Academic journal article IUP Journal of Applied Finance

Institutional Preference for Firm Attributes: Evidence from India

Academic journal article IUP Journal of Applied Finance

Institutional Preference for Firm Attributes: Evidence from India

Article excerpt

(ProQuest: ... denotes formulae omitted.)

Introduction

Institutional investors now manage a significant fraction of equity ownership and an even larger portion of trading volumes in most of the leading financial markets of the world. While institutional investors are not a homogeneous group, they do exhibit important common features which arguably distinguish them from individual investors. This paper examines the firm characteristics typically preferred by institutional investors before investing in a stock in the Indian equity market, and also explores the implications of such preferences in terms of their subsequent performance.

The growth and significance of institutional ownership and the factors leading to it have not gone unnoticed by academics. In the US context, Friedman (1996) shows that aggregate institutional ownership increased from less than 10% in 1950 to over 50% in 1994 and discusses the implication of the same for capital formation, stock market volatility and corporate governance. A few important papers published around that time were the ones by Del Guercio (1996) and Falkenstein (1996). Del Guercio (1996) examines the holdings of mutual funds and banks in 1988 and finds that banks were more tilted towards "prudent" stocks. Falkenstein (1996), working with data on two years of mutual funds' holdings of NYSE stocks, finds preferences for stocks with high liquidity, information flow and volatility. Coval and Moskowitz (1999) examine US investors' holdings in domestic portfolios and found that investment managers strongly preferred stocks close to home. A strong preference for domestic equities exhibited by international investors, called the 'home bias' phenomenon, has also been reported in some contemporary works like French and Poterba (1991), Tesar and Werner (1995) and Lewis (1999). This may be an indication that asymmetric information and investment barriers, although not fully explaining the phenomenon, are important factors in explaining portfolio selection bias.

Kang and Stulz (1997), working with data on all Japanese firms listed in the Tokyo Stock Exchange between 1975 and 1991, document that foreign investors overweigh shares of firms in manufacturing industries, with large market capitalization and revenues, good accounting performance, low unsystematic risk and low leverage. They also found that after controlling for size, firms which export more, firms with greater turnover, and firms that have ADRs have greater foreign institutional ownership. Dahlquist and Robertsson (2001) use a Swedish dataset and found that both foreign and domestic investors prefer large firms with high liquidity and better corporate governance. In contrast to the view that this preference was derived from a "foreign" bias, they found that this was rather an institutional bias than a foreign bias. The results of Kang and Stulz (1997) and Dahlquist and Robertsson (2001) clearly indicate that foreign investors favor firms with characteristics such as large size, low debt ratio and good governance. Grinblatt and Keloharju (2000) analyze the trading behavior of various classes of investors in the Finnish market. They found that the degree of sophistication of the institution matters in selection of investment avenues. They report that domestic institutional investors in Finland have taken opposite positions of that of the more sophisticated foreign institutional investors. In a similar line, Seasholes (2000) reports in the context of Taiwan and Thailand that both domestic institutional investors and retail investors trade against the flow generated by foreign investors.

However, Choe et al. (1999) come up with a conclusion that Korean domestic institutions generally behaved like foreign investors. Gompers and Metrick (2001) use quarterly US data from 1980 to 1996 and find similar conclusions as to the common traits looked at by institutional investors, viz., large size, high liquidity stocks. They, however, report a preference toward stocks with low prior period returns, i. …

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