Effects of Institutional Ownership

Institutional investors, who currently control almost 60% of the outstanding common shares of stock in the United States, are a potent force. Hewlett-Packard Co. could easily have failed in its landmark $19 billion merger with Compaq Computer Corp. had many institutional investors elected to block that deal. Indeed, such shareholders can greatly influence a company's corporate strategy by exerting subtle (or not so subtle) pressures on executives. But recent research has shown that not all institutional investors are alike. In fact, different groups often have contradictory views regarding, for example, whether a corporation should fund internal efforts to develop a technology or instead acquire it from the outside. Another crucial factor is whether a company's board is composed mainly of outside directors or inside executives.

Prior research has found links between institutional investors and corporate strategy, but the results have been inconclusive. One theory asserts that pressures from institutional investors tend to make company executives focus on short-term results, and so those organizations become risk-averse. For example, institutional investors might shy away from companies pursuing entrepreneurial activities, such as research and development to generate revolutionary new products, which then discourages those businesses from pursuing similar projects in the future. But another theory contends that institutional investors favor companies that take risks, such as allocating considerable R&D funds for focused, opportunistic projects. According to that argument, institutional shareholders typically manage broadly diversified portfolios, which allow them to spread and balance risks, so they are more willing to invest in companies that pursue riskier ventures with potentially high payoffs.

There's a reason for the apparent discrepancy regarding what institutional investors truly want. According to “Conflicting Voices: The Effects of Institutional Ownership Heterogeneity and Internal Governance on Corporate Innovation Strategies,” published in the August–September 2002 Academy of Management Journal, the simple fact is that institutional investors are not homogeneous. The authors are Robert E. Hoskisson, professor of management at the University of Oklahoma; Michael A. Hitt, distinguished professor of management at Texas A&M University; Richard A. Johnson, professor of management at the University of Oklahoma; and Wayne Grossman, assistant professor of management, entrepreneurship and general business at Hofstra University. They contend that managers of pension funds behave quite differently from their counterparts who oversee investment funds. The former prefer companies that develop technologies internally, while the latter favor businesses that acquire innovations from external sources.