CBI: Alicia Davis, "Is There a Corporate Governance Clientele Effect?"
Institutional investors, because of their relatively larger ownership stakes, have more incentive than retail investors to monitor the companies in which they invest, particularly if it is costly to exit. Since owning shares in a well-governed firm reduces an investor’s own monitoring costs and also may provide higher liquidity and lower associated trading costs, such investments are attractive to institutional investors. In a recent study, Visiting Professor Alicia Davis finds that higher governance quality, as defined by a metric that heavily weights internal governance factors (e.g., board composition), is associated with higher proportions of institutional trading and ownership. This finding is consistent with the presence of a corporate governance clientele effect and the reasonable conjecture that institutions have more reason to prefer well-governed companies than retail investors. However, Davis also finds that higher governance quality, as defined by a metric focused on external governance (i.e., exposure to the market for corporate control), is associated with higher proportions of trading and ownership by individuals. It is unlikely that retail investors have a stronger aversion to firms with antitakeover protections in place than institutions, so this result is unlikely due to the presence of a corporate governance clientele effect. One possible explanation lies beyond investor governance preferences. Retail investors, in general, are more loyal to management than their institutional counterparts. This often makes individual investors key players in close votes accompanying battles for corporate control and firms with large retail shareholder bases, on the margin, less attractive takeover targets. Therefore, the presence of retail investors may function as a partial substitute for antitakeover defenses. The fact that the study’s overall findings hold only for firms that pay dividends--and the ones therefore more likely to engender retail investor loyalty--lends support to this view.