WP 2011-10 Institutional Investors and Crash Risk: Monitoring or Expropriation?

AUTHORS: Jeffrey L. Callen and Xiaohua Fang

ABSTRACT. This study tests two opposing views of institutional investors—monitoring versus expropriation--by investigating whether institutional ownership is positively or negatively related to future firm-specific stock price crash risk. We present robust evidence that institutional ownership is positively associated with future stock price crash risk. After further classifying institutional investors into transient, dedicated, and quasi-indexer types, we show that the overall positive relation between institutional ownership and future stock price crash risk is driven primarily by transient institutions, with dedicated institutions serving a monitoring role in reducing future stock price crash risk. We also find that institutional ownership by public pension funds (bank trusts, investment companies, and independent investment advisors) is significantly negatively (positively) associated with future crash risk. We also find that opaque financial reporting exacerbates the impact of institutional investors on future stock price crash risk. The findings in this study are shown inter alia to be robust to endogeneity concerns and alternative institutional investment metrics.