How Do Institutional Investors Influence Leverage?
A new study by Johnson’s Roni Michaely shows that firms with more institutional investors issue less debt
A recent study by Roni Michaely, Rudd Family Professor of Management Professor of Finance at the Samuel Curtis Johnson Graduate School of Management, reached a number of important conclusions about the effect of institutional equity ownership on firms’ capital structures. In the working paper “Do Institutional Investors Influence Capital Structure Decisions?” Michaely reports that firms with higher institutional holdings have lower leverage. Michaely also discovered that the presence of institutional investors influenced firms to issue more equity and less debt. The paper does not find strong evidence that the relation goes the other way around—that is, that firms’ decisions to lower their leverage does not result in institutional investors acquiring more stock in those firms.
Michaely’s paper documents that institutional holdings have grown rapidly (by 800 percent from 1979 to 2009), and that the presence of such institutional investors appears to have had a self-perpetuating effect, as far as reducing leverage. Once a company receives an infusion of institutional equity, the company has an easier time issuing more equity. Second, the presence of institutional investors appears to be exercising a chastening effect on companies’ willingness to issue debt. Institutionally-held companies’ propensities to issue more equity and less debt complement each other and lead to a cumulative reduction in leveraging. Third, Michaely discovered that the effect of institutional holdings on leverage was stronger for small firms with extensive growth opportunities than for large firms with limited growth opportunities.
Michaely’s research is an important empirical contribution to the body of capital structure decisions and the role of institutions in financial markets. It recently got the attention of the investor-oriented publication, Seeking Alpha, which reported on the conclusions of the working paper.