Institutional Investor – Definition

Cite this article as:"Institutional Investor – Definition," in The Business Professor, updated April 26, 2019, last accessed October 24, 2020, https://thebusinessprofessor.com/lesson/institutional-investor-definition/.

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Institutional Investor Definition

Put simply, institutional investors are institutions dealing in the trade of large quantities of securities. They are generally allowed special privileges, such as lower trading commissions as a result of the magnitude of their trades.

They are also less subjected to investor-protective regulations, thus are better experienced and positioned to secure themselves.

Below are the known categories of institutional investors:

  • Commercial banking institutions
  • Hedge funds
  • Pension funds
  • Insurance companies
  • Endowment funds
  • Mutual funds

A Little More On What is an Institutional Investor

Equipped to perform a broad range of research on the various investment options that are usually not open to retail investors, institutional investors are experts in the investment domain as they have specialized skills and resources.

They are also the biggest influencers of the supply, demand and market rates of securities. Because of this, retailers research their regulatory filings with the SEC to evaluate their trading investment options.

Expectedly, to avoid paying increased prices due to high demand for those securities, retail investors avoid investing in securities the institutional investors are trading off.

Even though retail and institutional investors invest in similar securities, there are usually differentiated by the nature of securities, i.e. swaps and forwards and the volume of transactions they undertake. On the one hand, retail investors invest in smaller companies and easily diversify their portfolios and sell their stocks in smaller price fluctuations. Institutional investors, on the other hand, invest in larger companies.

References for Institutional Investor

Academic Research on  Institutional Investor

•    Liquidity versus control: The institutional investor as corporate monitor, Coffee, J. C. (1991). Columbia law review, 91(6), 1277-1368.

•    Hail Britannia: institutional investor behavior under limited regulation Black, B. S., & Coffee Jr, J. C. (1993). Mich. L. Rev., 92, 1997.

•    Volatility and the institutional investor, Sias, R. W. (1996). Financial Analysts Journal, 52(2), 13-20. Contrary to most academic theory predictions, a positive contemporary relationship has been noted between institutional ownership and volatility of security return after capitalization is accounted for. The link correlates with the theories that riskier securities attracted institutional investors or an upsurge triggered increased volatility. The results are empirical, but they correspond with the latter interpretation

•    Less is more: making institutional investor activism a valuable mechanism of corporate governance, Romano, R. (2001). Less is more: making institutional investor activism a valuable mechanism of corporate governance. Yale J. on Reg., 18, 174.

•    An empirical examination of institutional investor preferences for corporate social performance, Cox, P., Brammer, S., & Millington, A. (2004). Journal of Business Ethics, 52(1), 27-43. Using over 500 UK companies, the paper examines the UK’s institutional shareholding and its connection with these companies’ social responsibility. From the evaluation of the various ownership models that distinguish long and short investors and other components incorporating both measures of corporate social performance (CSP), the study discovered that long term institutional investments related positively to CSP, lending more credence to studies carried out by earlier researchers.

•    The antecedents of institutional investor activism, Ryan, L. V., & Schneider, M. (2002). Academy of Management Review, 27(4), 554-573. There are varying results from recent studies on the effect of institutional investors on US corporations. The article argues that a better understanding of investor activism could offer clarity to subsequent researches. It incorporates literature from various fields to reach an integrated model of different variables. These variables may initiate variations in the activism level of these investors, hence their effect on the behavior of the involved firms

•    Do boards pay attention when institutional investor activists “just vote no”?, Del Guercio, D., Seery, L., & Woidtke, T. (2008). Journal of Financial Economics, 90(1), 84-103. The paper describes the “just vote no” campaign as a tool in institutional investor activists campaigns that involves withholding votes to express dissatisfaction with management’s performance or a firm’s corporate governance structure.

•    Accounting earnings announcements, institutional investor concentration, and common stock returns, Potter, G. (1992). Journal of Accounting Research, 146-155.

•    Institutional investor type, earnings management and benchmark beaters, Koh, P. S. (2007). Journal of Accounting and Public Policy, 26(3), 267-299.

•    Accounting earnings announcements, institutional investor concentration, and common stock returns, Potter, G. (1992). Journal of Accounting Research, 146-155.

Institutional investor type, earnings management, and benchmark beaters, Koh, P. S. (2007). Journal of Accounting and Public Policy, 26(3), 267-299. In this paper, investors are classified by their investment horizons to examine the relationship between institutional investors’ types and their discretionary earnings management strategies. Transient institutional ownership and aggressive earning management are not connected and are noticeable only in firms that manage to reach their earning targets. Though the study emphasizes the need to consider the type of institutional investor and the setting clearly, it also suggests that transient institution related myopia may not be as commonly postulated by critics.

•    Currency returns, intrinsic value, and institutionalinvestor flows, Froot, K. A., & Ramadorai, T. (2005). The Journal of Finance, 60(3), 1535-1566. The results of decomposing currency return into permanent intrinsic value shocks, expected-return shocks and exploring the interactions between all of these shocks reveal that expected return shocks dwarf intrinsic-value shocks. The results also suggest that flows are related to short-term currency returns with the long term values better explained by the basics. Rationalizing the poor performance of exchange rate models, the study concludes that by ignoring the difference between exchange-rate changes, earlier tests blur the link between fundamentals and currencies.

•    Corporate board gender diversity and stock performance: The competence gap or institutional investor bias, Dobbin, F., & Jung, J. (2010). NCL Rev., 89, 809. While women have gradually been making advances on corporate boards, gaining14.8% of Fortune 500 seats in 2007, their effect on organizational performance is still somewhat debatable. According to research from different periods, board diversity is linked with better stock values and even more gains.

•    Institutional investor preferences for corporate governance mechanisms, Bushee, B. J., Carter, M. E., & Gerakos, J. (2013). Journal of Management Accounting Research, 26(2), 123-149. The study examines institutional investors’ preference for corporate governance mechanisms with little evidence of a relationship between governance mechanism and complete institutional ownership. Revealed preferences however identified a small set of governance-sensitive institutions exhibiting an unwavering relationship between ownership levels and governance mechanisms.

 

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