Internalizing Governance Externalities: The Role of Institutional Cross-Ownership

We analyze the role of institutional cross-ownership in internalizing corporate governance externalities using granular mutual fund proxy voting data. Exploiting within-proposal and within-institution variation, we show that an institution's holdings in peer firms are positively associated with the likelihood that the institution votes against management on shareholder-sponsored governance proposals. We further find that high aggregate cross-ownership positively predicts management losing a vote. Overall, our results provide evidence that cross-ownership incentivizes institutional investors to play a more active monitoring role, suggesting that institutional cross-ownership serves as a market-based mechanism to alleviate the inefficiency induced by governance externalities.