I show shareholder litigation rights are an important tool for mitigating agency conflicts. To empirically identify the effects of litigation, I use the staggered adoption of universal demand (UD) laws in 23 states between 1989 and 2005. These laws create a significant obstacle to lawsuits against directors and officers for breach of fiduciary duty. UD laws are associated with increased use of governance provisions (e.g., classified boards) that entrench managers or otherwise limit shareholder voice. I also document fewer institutional blockholders, changes to financial policies and CEO compensation, and lower accounting performance for firms subject to UD. Overall, my findings cast doubt on the traditional notion that shareholder lawsuits primarily benefit attorneys rather than corporations or their shareholders.
Passive institutional investors are a growing and increasingly important component of institutional holdings. To examine whether and by which mechanisms passive investors influence firms’ governance structure, we use an instrumental variable estimation and exploit variation in passive institutional ownership that is due to assignment of stocks to either the Russell 1000 or 2000 index. We find that an increase in ownership by passive institutions is associated with more independent directors, the removal of poison pills and restrictions on shareholders’ ability to call special meetings, and fewer dual class share structures. Passive investors appear to exert influence through their large voting blocs—passive ownership is associated with less support for management proposals and more support for shareholder-initiated governance proposals. While we do not find direct evidence that the increased presence of passive investors facilitates activism by other investors, we do find that ownership by passive investors is associated corporate policies that are likely to mitigate the prospect of an activist campaign, including less cash holdings and higher dividend payouts. In contrast to conventional wisdom, our findings suggest that passive investors play a key role in influencing firms’ governance choices.
The Growth of Passive Investors and Implications for Stock Market Liquidity (with Marshall Blume, Todd Gormley, and Don Keim)
Recent decades have witnessed a steady increase in stock market liquidity. We examine whether the concurrent and rapid increase of passive institutional investments in common stocks has contributed to this increase in liquidity. To overcome concerns regarding omitted variables and simultaneity biases, we use an instrumental variable estimation and exploit variation in passive ownership that is due to assignment of stocks to either the Russell 1000 or 2000 index. We find that an increase in ownership by passive institutional investors is associated with a decrease in illiquidity, as captured by the Amihud measure of illiquidity. The association between passive ownership and liquidity is increasing over time and robust to controlling for time-invariant differences across stocks. The magnitudes of our estimates suggest the growth of passive institutional holdings over the last three decades is a significant contributor to the coinciding increase in stock liquidity.