The Influence of Institutional Shareholdings in the Corporate Governance of UK Firms

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The Influence of Institutional Shareholdings in the Corporate Governance of UK Firms

Mike Strivens

PhD

2006-02

University of Manchester

430

List of Tables 9List of Figures 11Abstract 12Declaration 13Copyright and ownership of intellectual property rights 14Preface 15Acknowledgements 16Chapter 1 Introduction 191.1 Overview 191.2 Background and motivation to the research 201.3 Research objectives and contribution 231.4 Target audience 261.5 Structure of thesis 27Chapter 2 Theoretical and empirical background 312.1 Introduction 312.2 The nature of the corporate governance problem 322.2.1 Separation of ownership and control 332.2.1.1 Insider system of corporate governance 342.2.1.2 Outsider system of corporate governance 342.2.2 Asymmetric information 362.2.2.1 Adverse selection 362.2.2.2 Moral hazard 372.2.3 Agency theory 392.2.3.1 Contracts 392.2.3.2 Agency costs inherent in the modern corporation 412.2.3.4 Basic principal-agent model 442.2.3.5 Extensions to the basic principal-agent model 452.2.3.6 Game theory 482.2.4 Incomplete contracts 492.2.4.1 Managerial power approach 492.2.4.2 The perceived cost approach 522.2.5 The corporate governance monitoring environment 542.2.5.1 Board of Directors and powers of the general meeting 542.2.5.2 Market mechanisms 572.2.5.3 Accounting quality and disclosure (regulatory environment) 612.2.5.4 Executive remuneration 632.2.5.5 Ownership structure 632.3 Institutional Ownership 642.3.1 Introduction 642.3.2 Institutional shareholdings in the UK 672.3.3 The influence of institutional trade associations 692.3.3.1 The Institutional Shareholders' Committee 712.3.4 Institutional objectives and incentives 712.3.5 Why institutions don’t intervene in the governance of corporations 742.3.5.1 ‘Exit’ or ‘Voice’ Framework 752.3.5.2 Agency problems between institutions and beneficiaries 772.3.5.3 Size of institutional shareholdings 782.3.5.4 Free rider problems 792.3.5.5 Conflicts of interest 802.3.6 Institutional investor intervention 812.3.6.1 Long term monitoring 852.3.6.2 Short-termism 862.3.7 Summary 892.4 Executive remuneration and firm performance research: a literature review 902.4.1 Introduction 902.4.2 Executive remuneration firm performance research in the USA 922.4.3 UK executive remuneration firm performance research 972.4.4 Other relevant governance issues 1022.4.4.1 The influence of institutional investors 1032.4.4.2 The influence of remuneration committees 1052.4.4.3 The impact of environmental changes on remuneration 1062.4.5 Summary 1082.5 CEO turnover and firm performance research: a literature review 1092.5.1 Introduction 1092.5.2 CEO turnover-firm performance research in the USA 1102.5.3 UK CEO turnover-firm performance research 1122.5.4 Combined studies of executive remuneration and CEO turnover firm performance research 1142.5.5 Summary 1182.6 Conclusions 119Appendix 2.1 - ISC Statement of Responsibilities 2005 122Chapter 3 Firm characteristics and institutional shareholders 1313.1 Introduction 1313.1.1 Background 1313.1.2 Research issue and contribution 1323.2 Literature review 1343.2.1 Institutional investors and corporate governance 1353.2.2 Hypotheses development 1383.2.2.1 Directors’ ownership 1393.2.2.2 Board structure 1403.2.2.3 Firm characteristics 1413.2.2.4 Firm risk 1433.2.2.5 CEO characteristics 1443.2.2.6 Other factors 1453.3 Sample description and research methodology 1473.3.1 Sample description 1473.3.1.1 Sample selection process 1473.3.1.2 Data 1483.3.1.3 Inflation 1503.3.2 Research methodology 1503.3.2.1 Control variables 1503.3.2.2 Omitted control variables 1533.4 Univariate analysis 1563.4.1 Overall sample 1563.4.2 Descriptive statistics 1573.4.3 Dummy variable statistics 1583.4.4 Institutional shareholdings statistics 1583.4.5 CEOs and Directors’ shareholdings 1593.4.6 CEO age 1593.4.7 Variable correlations 1603.5 Multivariate analysis 1603.5.1 Relationship between firm characteristics and institutional shareholdings 1613.5.2 Censored regressions of institutional shareholdings 1633.5.3 Relationship between firm characteristics and large institutional shareholdings 1643.5.4 Robustness tests 1653.5.4.1 Coefficient estimates from regressions by year 1663.5.4.2 Coefficient estimates from regressions using the absolute value of institutional investor shareholdings 1663.5.4.3 Coefficient estimates from regressions using a holdout sample 1673.5.4.4 Proportion of institutional shareholdings to outside shareholdings 1683.5.4.5 Institutional shareholdings with zero percent 1683.6 Summary of findings and conclusion 1683.6.1 Summary of findings 1693.6.2 Further work 172Chapter 4 The influence of institutional investors over CEO remuneration 2034.1 Introduction 2034.1.1 Background 2034.1.2 Research issue and contribution 2044.2 Literature review and hypotheses development 2064.2.1 Institutional investors and executive remuneration 2064.2.1.1 Endogenity of institutional ownership 2094.2.2 The structure and timing of CEO remuneration 2104.2.3 Hypothesis development 2144.2.3.1 Institutional investors and CEO remuneration 2144.2.3.2 Timing of salary and bonuses 2154.3 Research methodology and sample description 2164.3.1 Research methodology 2164.3.1.1 Influence of institutional shareholdings on magnitude of CEO remuneration 2174.3.1.2 Influence of institutional shareholdings on the remuneration-for-performance relationship 2234.3.1.3 Timing of performance 2244.3.2 Sample description and data collected 2254.3.2.1 CEO remuneration data 2254.3.2.2 Inflation 2264.4 Univariate analysis 2264.4.1 Overall sample 2264.4.2 Descriptive statistics 2274.4.3 Dummy variable statistics 2294.4.4 Institutional ownership statistics 2294.4.5 Variable correlations 2294.5 Multivariate analysis 2314.5.1 Influence of large institutional shareholdings on the level of CEO cash-based remuneration 2324.5.2 Influence of large institutional shareholdings on the relationship between remuneration and firm performance 2344.5.3 Should salaries and bonuses be modelled separately? 2374.5.4 Robustness tests 2404.5.4.1 Alternative measures of firm performance 2414.5.4.2 Outliers 2414.5.4.3 Proportion of institutional investor ownership to all outside investor ownership 2414.5.4.4 Institutional investors with zero holdings 2414.5.4.5 Zero bonuses 2424.5.4.6 CEO Turnover 2424.5.4.7 Coefficient estimates from regressions using a holdout sample 2434.5.4.8 Non-linear relationships 2434.6 Summary and Conclusions 2444.6.1 Summary of findings 2454.6.2 Further work 247Appendix 4.1 – UK Salary and Bonus Plan Arrangements 249Chapter 5 The influence of institutional investors over CEO turnover 2895.1 Introduction 2895.1.1 Background 2895.1.2 Research issue and contribution 2915.2 Literature review and hypotheses development 2925.2.1 Background 2925.2.3 Institutional ownership and CEO turnover 2935.2.4 Endogenity of institutional ownership 2965.2.5 Firm performance 2975.2.6 Hypotheses development 2985.2.6.1 Forced turnovers 2985.2.6.2 Voluntary turnovers 2995.3 Research methodology and sample description 3005.3.1 Research methodology 3005.3.1.1 Empirical specification 3005.3.1.2 Empirical models 3015.3.2 Sample description and data collected 3065.3.2.1 CEO turnover data 3065.3.2.2 Inflation 3095.4 Univariate analysis 3095.4.1 Overall sample 3095.4.2 Sample statistics 3105.4.2.1 Probit regression sample 3105.4.2.2 CEO Turnover sample 3125.4.3 Dummy variables 3145.4.3.1 Probit regression sample 3145.4.3.1 CEO Turnover sample 3145.4.4 Institutional ownership statistics 3155.4.5 Departing CEO shareholdings 3155.4.6 Performance changes around CEO turnover events 3155.4.7 Probability of CEO turnover changes for different performance deciles 3175.4.8 The correlations of regressors 3185.4.9 Turnover sample comparisons 3185.4.9.1 Comparison between no turnover and all turnover samples 3185.4.9.2 Comparison between forced and voluntary CEO turnover samples 3195.4.10 Summary 3205.5 Probit Analysis 3215.5.1 Empirical results 3215.5.2 Discussion of results 3315.5.2.1 CEOs are fired for poor firm performance 3315.5.2.2 Large institutional shareholdings do influence forced departures 3325.5.2.3 Older CEOs are easier to fire! 3335.5.2.4 CEOs who are also Chair are less likely to be forced out 3335.5.2.5 Large firms are more likely to lose their CEOs 3345.5.2.6 Firms with high gearing are more likely to fire their CEOs 3355.5.2.7 CEOs with large shareholdings become entrenched 3355.5.3 Robustness of results 3365.5.3.1 Alternative firm performance measures 3365.5.3.2 Institutional shareholdings with zero holdings 3365.5.3.3 Using LOGIT models 3375.6 Conclusions 3375.6.1 Summary of findings 3375.6.2 Further work 339Chapter 6 Conclusions 3856.1 Introduction 3856.2 Summary of findings 3856.2.1 Chapter 3 – Firm characteristics and institutional investors 3866.2.2 Chapter 4 – Institutional investors and CEO remuneration 3896.2.3 Chapter 5 – Institutional investors and CEO turnover 3926.3 Limitations of the study 3936.3.1 Exclusion of equity-based remuneration 3936.3.1.1 Likely impact on the reported results 3956.3.2 Focus on publicly available data 3956.3.2.1 Likely impact on the reported results 3966.4 Future research 3966.4.1 Extending research on relationship between firm characteristics and institutional shareholdings (Chapter 3) 3966.4.1.1 Change of institutional ownership 3966.4.1.2 Analysis by institutional type 3966.4.1.3 Combined case-study research exercise 3976.4.2 Extending research on the relationship between institutional investors and executive remuneration (Chapter 4) 3976.4.2.1 Extending the definition of executive remuneration 3976.4.2.2 Research on a broader range of performance measures 3986.4.2.3 Relative Performance Evaluation (RPE) 3986.4.2.4 Use of performance information by UK remuneration committees 3986.4.3 Extending research on the relationship between institutional investors and CEO turnover (Chapter 5) 3986.4.3.1 Delisted firms 3986.4.3.2 Falling options values and CEO turnover 3996.5 Conclusions 399Bibliography 401

This thesis analyses several aspects of institutional investor influence in the corporate governance of UK firms. Chapter 1 introduces the thesis, and Chapter 2 provides a literature survey. The main original empirical research findings are presented in Chapters 3 to 5.Chapter 3 explores the key firm characteristics related to institutional investors. We show that institutional shareholdings, particularly those institutions with a large shareholding, are positively related to the proportion of outside directors on the board; with stock returns and with volatility. Institutional shareholdings are negatively related to the shareholdings of inside directors and firm size. Interestingly institutional shareholdings are positively related to CEO age but negatively related to the number of CEO’s years in office. This seems contradictory but it is consistent with institutional investors wanting experienced CEOs but not those individuals who have become entrenched. None of the measures proxying for the Cadbury recommendations for board structure, such as number or proportion of non-executive directors, CEO duality, or outside chair, has a significant relationship with institutional shareholdings.Chapter 4 analyses the relationship between institutional shareholdings and CEO cash-based remuneration. Uniquely to this field of research we also consider the different elements of remuneration separately to account for the timing differences relating to their award and performance criteria. First, we find that the presence of a large institutional shareholding, or high concentration of institutional shareholdings, does significantly reduce the magnitudes of salary and bonuses but they do not reduce the magnitude of benefits. However, the presence of an institutional investor, regardless of the size of their shareholding, has no relationship with the magnitude of any of the remuneration variables. Second, we find that institutional shareholdings significantly increases the positive relationship between bonus remuneration and firm performance, but that they do not have such a noticeable effect on the relationship between salary and benefits and firm performance. Third, we find that the presence of a large institutional shareholding, or high concentration of institutional shareholdings, reduces the rates of increase in salary, benefits and bonuses. Fourth, we find that the past practice of modelling salary and bonuses together can produce misleading results. We suggest that salary and bonuses should be modelled separately because they are payments for different reasons and relate to different periods of firm performance.Chapter 5 explores the influence that institutional investors have over CEO turnover. We show that the likelihood of a CEO being forced from office is negative and significantly related to firm performance and positive and significantly related to the presence of a large institutional shareholding or high concentration of institutional shareholdings.The findings in this thesis are robust to variations in research design. The conclusions are that the internal control mechanisms do work, that institutional investors are not the ‘passive’ investors often portrayed by some practitioners and early academic research and that institutional investors go to some lengths to ensure that their investee firms are properly governed.

• Corporate Governance
• Institutional Investors
• CEO Turnover
• CEO Remuneration

• Strivens, Mike

• Manchester Business School
• Faculty of Humanities

uk-ac-man-scw:161607

Strivens, Mike

25th May, 2012, 12:13:17

Strivens, Mike

28th May, 2015, 23:09:24