How Does Shareholding by Passive Institutional Investors Impact the Corporate Governance of European Firms?

Abstract

Research Question/Issue

The passive investment (PI) trend, characterized by the increasing inflow of investment funds into PI strategies, has resulted in an increase in the share of corporate ownership held via investments in PI strategies. This paper investigates this trend's consequential impact on European companies' corporate governance (CG).

Research Findings/Insights

We find that higher ownership by passive institutional investors (PIIs) is associated with fewer female directors, reduced independence in audit and nomination committees, and higher executive pay, negatively impacting CG. Nevertheless, our findings show that PIIs can increase the probability that a company has a policy regarding the adequate experience of board members and equal treatment of shareholders.

Theoretical/Academic Implications

We hypothesize that the level of ownership could be the missing link connecting mixed theories about the impact of ownership by PIIs on the CG of companies they invest in. A curvilinear relationship between the two could allow conflicting theories to coexist in one framework. We find weak evidence for a curvilinear relationship, but this relationship may become more prevalent if PII ownership of European companies increases because of regulatory changes.

Practitioner/Policy Implications

Some critics have proposed limiting PII voting rights, but our findings suggest that the effect of PII ownership may become less negative beyond a certain level of ownership and that PIIs may play a positive role in enhancing board experience and shareholder equity policies. Restricting PIIs may not necessarily be beneficial for the CG of companies they invest in.