfare reducing for the retail investor, and beneficial only to the impatient institutional investor. Chapter 3 presents an analysis on how monetary authorities seeking to stabilize inflation, output and smooth interest rates distort the term structure of interest rates and prices of risk relative to an economy where central authorities adjust the money supply without taking into consideration the slope of the yield curve. Closed-form expressions for all equilibrium quantities are presented and the impact of quantitative easing on prices, risk premium and volatility of financial markets instruments, such as stocks and bonds, are evaluated. The changes in macroeconomic variables such as consumption, money demand and investment policies are also investigated. Under the adopted parametrization, quantitative easing is welfare improving. In addition, quantitative easing increases nominal bond and equity volatility, while reducing both real and nominal bond yields for all maturities.

This dissertation contains five research projects within the context of two distinctive issues that concern the effectiveness of executive compensation in aligning executive interests with shareholders and how institutional investors play a role in structuring corporate governance mechanisms. The objective of this dissertation is to first determine how institutions should exert their influence if they are serious about alleviating agency problems and improving firm performance. Second, the thesis seeks to determine whether institutional investors use their influence to shape executive compensation and corporate governance mechanisms in a manner consistent with aligning managerial interests with shareholders and increasing shareholder wealth. The thesis finds that CEOs with option incentives increase the likelihood that a firm will increase risk by undertaking both major real investments and acquisitions. Moreover, CEO option grants are positively related to measures of firm valuation and operating performance suggesting option incentives are an important mechanism to align CEO interests with shareholders. This is robust to alternative measures of firm valuation and operating performance, also various estimation techniques. Using these findings to motivate the direction of institutional influence on executive compensation, it is found that institutional investors, particularly smaller activist traders, significantly increase option grant incentives received by executives. Institutional influence also raises CEO pay which is consistent with preservation of reservation CEO utility levels. Addressing the role of institutional investors in the context of other corporate governance mechanisms, it is found that institutional investor influence is also negatively related to board size and positively related to board independence, which is achieved by removal of inside directors. Such actions are consistent with empirical studies that show smaller boards and increased levels of independent directors improve firm performance and board decision making. The main conclusion from this dissertation is that option incentives are an effective mechanism to align CEO interests with those of shareholders. Institutional investors appear to recognise this importance, and effectively use their influence to increase options received by executives. Combined with institutional investors putting in place corporate boards that provide better oversight of management, institutional investors appear to be effective monitors of the firms in which they invest.

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Two essays on the stock preference and performance of institutional investors are included in the dissertation. In the first essay, I document that mutual fund managers and other institutional investors tend to hold stocks with higher betas. This effect holds even after precisely controlling for stocks’ risk characteristics such as size, book-to-market equity ratio and momentum. This is contrary to the widely accepted view that betas are no longer associated with expected returns. However, these results support my simple model where a fund manager’s payoff function depends on returns in excess of a benchmark. For the manager, on the one hand, he tends to load up with high beta stocks since he wants to co-move with the market and other factors as much as possible. On the other hand, the manager faces a trade-off between expected performance and the volatility of tracking error. My model thus shows that the manager prefers to choose higher beta than his benchmark, and that his beta choice has an optimal level which depends on his perceived factor returns and volatility. My empirical findings further confirm the model results. First, I show that the effect of managers holding higher beta stocks is robust to a number of alternative explanations including the effects of their liquidity selection or trading activities. Second, consistent with the model predictions of managers sticking close to their benchmarks during risky periods, I demonstrate that the average beta choice of mutual fund managers can predict future market volatility, even after controlling for other common volatility predictors, such as lagged volatility and implied volatility. The second essay is the first to explicitly address the performance of actively managed mutual funds conditioned on investor sentiment. Almost all fund size quintiles subsequently outperform the market when sentiment is low while all of them underperform the market when sentiment is high. This also holds true after adjusting the fund returns by various performance benchmarks. I further show that the impact of investor sentiment on fund performance is mostly due to small investor sentiment. These findings can partially validate the existence of actively managed mutual funds which underperform the market overall (Gruber 1996). In addition, when conditioning on investor sentiment, the pattern of decreasing returns to scale in mutual funds, recently documented in Chen, Hong, Huang, and Kubik (2004), is fully reversed when sentiment is high while the pattern persists and is more pronounced when sentiment is low. Further results suggest that smaller funds tend to hold smaller stocks, which is shown to drive the above patterns. I also document that smaller funds have more sentiment timing ability or feasibility than larger funds. These findings have many important implications including persistence of fund performance which may not exist under conventional performance measures. / text

High quality financial reporting is critically important for bank regulation, particularly market discipline, but limited evidence exists on why banks provide different levels of financial reporting quality. I examine whether institutional investors and financial analysts impact bank financial reporting quality. Although I find no impact of analysts on bank financial reporting quality, institutional ownership is positively associated with financial reporting quality, and this relation is strongest for banks with high information asymmetry and for “monitoring” institutional investors. Institutional investors also sell shares following the announcement of a restatement, suggesting they are willing to use the threat of exit as a mechanism to influence bank managers and demand financial reporting quality. Finally, I find institutional investors demand financial reporting quality primarily for high risk banks and also reduce ex-ante bank risk and ex-post non-performing loans. Collectively, these results suggest institutional investors are an important component of bank governance. / text

This dissertation contains five research projects within the context of two distinctive issues that concern the effectiveness of executive compensation in aligning executive interests with shareholders and how institutional investors play a role in structuring corporate governance mechanisms. The objective of this dissertation is to first determine how institutions should exert their influence if they are serious about alleviating agency problems and improving firm performance. Second, the thesis seeks to determine whether institutional investors use their influence to shape executive compensation and corporate governance mechanisms in a manner consistent with aligning managerial interests with shareholders and increasing shareholder wealth. The thesis finds that CEOs with option incentives increase the likelihood that a firm will increase risk by undertaking both major real investments and acquisitions. Moreover, CEO option grants are positively related to measures of firm valuation and operating performance suggesting option incentives are an important mechanism to align CEO interests with shareholders. This is robust to alternative measures of firm valuation and operating performance, also various estimation techniques. Using these findings to motivate the direction of institutional influence on executive compensation, it is found that institutional investors, particularly smaller activist traders, significantly increase option grant incentives received by executives. Institutional influence also raises CEO pay which is consistent with preservation of reservation CEO utility levels. Addressing the role of institutional investors in the context of other corporate governance mechanisms, it is found that institutional investor influence is also negatively related to board size and positively related to board independence, which is achieved by removal of inside directors. Such actions are consistent with empirical studies that show smaller boards and increased levels of independent directors improve firm performance and board decision making. The main conclusion from this dissertation is that option incentives are an effective mechanism to align CEO interests with those of shareholders. Institutional investors appear to recognise this importance, and effectively use their influence to increase options received by executives. Combined with institutional investors putting in place corporate boards that provide better oversight of management, institutional investors appear to be effective monitors of the firms in which they invest.