Academic journal article IUP Journal of Corporate Governance

Institutional Investments in India: A Review of the Literature

Academic journal article IUP Journal of Corporate Governance

Institutional Investments in India: A Review of the Literature

Article excerpt

Introduction

Researchers have recorded that large shareholders have an advantage or incentive to influence firm's managers and their decisions. Large shareholders can be broadly classified as insiders and outsiders. As outsiders, when financial institutions control larger shareholding, they tend to monitor corporate management's policies and actions, thereby addressing the agency problems. This enhances corporate governance and influences firm performance.

Institutional monitoring activities affect different aspects of a firm such as the size of a corporate board, executive compensation, accounting policies and disclosures and investment decisions. Research studies, also, have discussed the impact of different categories of institutional investors. As there is resource heterogeneity among these institutions, their effects on firm's performance are divergent (Douma et al., 2006). Similarly their capacity to address agency problem and influence governance are also diverse.

In India, institutional investment activities have a short history. Before the economic reforms, only a few institutions were operating in the Indian market which were mostly government-owned. However, post economic reforms in 1991, the environment for institutional investors expanded. Government policies promoted private participation and foreign investments in Indian financial markets, and there has been a significant growth in institutional investment since then.

The present paper reviews the extant studies in the Indian context. It summarizes and discusses the role of institutional investment as a whole and then the sub-segments as per the role of different categories of institutions, viz., Mutual Funds (MFs), banks and financial institutions and Foreign Institutional Investors (FIIs), and their influence on firm performance.

Discussion

Ownership and Firm Performance

The debate on ownership structure and its impact on firm performance can be traced to the landmark study by Berle and Means (1932). They raised a question-'Who controls the modern corporation?'-and discussed the problems that occur in widely held corporations in which ownership is dispersed among small investor-shareholders, while the control is in the hands of the managers.

Several studies followed Berle and Means and looked at the role of managers in meeting the objectives of the shareholders (Jensen and Meckling, 1976; Fama and Jensen, 1983; Grossman and Hart, 1986; and Jensen 1993). They discussed that the potential conflict of interest and the agency problem among various stakeholders emerge from two important sources: (1) Different stakeholders have different goals and preferences to achieve, hence there is a conflict of goals; and (2) Stakeholders have inadequate information on each other's actions, hence a conflict arises among them as to 'who is responsible for the success or failure of a firm'. Roe (1990) argued that the diffused ownership structure does not provide any incentive to any one owner to engage in monitoring of managers' actions. If one shareholder takes up the monitoring activity, the cost is borne by that specific investor, while the benefits are enjoyed by all. This leads to a free-rider problem (Shleifer and Vishny, 1986).

Large Shareholders and Firm Performance

A large set of studies have discussed that agency problems can be addressed with the involvement of large shareholders. These shareholders can engage in monitoring activity, and hence can affect or have the potential to enhance firm performance (Shleifer and Vishny, 1986; Admati, el al., 1994; Maug, 1998; and Noe, 2002). These researchers have also argued that although the monitoring benefits occur to all shareholders, only the large shareholders have an incentive as they enjoy scale economies of monitoring cost and its benefits.

Bethel et al. (1998) provided empirical support on the large stakeholders' monitoring role. They reported that the performance of a firm is enhanced after an investor acquires a large block of equity. …

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