Institutional investors have been a debatable issue and generated various investigations over the years. Research has established that the institutional investors are the dominant holder of assets in companies. However, their being so influential does not necessarily mean that their involvement would lead to higher financial performance by companies. This research paper focuses on the effect of the involvement of institutional investors on the financial performance of the companies. Financial Performance in this research paper is used as a barometer to indicate how a company can administer its assets to either improve or deteriorate its financial health. Higher financial performance of a firm would lead to better investment returns, which is the major interest of investor classes and in particular institutional investors. The research paper will attempt to point out the pros and cons of the influence of institutional investors on firms which have a bearing on financial performances.
Jill Solomon aptly suggests that institutional investors are the connection between shareholders and the companies in which they invest. They play a crucial role in the performance of the financial markets. Economic theory suggests that institutional investors contrast individual investors on the financial markets. UK specific, she points out that institutional investors are organizations that put in huge amounts of money in the shares and other financial assets of companies, home or foreign.
The most important type of institutional investors are Pension funds. The international institutional investors by investing money in companies help in the global movement of money.
Institutional investors differ among each other in their risk taking appetites as well as positioning themselves for maximum planned returns. They deal with enormous volumes of shares and hence, their influence on the movements of stock markets is implied. This paper will mainly focus on pension funds as they have been the most prominent among the institutional investors. In the past thirty years, shareholding has been highly concentrated in institutional investors. Among the institutional investors, the private and public pension funds are highly important.
Institutional investors, as compared to individual shareholders are more influential and have better resources. They relate mostly to firm level performance. They study the portfolio holdings of institutions in firms thereby influencing the corporate performance. Governance at firm level is directly proportional to global institutional investment.
The first part of the research paper describes the increasing influence of the institutional investors over the years. It then discusses the investment patterns of certain types of investors, in order to get a brief view of the various strategies used by the investors. Further, it goes on to the second part, where it tries to prove corporate governance as the link, between institutional investors and financial performance. Over the years this link has become stronger but not necessarily beneficial. The third part deals with the merits and demerits of institutional investors and their inferences. Finally, the paper analyzes the various ways of effective leverage of power by the institutional investors.
It has been observed that the recent trend is towards increasing shareholding by institutional investors as opposed to individual shareholders. The influence of institutional investors in UK is self evident, as more than 40% of the worth of shares, in the hands of all institutional investors, is managed by the topmost 25 institutional investors. Section 5 of the Hampel Report stated that: It is generally implicit that the power of share holders in corporate governance mainly concerns institutional investors, this is more prominent in the case of UK institutions. Since institutional investors like pension funds, unit and investment trusts as well as insurance companies, garner major portion of shares in UK companies, i.e. 60%. Of the balance, 40%, 20% are held by individuals, and high net worth individuals and 20% by foreign investors. As is evident by sheer strength of numbers, institutional investors have a greater say. (ss.5.1). Hampel report ss.5.2, amplifies the diversion in the activities of institutional investors, from drawing board policies to active participation in corporate firms .
In the US, there has been a gradual but visible change in asset composition between 1991- 1999. Exponential increase in equity prices are partly a reflection of the value of equity investments, as such in the period from 1991 – 1999 in the US the value of equity investments grew 18% on an average. Bonds registered a growth of 9%, whereas loans showed a modest 3% growth. When seen against volume of assets of institutional investors which grew to $19279 Billion in 1999, which was triple of its value from 1991, hence the shift in asset allocation is evident from the various percentage growths as to the favoured investment engines. Pension funds in the US are the leading institutional investors which recorded an year on year increase of 15% from 1991-99, during this boom period investment companies assets rose from $ 1376 Billion to $6289 Billion.
In the United Kingdom, the role of the institutional investors came to the limelight in 1973 with the Institutional Shareholders Committee. The leading class of institutional investors in the UK is the pension funds. 1994 figures for UK reveled that almost 66 billion pounds of all occupational pension fund assets was managed by mainly five pension funds. Since then pension fund assets have further grown in leaps and bounds.
The work of institutional investors has been applauded as they lead to higher financial performance of firms by using modes such as voting, engagement and dialogue, but at the same time they have also been criticized for emphasis on short–termism. As has been explained in the myopic institutions theory (Hansen and Hill, 1991) that institutional investors in the long run become more short sighted than the individual shareholders. The reason for this is the competition for accounts and their standing on the basis of their performance.[10}
This research paper attempts to give clarity to the influence of the institutional investors (mainly the pension funds) on firms. It lays foundation to the fact that institutional investors wield a greater influence than individual shareholders, in terms of their resources and the ways in which they could influence the firms. These resources if used progressively would definitely strengthen the companies' work ethics and long term strategies, consequently resulting in better governance.
Investment Patterns of Institutional Investors.
Mutual Funds comprise of cross section of investors who contribute to create a common pool of funds investing in securities e.g. stocks, bonds, money market instruments and similar assets. These funds are run competently by qualified fund managers, who strictly follow the norms of investment objectives of their prospectus. The fund managers deploy the funds capital after due diligence with an aim to create capital gains for the investors.[11} While those securities which are profitable but are not actively managed are lapped up by Unit Investment Trusts who in turn sell the shares held by the trusts to potential investors. These UIT are registered investment companies. However, there are certain differences between the Unit Investment Trust and Mutual Fund, the most significant one being the active management of the mutual fund, whereas a Unit Investment Trust is self governing. In the UIT shareholders receive the benefits accrued on the capital, interest and bonus from the trust at the designated periods. The proceeds of the trust would be tax free, in case the trust is investing in only tax free securities. Both risk and return in case of the Unit Investment Trust are usually low. However, sometimes UITs are preferable to mutual funds as their yearly working costs are lower than mutual funds, nonetheless, they frequently charge on sales and have fees for entrance or exit.[12} Then, there are those firms which are created to hold securities of other firms who raise their capital from public issue of shares which are traded on the stock exchanges; these are known as Investment Trusts. These institutional investors issue a fixed number of shares (traded at a discount on their net present value) which are bought by new investors from the existing share holders. These are closed ended funds. In this a unit holder is not a share holder of the unit trust and these units are not shares but qualify the interest of the investor in the unit trust's investment portfolio.[13}
Other high value institutional investors who have deep pockets for investment in the markets are Hedge Funds. These funds are highly flexible and opportunistic. They resort to various investment techniques to ensure high returns. Due to their flexibility they move into safe havens of options or bonds in a volatile market, or play the market by taking long or short positions in trade as well as use arbitrage while also using every opportunity to buy and sell undervalued securities. The main strategy of Hedge Funds is to preserve their capital and ensure positive returns in both uptrend and downtrend in markets. These funds have a very large flow of capital and can deploy large quantities of capital in the markets, they are very informed investors.[14}
Hedge funds have distinctive strategies in their investment appetite; the risk and return level vary for each strategy. For example, a macro hedge fund is volatile but has a higher return potential, they dabble in stock and bond markets, currencies, hoping to profit from global shifts in interest rates and various countries' economic policies. Then there are distressed – securities hedge funds that buy the equity or debt of companies entering or leaving behind financial suffering, these are conservative funds. While short selling in the equity markets are resorted to by Equity hedge funds. To shot sell in the equity markets the fund managers identify overvalued stocks or stock indexes, however such funds are either global or deal with in a particular country.
As per Davies, the pension funds work by first pooling the funds of beneficiaries and sponsors, then investing the same in order to make available pension for these beneficiaries in the future. It is indeed a kind of good for the society, as, in this way, the beneficiaries can accumulate their savings in their productive years, i.e., during their working period which is their safety factor/cushion after retirement. The big companies, public corporations, industry or trade groups usually come up with the sponsorships. Pension funds are assumed to be the choice of investors.
Life insurance companies have now emerged as major players in the market. Though their basic purpose was to provide insurance cover but they have diversified their products by giving long term home loans and pension schemes. By virtue of their products having a long term span life insurance companies are able to remain in the market with a long term view, thereby providing stability and not indulging in short-termism.
Of the above mentioned institutional investors, pension funds and life insurance companies seem to be most beneficial and stable for individual investors. Both in their own way aspire for the good of society. Although the basis of working of all institutional investors is returns, but, the pension funds and insurance companies tend to be the support engine for the vehicle of which the individual investors are passengers. They provide long term assurance to the investors.
A well governed company will always give better returns. Since the institutional investors are the major share holders, it is prudent for them to keenly monitor them. Institutional investors are influential because of share volume – this volume is attained through pooling from individuals, who pool in with the aim to get better returns. Institutional investors are better placed than banks and individual shareholder for equity as well as corporate bond financing. With a better network and research facilities at their disposal these institutional investors take informed decisions hence lend value to individual patrons, especially in countries where these individuals are not given strong legal protection.
The growing corporate governance role of institutional investors manifests itself in three ways:
First, equity and debt are the route taken by institutional investors to attain greater market control. This greater control gives them a ticket to increase their influence with companies and push for better reforms in corporate governance. Keeping the fund managers under the scanner allows them to take a call during take over battles to sell shares, if they are reasonably convinced that such a move will improve the performance of the company.
Second, post 1980, corporate governance has undergone a change, with intuitional investors having a greater say by virtue of enhanced control via the equity route. Whereby, though they have this influence they remain mostly passive investors as certain categories of intuitional investors are prohibited by regulations to exert dominant influence over the management of companies. A case in point is, where European insurance companies are restricted not to acquire dominant influence in business other than their own. There by, deducing that institutional ownership does not necessarily influence corporate governance as a rule.
Third, in Europe and Japan corporate control is exercised via debt. For this in countries like Germany and Japan maximum loans by pension funds are routed through banks or arranged by them. Thereby, placing the banks in the drivers seat and making them the watch dogs as external financers to monitor the management.
The role played by institutional investors depends from country to country. In countries where individual investors are not given enough legal protection the only escape route is institutional investors. They remain the major mode to monitor the management. Even though, in some cases, they might not be very influential but their presence itself keeps the management aware of an external checker to whom they are accountable, otherwise it would be a tough task for the individual investors to hold the management accountable.
Institutional investors vary in their investment strategies from conservative to aggressive. Importantly using indexation of markets, some funds are managed actively while others are passive in their strategies. Maximum institutional investors tend to use professional fund managers who are the points men in the institutional investors commitment in the financial market. 
CORPORATE GOVERNANCE THE LINK BETWEEN INSTITUTIONAL INVESTORS AND HIGHER FINANCIAL PERFORMANCE.
This part of the research paper aims to prove how corporate governance acts as the link between institutional investors and financial performance. If the institutional investors do their duty prudently and effectively, then the structure of corporate governance of companies would become responsive and efficient, which would lead to higher financial performance.
Higher risks in the financial markets are a consequence of bad corporate governance. Shareholder activism is definitely an effective mode of checking this problem. Particularly, when it comes to a powerful group like institutional investors, who wield much more power and resources, the system of checks and balances definitely ensures greater responsiveness. The Cadbury Report giving attention to Institutional investors insisted that, they, by virtue of being major share holders in the company, resort to suggest changes in standards of corporate governance. These suggestions of change are dictated by the commitment of these institutions to their beneficiaries or whosoever whose money is being invested, in ensuring positive changes in the governance of companies as opposed to selling their shares.
It is a known fact that poor corporate governance bears witness to major historic examples of corporate failures, be it Maxwell, Parmalat or Enron. The financial sheets of Enron were always doctored. It was like a bubble built on off- balance sheets that finally burst. Such creative accounting leads to misleading financial information, resulting in information asymmetry. If these firms would have been monitored effectively with the corporate governance in place, then probably such massive downfalls could have been averted.
However, principal focus of the activist shareholders is on firms with poor performance, thereby trying to compel the management of such firms to enhance their corporate performance, consequently improving shareholder value. Institutional investors as equity holders have gained great importance in the U.S. markets. As per research, equity ownership of large institutions augmented from 24.2% to almost touching 50% between the period from 1980 -1994. It is noteworthy that this boost has mainly been attributed to the expansion of pension assets.
As has been mentioned above, institutional investors who are well versed with their duties would not only focus on high performing firms but also on the firms with good potential whose performance is poor. Even though the motive might be to increase investor returns, but ultimately it would lead to better governance and in a spin-off result in higher financial performance of the firms.
The impact of institutional investors has always been a debatable topic. The positive impacts of activism are the flag bearer for the proponents of activism. They argue that the methods used to target the firms is to enhance monitoring of the management, thereby implying that better monitoring would produce results that would be valuable to investors as well as help the company to be financially solvent. Investors with sizable stakes in a reputed company are more motivated to take on monitoring activities, as it would be possible for them to offset the costs incurred for monitoring by the higher investment returns obtained by astute monitoring. The proponents also assert the fact that the activists focus on long-termism of firms thereby helping the management to perk up long-term performance. Conversely the opponents to the positive view argue that in the case of pension funds, they do not have sufficient expertise to advise corporate management. Authors like Murphy and Van Nuys (1994) raise their apprehension on the incentive structure on the pension funds and express their surprise to the fact that these funds are even engaged in this activity. Their research has also shown that, the statistics on shareholder activism consisted of 2042 proxy proposals made by shareholders on the governance of corporations which were submitted at 452 companies from 1987 to 1994.
It has been seen that the incentive arrangement of the pension funds is not a sufficient reason to get them actively involved in the monitoring activity. But, the fact that their main job is to attract more clients can be given effect to only if they show higher returns, which can be genuinely attained by better monitoring of companies which in turn leads to better governance. This in itself incentivizes them to perform their duty towards the actual beneficiaries well.
An acceptable fact is that, if the boards are not effectively monitored by fund managers then the boards might start working for the management and become passive in their approach. All this can be avoided by effective corporate governance of which institutional investors are a part. They can use their influence to force managers to allocate profits to the shareholders. Legal enforcement of rights is definitely more feasible for institutional investors. However, there is sometimes a possibility of the larger investors superseding the interests of the minority investors for their private motives. In agreement with the above view, it has been found that those firms would be more successful, in which, up to 5% of the stake is held by shareholders. The 5% limit is enforced by regulation or a reason to remain liquid. This particular condition is to garner better returns.
The large blocks held by institutional investors and the power enjoyed by them brings with itself more of responsibility. Their actions and monitoring role is now more closely scrutinized. Empirical work on corporate governance has shown that the 5% limit criterion is the right figure to encourage corporate performance. By improving corporate governance, the institutional investors help in boosting an overall corporate sector performance. 
Pack of stocks in the New York Stock Exchange, studied over a period of a yearly time frame, which receives maximum increase in institutional ownership is seen to show higher returns by over 28% than the pack of those stocks that register a decrease in institutional ownership. This high percentage of returns lends credence to the theory that institutional ownership and returns are directly proportional to each other. Similarly, mutual funds too, show the same connection when analyzed quarterly. However, numerous studies have been unable to establish the link between this positive sway between variations in institutional ownership and returns, lending credence to the hypothesis. (1) Institutional buying of stocks create price pressure, which, in turn, pushes up the prices; (2) Institutional investors invest on the prevalent trends, thereby, taking advantage of the momentum; and (3) Institutions are better informed allowing them to successfully forecast inter period returns. 
The price pressure hypothesis is basically governed by the demand and supply of shares which forms a basis for this hypothesis to take effect. Some stocks are on the possession radar of a number of institutions when they are not hampered by availability of shares. As per price pressure hypothesis price enhancement is a result of higher demand caused by this buying. The price increase as a result of buying by large institutions cannot be countermanded by resorting to selling by individuals and smaller institutions. The liquidity hypothesis deduces that institutional trading may impact prices. Large institutions initiate trades to displace small investors or individuals, these high net worth institutional investors receive price concessions as compensation. (The "liquidity hypothesis"). Liquidity and fluctuations in value is consistent as per studies by Grossman and Miller (1988) and Stoll (1978). Besides this the volume of shares and the trading experience make the institutional investors better informed (the "informed trading hypothesis"). The microstructure models give credence to the pattern. Looking into the informed trading it has been found that higher institutional ownership leads to lower post earning. This is further strengthened by research, which sufficiently clears that the price volatility of firms is lower when the institutional possession is high. Nofsinger and Sias (1999) and Chakravarty (2000) have deduced that daily fluctuations in the value of securities are caused by daily changing hands by the institutions when studied over a quarter.
The informed trading hypothesis qualifies that the institutional investors have more information and hence, forecast intra-period returns successfully justifying the higher values as a result of institutional ownership changing hands. Hence, their purchase of stocks should give higher returns than those they sell. Link has been established between institutional demand and returns, giving substance to the fact that institutional investors can forecast returns.
As per Long, Shleifer, Summers, and Waldmann, 1990; Cutler, Poterba, and Summers, 1990; Hong and Stein, 1999, smart investors indulge in trading strategies which are derived from positive feedback. Also as suggested institutional investors purchase or sell stocks, performance based. (e.g.Grinblatt, Titman, and Wermers, 1995; Wermers, 1999, 2000; Nofsinger and Sias, 1999; Cai, Kaul, and Zheng, 2000). As daily data on institutional holdings in not available and ownership changes are only visible at the end of three months, an intelligent guess can only estimate proportions between the returns and changes in ownership over a truncated time frame. It has also been stated by Agrawal and Knoeber, large block of shares held by institutions, can lead to effective disciplining monitoring and thereby improving the firm's performance.
One of the examples of activist shareholders has been given by way of reference to CalPERS (California Public Employees Retirement System). During the initial stages (i.e. from 1987-1988) when CalPERS started targeting the governance structures of firms, barely around 7% either adopted the resolution made or made changes with a view to come to an agreement. But these resolutions were related to takeovers and as a result of the almost negligible outcome, CalPERS switched over to performance related resolutions. It was seen in the period from 1989 to 1993, that the resolution was either adopted or the target of the first year was settled by 72% of the firms. The consequences of activism on the investment of the shareholders is usually reliant on the result of targeting. This amply shows the important role played by institutional investors.
A firm's performance is directly proportional to the managements' governance skills. The expertise and skills of the management are multidimensional which are honed through experience, professionalism in keeping the interests of the firm first and foremost. Proper governance, even if does not lead to value creation, can definitely avoid value destruction. Mc Kinsey and Company which had been working with institutional investors for years with the idea of pegging a precise number for the value credited by them to governance finally produced results in July 2000 which ranged from 20 to 40% of value.
The relation between corporate governance and the financial performance of a firm is self evident. The better the governance mechanisms and strategies, the higher would be the financial performance. It might take time for the financial performance to improve but it would definitely be a stronger foundation that would be long term. However, good corporate governance cannot be achieved by a company all by itself. If the company is left to itself then the managers and directors will end up pursuing their interests prior to others' interests and in the long run the company would go bust. It would be like a class without a teacher. Hence, institutional investors are those teachers who monitor the class effectively and make sure their class i.e., the company ultimately performs well.
MERITS AND DEMERITS OF INSTITUTIONAL INVESTORS
Institutional investors have an edge over individual investors and banks in numerous ways, but, not without disadvantages. This part of the paper would discuss both the pros and cons of institutional investment. As has been very aptly stated by Prof. Clarke: "As the power of the institutions expands further they could either become an irresistible force for further economic instability induced by short-termism, or they could impress upon markets and companies longer-term horizons, and the pursuit of sustainability." 
The example of Deutsche Asset Management which changed their vote based on a phone call from a CEO that her merger plans were scuttled due to their negative votes and she was constrained to point out of her business interests with Deutsche Asset managements' mother company, shows the ineffectiveness of institutional investors.
Institutional investors are definitely considered to be a strong corporate governance mechanism to keep a check on company management, as they have considerable amount of clout to influence the company management and can bring in line the interests of management with those of the shareholder groups. However, by virtue of this influence they have greater access to privileged information which is not available with the shareholder giving them an unfair advantage. Some academicians like Agrawal and Knoeber (1996) believe that investor involvement can boost the financial performance of the firm.
In certain quarters, it is perceived that agency problems arising are the creation of Institutional investors, while it is debatable, it must be realized that they are the ones who can end the same. These institutional investors control large blocks of shares which often results in gap between ownership and control. The advantages outweigh the disadvantages as concentrated ownership block enforces better monitoring of companies which in turn helps to come over the agency issue. However, accountability is another issue reported from time to time. For greater transparency, a new city code has been published in the UK that directs fund managers and foreign investors to come out clean as to their use of due diligence in their monitoring activities. The Stewardship Code, produced by the Financial Reporting Council (FRC), will lay down investors' responsibilities.
- Institutional investors are required to post on their websites as to how they are meeting the provisions of the code. Based on which the Financial Services Authority will decide whether to enforce authorized asset mangers on a "comply or explain" basis.
- The fund managers will attend the general meetings of the companies and ensure that the company boards and committee structures are effective, independent directors perform, including meeting the chairman and other board members where necessary. Ensuring first hand information and greater involvement.
- Records of all personal meetings with companies and their voting considerations relating to shareholders will be kept. So that corrective actions are taken to avoid shareholder losses.
- This also is required from foreign and overseas investors. Also UK-based asset managers are required to comply with regard to their overseas holdings.
However, this Code would not be enough to justify that institutional investors would do their job properly. The Operating and Financial Review which would have been useful for the stakeholders was never allowed to be made mandatory. Hence, it is very difficult to judge how far the recommendations made by the code would be effective.
The real beneficiaries are not the institutional investors (pension funds), but the customers who pool in their money. This makes their position suspicious, and their duty to ensure that the investment returns are maximized is more serious than it seems to be as their reputation is at stake. But this does not end the dilemma that the shareholders are faced with. They have to keep a constant check on the managers as well as watch the actions of the institutional investors. This brings about an additional layer of agency problem. Moreover the situation in case of pension funds is different from other institutional investors, because pension funds have a group of pension trustees whose fiduciary duty is to ensure the ultimate maximization of the pension.
The result of the presence of such intermediaries is immense emphasis on short-termism, so as to make the investment returns look highly attractive. In order to do this, the intermediaries make use of their influence to pressurize the management of companies, thereby causing harm to the long term survival of the company (Graves and Waddock,1990, 76-77). However, as has been mentioned in a recent publication, 'Tomorrow's Owners-Stewardship of Tomorrow's Company', the main motive of institutional investors is their sustainability, as there are two effects to this, either it would be advantageous to them if they monitor the companies effectively or they should be ready to bear the negative consequences, if they do not do their job properly. Certain academicians argue that the power and resources held by the institutional investors is used by them as an effective monitoring and disciplining mechanism.
Mackenzie airs and endorses another area of concern, regarding delegation of duties by fund managers to individuals with inadequate knowledge thereby making him the scape goat.
As seen above, the serious problem of short- termism is posed because of the presence of intermediaries. However, in the present day world the institutional investors have become more conscious than before, moreover, the clients who pool in their money are also well alert of the negativities, hence the institutional investors need to show a record of good work to attract more clients. Their endeavor to survive in the market makes them perform their duties effectively.
Myners tried to find out the problem with the trustees and conducted a research for the same where he found: 62% of trustees had no expertise in finance or investment; 77% of trustees were not assisted by any in-house professional; The training received by more than half of the trustees was not enough; almost half of the trustees did not take any course in their first year ; 49% of trustees spent only around less than 12 hours a year for the preparation of investment matters. This gives vent to the inadequacies of governance issues which may ultimately have a direct affect on the functioning of the company.
In the constantly evolving market and involvement of institutional investors there emerges flexibility potential of institutional investors to guard their investment and maximize returns. Institutional investors to minimize their exposure, dump risky ventures to the household sector wherein policies offered by life insurance companies offer high value return on policies which are only partially guaranteed and the major portion is performance linked (such as variable-life or unit-linked policies).
This necessitated keeping pace with the changing financial environment resulting in fine tuning methods of resource reallocation at the required time, over different regions and industries. The optimal deployment of household funds over their investment period is the basic requirement of an aging population. Over a period of time the confidence has eroded in the promises of social security pension systems. Capital markets provide flexibility, this is the reason for investors seeking switch of retirement savings, to mutual funds or insurance companies ( see section 1.5.3 and Husier 1990) seeking to get higher returns. In OECD countries an there is an increased demand for long- term saving, for security. However investors are not looking for maturity value of the long term savings only and would like to look for higher value of their worth taking the institutional investment route.
Investment through large institutions, by sheer scale of investments reduces the average costs for investors. Whereby the commission charges are reduced as well as the advisory fees of investment managers are shared amongst the investors.
The domestic securities are balanced with both debt and equity where by risky exposures are minimized. Institutional investors are better positioned than individual investors, as their portfolios are professionally managed and can take full advantage of both international investments as well as domestic securities.
Institutional investors minimize risks as the risk is shared amongst the investors thereby reducing the impact. Besides this a manager can choose to hedge, diversify or insure his investments. Various incentives are given to institutions as per their requirement, thereby attracting others. Clients are provided life cover or defined pension benefits.
Institutional investors have long term liabilities, thereby having a longer holding power to tide over volatility in the markets and can plan their period of investment or disinvestment thereby giving them an edge over banks and individual investors. Most of the institutional investors have their assets and liabilities balanced which allows them flexibility and stability resulting in superior leverage in corporate governance.
Certain constrains which have prevented institutional investors from performing their responsibilities effectively have been brought to the fore by David and Kochhar in their research paper. They mention the business associations shared between the investors and the companies. They cite example of British Gas in which the views of the minority shareholders was suppressed because of the proxy votes by the institutional investors in favour of Cedric Brown, the then director of the company to run the company. The extreme unnecessary regulations passed by the government also restrict the activities of these investors to a certain extent. One more reason that restricts their ability to monitor companies effectively , is the lack of access to the information required to monitor management effectively. However, in spite of these restrictions institutional investors have performed their duties reasonably well. The area of director remuneration has witnessed fair amount of institutional investor activism. The fact that the institutional investors have been trying to monitor the companies well in order to increase shareholder returns, also helps in supplementing and maintaining good financial health of the company.
However, there are certain disincentives which hinder institutional investors from taking actions. At a conference held in Russia, majority view was that once placed under the actual responsibility of aligning investor and management interests as part of good corporate governance, investors of good caliber also display signs which are rather submissive. One of the major hindrances is the cost. It acts as an absolute disincentive, as the cost incurred to keep a watch on the management of a company or to take any action in order to discipline them might be more than the perks received. Nonetheless, if the monetary returns are promising then there would be some enthusiasm to get involved.
The equity managers' struggle for their survival, but this struggle and effort would be very discouraging if such equity manager, who incurred cost for monitoring, receives lower returns than the other manager who did not take any such efforts for monitoring. Only because of the fear that their competitors may be in a better position, the institutional investors cannot get away with their main job i.e., shareholder wealth maximization which cannot be attained without proper monitoring.
The decision in the Prudential case was very discouraging for institutional investor activism. In this case, Prudential had 3% of the shares of Newman Industries. Their allegation was against two directors who had committed a fraud of 400,000 pounds against the corporation. Prudential was triumphant initially, however the court of appeal, in approving of the appeal observed. That though the plaintiffs are initiating a method of regulating companies without the involvement of a statutory body in the public interest. The court views voluntary self regulation of the companies as a concern of the city, while compulsory regulation for companies are enacted by parliament. The court further refused to draw any general conclusion from this rare case but pointed out that the results of the present action gave them reason to ponder.
Nonetheless, in spite of these discouragements, institutional investors have the capability of acting in a proactive manner when it comes to keeping a watch on the company management. Some of the major examples are those of IBM, Westinghouse, where pension funds played an active role (with the active hold up from mutual funds like fidelity) around the period of 1992-93, portraying their capacity to remove the serving CEO'S and some members of the boards of directors when these firms were giving poor financial performance.
As is revealed in De Long's study, in the US the impact of institutional investment on firm performance cannot be established . Though certain institutional investors may have the expertise to guide their portfolio companies to an enhanced performance.
Political, economic and certain legal factors contribute to this inconclusive result of institutional institutions impact on firms performances. (e.g. Black., 1990: Roe 1994). It has been established that restrictions on US institutions are more stringent than UK institutions. (Black and Coffee 1994; Roe 1993a). However, in the UK large shareholders do not indulge in monitoring the management as :
- They have not obtained reliable information.
- They are uncertain if the benefits of intervention are commensurate with the
- Requirement for liquidity and limit on the institutions capabilities.
As has been stated above the evidence of the effect of activism on a firms performance is mixed. Certain studies have shown an unconstructive link between high institutional ownership and firms performances. However, some recent studies have failed to establish this. Other studies also showed zero association between the performance by firms and the activism by institutions. (Daily, Johnson, Elstrand and Dalton 1996). However, Nesbitt 1994 did report of positive stock price increase in the long run for firms which were in CalPERS radar. In fact Opler and Sokobin 1997 also find noteworthy above-market performance after targeting. Although there is no sound evidence of the effect of institutional investors on firm performance but the fact that they have been effective in corporate monitoring is self evident. The rise in shareholder activism in case of director's remuneration, greater board independence, separation of the role of CEO and Chairman increased use of voting and more of engagement and dialogue are all ways of improving corporate performance thereby, leading to better financial performance. Hence, the positive influence of the involvement on the firm's overall performance is definitely noteworthy.
lack(1992) and Pound(1992), show their skepticism about institutional investors in their work, by stating that, they would not want to incur heavier costs by takeover bids or proxy proposals and therefore, save on those expenses by taking actions in relation to corporate governance which is ultimately cheaper. However, Ryan (1998), Gordon (1993), and Pozen (1994) state that the recommendations made by institutional investors might possibly encourage managers to take certain steps that would enhance the worth of the firm. The profit concerns which the institutional investors have, is clearly evident from certain examples in which the institutional investors played a key role in encouraging the company to make a decision for appointing new outside directors and reversing the diversification strategy of the company which did not seem to yield much profits. 
In a research conducted by McConnell and Servaes (1990), a positive relation has been found between institutional investors and the U.S. firms. It has been argued that the large blocks of shares held by institutional investors act as an incentive to allow them to monitor corporate performance more effectively as they have substantial voting rights which can be used when deemed necessary.
The active monitoring hypothesis has shown that institutional investors would not vote for amendments that have the possibility of bringing about depreciation in shareholder wealth. In fact a positive relation has been shown to exist between institutional ownership and productivity by McConnell and Servaes (1990), as has been measured by Tobin's q.
The financial expertise that institutional investors have is very essential to study the financial data produced by the firms. As it is known accountability is the threshold of value creation and shareholder activism in the true sense is very important for the management to be accountable.
This section of the research has taken into account the positive and negative preponderances of institutional investment. However, as a combined package they are beneficial to the society. For eg. in case of takeover of a target company, the bidder has to spend huge amounts of money. This wastage can be avoided if the institutional investors use their diligence to replace the inefficient management and follow the norms in achieving a sound board. Their overall impact would be positive.
WAYS TO IMPROVE THE EFFECTIVENESS OF INSTITUTIONAL INVESTORS.
As has been observed in this research paper, there are certain hindrances which prevent the institutional investors from using their powers effectively. In this modern and complex world, it is not easy to trace ways so as to increase their effectiveness. However, it is suggested that if they are given more protection (in terms of disclosure, accounting, and certain specific information which is required to make the right kind of investment) bold decisions could be taken. There is a requirement of more transparency in the voting procedure whereby institutions are strengthened. This might help to improve their effectiveness.
Moreover, there is a possibility that if better incentives are given to institutional investors it would initiate them to enthusiastically participate in the affairs of the company. This was explained by Admati, Pfleiderer and Zechner, where they asserted that the activism stabilizes and is balanced where the shareholders are sure that the benefits that they would attain out of the activism would be more than the costs incurred by activism. This also incentivizes them to effectively monitor management in spite of a major hindrance in monitoring i.e. piggy back riding by other shareholders.
Martin and McConell (1991) have shown a negative relationship between the firms with poor stock price performance and the possibility of being the target of activism. However, the same research paper also examines the threat of activism. It suggests that if the firms foresee a probability of being targeted by activism, then the threat itself would be enough to bring in line the benefit of managers to that of the shareholders.
Though institutional investors possess numerous tools at their disposal, their nemesis often is the stringent regulations that govern the portfolios. This has a direct bearing on asset allocation, thereby enforcing a conservative approach such as a prudent man rule (the rule, that assets should be invested in a manner that would be approved by a prudent investor). This study assesses these varied regulations as 'governors' which impact investment patterns.
In a suggestion made by Greco (2001), the focus was on the Government to amend the laws to an extent that would be essential to empower pension funds to curb too much and unrestrained power of companies and would also require the abiding by their actual fiduciary duty.
The pension fund trustees should be given more training. However, institutional investors are portfolio investors and they have financial expertise at their disposal, this expertise is indeed very essential to read between the lines of the financial data produced by the firms, thereby deciphering the documentary financial haze and take an informed call.
There should be harmonization in terms of investment. As institutional investors are now an international organization, there should be some international body to supervise their working and intervene when required.
This research has shown that there is no simplistic way of arriving at a view of whether involvement of institutional investors leads to higher financial performance. Some researches show enhanced performances, while others are quick to point out the anomalies.
The aim of this paper was to assess the impact of institutional investors on financial performance of firms. This paper has examined the institutional investors on an overall basis and provided suggestions to improve the ways in which they can use their powers more effectively. Though this research has shown that the views regarding the effect of their involvement are very divergent, however, the paper suggests the fact, that there is a great potential of attaining very high standards of corporate governance in companies / institutions as a result of institutional investor activism. There are various limitations which obstruct the institutional investors from doing their job efficiently. One of the key factors of success would be to oversee that the quality of indicators must be given prominence and taken into account to make a fair assessment of organizations:-
- Political stability
- Government focus
- Regulatory quality
- Rule of law
- Corruption Watch
- Economic freedom
- Political freedom
International institutional investors bring in best international practices of corporate governance. Moreover, in countries where institutional investors are enthusiastically involved in corporate governance, they have the capacity to reduce the cost of capital for firms and also boost stock markets. In the same breadth it is pointed out that fund e.g. like pension funds, if subject to direct or indirect political control , as a result of putting their political agendas ahead of the funds beneficiaries will always post poor financial results. From an academic perspective the inference of "does the involvement of institutional investors lead to higher financial performance" is a matter of perception in a given set of conditions, which may differ from country to country.
As seen across the globe, the investment spectra of institutional investors are on the rise, placing large amounts of funds required to be deployed for the purpose of wealth creation. To ensure a balanced return the stringent rules and regulations must be in place and must be dynamic to keep up with the changing investment patterns and investment vehicles, especially to oversee fraudulent practices affecting the investors. Institutional investors play a major role in augmenting the governance in companies and function as conscience keepers of the companies, which in the long run will create wealth for the investors thereby increasing the financial performance of the company.
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