The influence of institutional investors’ social capital on corporate decisions, policies and outcomes

Abstract

While in the 1970s individuals owned about 80% of public corporations outstanding shares in the United States, nowadays institutional investors control about 80% of S&P1500 firms’ outstanding shares. This change has effectively concentrated ownership of public corporations and voting power in institutional investors' hands. The extant literature has discussed the influence of institutional investors on portfolio firms through their ownership size, voting power and activism. However, little is said about the influence of institutional investors social capital on portfolio firms’ policies and decisions. This thesis aims to examine the role of institutional investors social capital on portfolio firms’ decisions, policies and outcomes. Specifically, it examines the influence relating to CEO compensation and turnover decisions, firms risk-taking policies and firm performance. I utilise social network theory to explain how institutional investors may be able to influence portfolio firms’ CEOs. The main principal of social network theory relates to the ability of social connections to create value. A social network makes it possible for actors to create value for several reasons. Social connections are a source of influence and new information. Accessing new information that is not publicly available could be valuable. Furthermore, actors within a network have diverse knowledge which when shared through interactions become beneficial for innovations and also enhance learning (Granovetter, 1985; Burt, 1992). In addition, social connections are not bound by existing knowledge but can also foster new knowledge creation (Schonstrom, 2005). Another source of value is decision quality that may be enhanced as a connected actor learns from others in the same network who have multiple and varied experiences. Using hand-collected biographical and demographical data for both institutional investors representatives (i.e., CEO of investments firms, mutual fund managers and so on) and CEOs of portfolio firms, I create an index measuring their social affiliation to each other (Affiliation index). The sample includes fortune 100 firms and spans the period from 2000 to 2016. The results in chapter 6 show that CEO compensation is positively associated with levels of the Affiliation index. However, the results also show that CEO ties to institutional investors are not associated with a significant reduction in CEO pay-performance sensitivity, an increase in CEO pay relative to the top management team or a reduction in CEO turnover and turnover sensitivity to performance. Generally, the results are not consistent with the hypothesis that social ties always lead to collusion and inefficient “favouritism”. Portfolio firms level of risk-taking is important to institutional investors as it affects their portfolio risk exposure and returns. The results of the second empirical chapter (i.e. chapter 7) show that CEO ties to institutional investors are negatively associated with levels of firm risk-taking. Specifically, the results show that 20% of the reduction in portfolio firm risk-taking that is attributed to ties with institutional investors is channelled through portfolio firm level of leverage. Finally, the last empirical chapter (i.e. chapter 8) shows that the social ties of portfolio firms CEOs with institutional investors are positively associated with firm financial performance. Most of the positive influence of institutional investors on portfolio firm financial performance appears to be concentrated on firms that need advising and monitoring the most. The evidence thus far supports the hypothesis that social ties may be a conduit for efficient information transfer, contract enforcement, transparency and trust. The results withstand a battery of robustness tests.