Institutional Ownership, Diversification, and Riskiness of Bank Holding Companies

Date01 August 2013
Published date01 August 2013
The Financial Review 48 (2013) 385–415
Institutional Ownership, Diversification,
and Riskiness of Bank Holding Companies
Saiying Deng
Southern Illinois University, Carbondale
Elyas Elyasiani
Temple University
Jingyi Jia
Southern Illinois University, Edwardsville
We examine the relationship among the level and stability of institutional ownership,
diversification,and riskiness of publicly traded bank holding companies. We find that large and
stable institutional ownership is associated with a higher (lower) level of geographic, revenue,
and nontraditional banking (asset) diversification and lower risk, suggesting that institutional
investorsare prudent and favor risk-reducing diversification strategies. The association between
institutional ownership level and diversification is more pronounced under deregulation and
during the crisis, suggesting a substitution effect between regulation and market discipline,
and a greater level of monitoring and/or advising by institutional investors during the crisis,
Keywords: BHC, diversification, institutional ownership, risk, marketdiscipline institutional
ownership, diversification and riskiness of bank holding companies
JEL Classifications: G21, G32
Corresponding author: Department of Finance, Fox School of Business and Management,
Temple University, Philadelphia, PA 19122; Phone: (215) 204-5881; Fax: (215) 204-1697; E-mail:
C2013, The Eastern Finance Association 385
386 S. Deng et al./The Financial Review 48 (2013) 385–415
1. Introduction
In the recent decades, institutional investors have become the largest sharehold-
ers of publicly traded firms. According to the Federal Reserve Board’sFlow of Funds
Report, institutional investors owned about 66% of U.S. equities by the end of the
third quarter of 2011.1Existing studies have shown that institutional investors play
a major role in monitoring the investee firms and in directing their crucial decisions
such as mergers and acquisitions (M&A) (Chen, Harford and Li, 2007), antitakeover
provisions (Brickley, Lease and Smith, 1988), research and development (R&D)
expenditures (Bushee, 1998), executive compensation structure (Almazan, Hartzell
and Starks, 2005), and management turnover (Kaplan and Minton, 1994; Kang and
Shivdasani, 1995).2
Within the group of institutional investors, those with large equity stakes and
long-term investment horizons have greater incentives to monitor the management
because there is a higher likelihood that their monitoring benefits will exceed their
monitoring costs over the duration of their ownership (Shleifer and Vishny, 1986;
Huddart, 1993; Chen, Harford and Li, 2007; Elyasiani and Jia, 2010). In addition,
some institutional investors such as hedge funds and internally managed pension
funds take large stakes in a small number of firms and act as shareholder activists to
assure the effectiveness of their influence on the investeefirm strategies (Del Guercio
and Hawkins, 1999).
A notable lapse in the existing literature is the failure to investigate the role
of institutional ownership in the strategic decision of firm diversification and its
consequent risk effects. For instance, Campa and Kedia (2002) treat diversification
as an endogenous decision based on firm characteristics but exclude the role of
the ownership variables altogether in this regard. Denis, Denis and Sarin (1997)
also include managerial and large block-holder ownership measures but exclude
institutional ownership as a determinant of diversification.
We intend to fill this void by employing bank holding company (BHC) data
to examine the association between the distribution of institutional ownership and
different dimensions of diversification,as well as the consequent risk effects. We also
investigate whether these effects are bidirectional in nature and whether the market
discipline exerted by institutional shareholders in restricting firm risk taking is a
substitute for regulation. Finally, we investigate whether these effects strengthen or
diminish during the financial crisis of 2007–2009.
2As an example, a recent Wall Street Journal article reports that billionaire Nelson Peltz, an activist
investor,quietly accumulated a 4.3% stake in Legg Mason Inc., one of the biggest mutual-fund companies,
and pushed for a seat on its board. Mr. Peltz’sboard appointment shows how much sway activist investors
can exert over corporate targets (see “Peltz Grabs Stake in Mutual Fund Firm Legg Mason,” Wall Street
Journal 10/26/2009).

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