We re-examine the determinants of institutional ownership (IO) from a segmentation perspective -- i.e. accounting for a hypothesized systematic exclusion of stocks that cause high implementation or agency costs. Incorporating segmentation effects substantially improves both explained variance in IO and model parsimony (essentially requiring just one input: market capitalization). Our evidence clearly establishes a role for both implementation costs and agency considerations in explaining segmentation effects. Implementation costs bind for larger, less diversified, and higher turnover institutions. Agency costs bind for smaller institutions and clienteles sensitive to fiduciary diligence. Agency concerns dominate; characteristics relating to the agency hypothesis have far more explanatory power in identifying the cross-section of segmentation effects than characteristics relating to the implementation hypothesis. Importantly, our study finds evidence for interior optimum with respect to the institution's scale, due to the counteracting effect between implementation and agency frictions.
We then explore three implications of segmentation for the equity market. First, a mass exodus of publicly listed stocks predicted to fall outside institutions' investable universe helps explain the listing puzzle. There has been no comparable exit by institutionally investable stocks. Second, institutional segmentation can lead to narrow investment opportunity sets, which limit money managers' ability to take advantage of profitable opportunities outside their investment segment. In this respect, we construct pricing factors that are feasible (ex-ante) for institutions and benchmark their performance. We find evidence consistent with the demand-based asset pricing view. Specifically, IO return factors yield higher return premia and worsened institutional performance relative to standard benchmarks in an expanding institutional setting (pre-millennium). Third, we use our logistic model and examine the effect of aggregated segmentation on the institutions' portfolio returns. Our findings suggest that investment constraints cut profitable opportunities and restrict institutions from generating alpha. In addition, we find that stocks with abnormal institutional ownership generate significant positive returns, suggesting institution actions are informed. / Doctor of Philosophy / We demonstrate that implementation and agency frictions restrict professional money managers from ownership of particular stocks. We characterize this systematic exclusion of stocks as segmentation and show that a specification that accommodates the segmentation effect substantially improves the empirical fit of institutional demand. The adjusted R-squared increases substantially; the residuals are better behaved, and the dimensionality of institutions' demands for stock characteristics reduces from a list of 8-10 standard characteristics (e.g., market cap, liquidity, index membership, volatility, beta) to just one: a stock's market capitalization.
Our evidence identifies a prominent role for both implementation costs and agency costs as determinants of institutional segmentation. Implementation costs bind for larger, less diversified, and higher turnover institutions. Agency costs bind for smaller institutions and clienteles sensitive to fiduciary diligence. In fact, we find that segmentation arises from a trade-off between implementation costs (which bind for larger institutions) and agency considerations (which bind for smaller institutions). Agency concerns dominate; characteristics relating to the agency hypothesis have far more explanatory power in identifying the cross-section of segmentation effects than characteristics relating to the implementation hypothesis.
More importantly, we find evidence for interior optimum with respect to the institution's scale, due to the counteracting effect between implementation and agency frictions. This conclusion is important to considerations of scale economies/diseconomies in investment management. The agency story goes in the opposite direction to the conventional wisdom underlying scale arguments.
We then explore three implications of segmentation for the equity market. First, our evidence suggests that institutional segmentation coupled with growing institutional dominance in public equity markets may have had a truncating effect on the universe of listed stocks. Stocks predicted to fall outside of institutions' investable universe were common prior to the 1990s, but are now almost nonexistent. By contrast, stocks predicted to fall within institutions' investable universe have not declined over time.
Second, institutional segmentation can lead to narrow investment opportunity sets, which limit money managers' ability to take advantage of profitable opportunities outside their investment segment. In this respect, we construct pricing factors that are feasible (ex-ante) for institutions and benchmark their performance. We find evidence consistent with the demand-based asset pricing view. Specifically, feasible return factors yield higher return premia and worsened institutional performance relative to standard benchmarks in an expanding institutional setting (pre-millennium).
Third, we use logistic specification and examine the effect of aggregated segmentation on the institutions' portfolio returns. Our findings suggest that investment constraints cut profitable opportunities and restrict institutions from generating alpha. In addition, we find that stocks with high (low) abnormal institutional ownership generate significant positive (negative) returns, suggesting institution actions are informed.
| Identifer | oai:union.ndltd.org:VTETD/oai:vtechworks.lib.vt.edu:10919/111388 |
| Date | 27 July 2022 |
| Creators | Hosseinian, Amin |
| Contributors | Finance, Edelen, Roger M., Kumar, Raman, Ye, Pengfei, Paye, Bradley S., Kadlec, Gregory B. |
| Publisher | Virginia Tech |
| Source Sets | Virginia Tech Theses and Dissertation |
| Language | English |
| Detected Language | English |
| Type | Dissertation |
| Format | ETD, application/pdf, application/pdf |
| Rights | Creative Commons Attribution-ShareAlike 4.0 International, http://creativecommons.org/licenses/by-sa/4.0/ |
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