Does informal governance matter to institutional investors? Evidence from social capital

Abstract

We find a positive association between institutional ownership and social capital. The social norms in a region, while not imposed by businesses or laws, play a monitoring role that disciplines managers from self-serving behaviors. The resulting trustworthiness, through its mitigation of agency problems, drives the investment preferences of institutions. Our subsample analyses based on information asymmetry and financial performance support this inference. Further, the positive association is evident for transient investors and quasi-indexers but not for dedicated institutional investors. Overall, our study underscores the impact of informal governance on institutions' investment decisions.