Identifying and Attracting the "right" Investors: Evidence on the Behavior of Institutional Investors

This article summarizes the findings of research the author has conducted over the past seven years that aims to answer a number of questions about institutional investors: Are there significant differences among institutional investors in time horizon and other trading practices that would enable such investors to be classified into types on the basis of their observable behavior? Assuming the answer to the first is yes, do corporate managers respond differently to the pressures created by different types of investors– and, by implication, are certain kinds of investors more desirable from corporate management's point of view? What kinds of companies tend to attract each type of investor, and how does a company's disclosure policy affect that process? The author's approach identifies three categories of institutional investors: (1) “transient” institutions, which exhibit high portfolio turnover and own small stakes in portfolio companies; (2) “dedicated” holders, which provide stable ownership and take large positions in individual firms; and (3) “quasi‐indexers,” which also trade infrequently but own small stakes (similar to an index strategy). As might be expected, the disproportionate presence of transient institutions in a company's investor base appears to intensify pressure for short‐term performance while also resulting in excess volatility in the stock price. Also not surprising, transient investors are attracted to companies with investor relations activities geared toward forward‐looking information and “news events,” like management earnings forecasts, that constitute trading opportunities for such investors. By contrast, quasi‐indexers and dedicated institutions are largely insensitive to shortterm performance and their presence is associated with lower stock price volatility. The research also suggests that companies that focus their disclosure activities on historical information as opposed to earnings forecasts tend to attract quasi‐indexers instead of transient investors. In sum, the author's research suggests that changes in disclosure practices have the potential to shift the composition of a firm's investor base away from transient investors and toward more patient capital. By removing some of the external pressures for short‐term performance, such a shift could encourage managers to establish a culture based on long‐run value maximization.