The cost of distracted investors

Le Zhang

3 minute read

The board of directors is responsible for the strategic direction, governance and oversight of the firm and, therefore, is ultimately accountable for its performance. 

But, who monitors how well the board does its job? 

A paper by ANU College of Business and Economics’ Dr Le Zhang and his co-authors help answer this question, investigating whether institutional investors perform an important monitoring role. 

To do this, Le and the team study board behaviour following exogenous shocks to other parts of institutional investors’ portfolios and, therefore, their ability to monitor the firm.   

“Suppose there are two large stockholdings in a mutual fund investor’s portfolio, for instance a bank and a pharmaceutical firm. When the pharmaceutical industry is experiencing extremely poor or good performance, the mutual fund manager needs to allocate more time and effort to the pharmaceutical firm. Assuming the attention and effort of a fund manager is in limited supply, the bank will accordingly receive less attention and monitoring,” Le explains.

The study reveals the considerable impact investor monitoring has on board performance. In particular, it reveals that regular monitoring by institutional investors significantly improves director incentives to expend effort in monitoring management. 

It also suggests that distracted institutions are less likely to discipline ineffective directors with negative votes. 

“As a consequence, independent directors face weaker monitoring incentives and exhibit poor board performance,” Le points out. 

For example, when institutional shareholders are distracted, boards hold fewer meetings and independent directors miss more board meetings. 

“As a result of the poor board performance, firms are more likely to grant their CEOs excessive pay and manipulate their earnings. They are also more likely to undertake value-destroying mergers and in general have lower equity valuation,” argues Le. 

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