Shareholder coordination and stock price informativeness

AuthorChristos Pantzalis,Incheol Kim,Bin Wang
Date01 May 2018
Published date01 May 2018
DOIhttp://doi.org/10.1111/jbfa.12289
DOI: 10.1111/jbfa.12289
Shareholder coordination and stock price
informativeness
Incheol Kim1Christos Pantzalis2Bin Wang3
1Departmentof Economics and Finance, The
Universityof Texas Rio Grande Valley,Edinburg,
TX78539, USA
2Departmentof Finance, College of Business
Administration,University of South Florida,
Tampa,FL 33620, USA
3Departmentof Finance, College of Busi-
nessAdministration, Marquette University,
Milwaukee,WI, 53210, USA
Correspondence
IncheolKim, Department of Economics and
Finance,The University of TexasRio Grande
Valley,Edinburg,TX 78539.
Email:incheol.kim@utrgv.edu
Abstract
We show that firm-specific information is more likely to be incorpo-
ratedinto stock prices when firms have stronger shareholder coordi-
nation. The premise of our work is that geographicproximity reduces
communication costs among shareholders, thereby leading to bet-
ter coordination. The positive coordination-informativenessrelation
is driven mainly by shareholder coordination among dedicated and
independent institutions. We further show that the positive effect
is more pronounced for firms with weaker governance mechanisms,
suggesting that shareholder coordination could serve as a substitute
conduit of price discovery.Lastly, we propose that shareholder coor-
dination improves stock price informativeness through the channel
of enhanced voluntary disclosure quality.
KEYWORDS
geographic proximity, shareholder coordination, stock price
informativeness
1INTRODUCTION
A number of studies highlight that equity ownership by institutional investors has explosivelyincreased over the last
20 years in the U.S. stock market.1Inaddition, corporate ownership structure has become more dispersed in terms of
the number and types of institutional investors.2Financial theory suggests that when ownership is dispersed among
many small individual shareholders, corporate governance benefits from the existence of large shareholders (e.g.,
Maug, 1998; Shleifer & Vishny,1986) who are often institutions (e.g., Hartzell & Starks, 2003; Kahn & Winton, 1998).
Institutional investors actively engage in the monitoring of self-serving managers, acting as a disciplinary mechanism
that attenuates agency costs (e.g., Chen, Harford, & Li, 2007; Gillan & Starks, 2000). Past studies on the effectiveness
of institutional investors in corporategovernance have mostly focused on institutions’ information-gathering and ana-
lytical abilities (e.g., Ayers,Ramalingegowda, & Yeung, 2011; Chhaochharia, Kumar, & Niessen-Ruenzi, 2012), but have
largely overlooked the importance of coordination among institutional shareholders. Shareholder coordination, if in
place, can facilitate the cooperation among the institutional investors and thereby enhance monitoring effectiveness
1Forexample, Lewellen (2011) documents that institutions in the 13F database held 32% of total market value at the beginning in 1980. The number increases
to68% by the end of 2007.
2Forexample, in our sample, the number of institutions holding an average stock is 41 in 1994, but the number increases to 131 in 2010.
686 c
2017 John Wiley & Sons Ltd wileyonlinelibrary.com/journal/jbfa JBus Fin Acc. 2018;45:686–713.
KIM ET AL.687
by significantly weakening the free-rider problem which aggravates agency conflicts (Grossman & Hart, 1980). This
notion is supported by survey evidence documented by McCahery,Sautner, and Starks (2010) showing that 59% of
institutional investorsamong respondents consider coordination with other institutional investors as a way to improve
monitoring of managers.
In this article, we study the role of shareholder coordination, proxied by geographic proximity among prominent
shareholders such as institutional investors, in increasing a firm's transparency and in encouraging the incorporation
of more firm-specific information into stock prices. Monitoring effort and effectiveness is intensified through the coor-
dination among shareholders (e.g.,Huang, 2013). As a result, managers under scrutiny are more likely to disclose timely
and quality information to the public. On the one hand, uninformed investors drawnby trustworthy public information
are more likelyto possess ownership and thereby incorporate firm-specific information into stock prices. On the other
hand, informed investors are more incentivized to collect private firm-specific information as the marginal benefits of
trading with uninformed investors increase. Kyle (1985) demonstrates that private information is incorporated into
stock prices through trades placed by informed traders. In other words, we hypothesize that the positive impact of
shareholder coordination on stock price informativeness is achieved through greater corporate disclosure by reveal-
ing more firm-specific information to the market and encouraging more collection of private information at reduced
cost.
Tomeasure the degree of coordination at the firm level, we calculate the average of the geographic distance among
institutional investors weighted byownership. The rationale of our proxy lies in the fact that institutional investors are
more likely to coordinate their corporatemonitoring efforts when potential connections between them become more
likely with proximity.Social network literature suggests that social networks are more likely to develop when there is
homophily,i.e. the tendency of individuals to associate and bond with others driven by familiarity,often emanating from
geographicproximity.3Since the weighted average of distance is inverselyassociated with the level of coordination, we
multiply it by 1 for convenience sake.Therefore, the coordination measure is the inverse of the weighted average of
the geographic distance among institutional shareholders (hereafter COORD).
Our baseline results show the positive relation between the shareholder coordination and the stock price informa-
tiveness, measured as idiosyncratic volatility (IV).4Existing literature shows that dedicated (e.g., Bushee, 1998) and
independent institutional investors (e.g., Brickley,Lease, & Smith, 1988) are more active monitors5than their counter
peers (transient and grey institutional investors). We further find that the positive relation between coordination
and stock price informativeness is driven mainly by the coordination among dedicated and independent institutional
investors.Our finding supports the notion that coordination among active monitors enhances monitoring effectiveness
and thereby improvesa firm's information environment.
Next, we examine whether there is a complement or substitution effect between shareholder coordination and
othergovernance mechanisms that have been shown to be related with stock price informativeness.6The literature has
shown that governance mechanisms such as antitakeover provisions (Ferreira& Laux, 2007), board gender diversity
(Gul, Srinidhi, & Ng, 2011), and blockholder ownership (Brockman & Yan,2009) are significantly positively related to
price informativeness. Our results show that the impact of shareholder coordination on price informativeness is more
3Geographic proximity has been shown to be influential in the developmentof close relationships such as dealings among floor traders (Baker, 1984), the
forming of interlocked corporate boards (Kono, Palmer,Friedland, & Zafonte, 1998), and investment patterns of venture capital firms (Sorenson & Stuart,
2001). Finance literature has also shown that geographicproximity facilitates communication and the exchange of ideas among mutual fund managers (e.g.,
Grinblatt& Keloharju, 2001; Hong, Kubik, & Stein, 2005; Ivković & Weisbenner, 2005). Therefore, geographic proximityamong institutional shareholders is a
legitimateproxy for shareholder coordination.
4Idiosyncraticvolatility and probability of informed trading have been widely used as proxies for stock price informativeness in the literature (e.g., Ferreira&
Laux,2007; Ferreira, Ferreira, & Raposo, 2011).
5Bushee (1998) finds that the investment horizon of institutional investorsis positively associated with a firm's R&D spending that could create long-term
value.Brickley et al. (1988) show that independent institutional investors are more likely to pass proposals on antitakeover amendments.
6Corporate governancemechanisms can generally be classified into two categories: internal and external governance mechanisms. Large shareholdersand
board directors are often viewed as the main internal governance mechanisms (e.g., Franks& Mayer, 1996), while takeovers and the market for corporate
control are the main externalgovernance mechanisms (e.g., Jensen, 1993). We view shareholder coordination as the internal governance mechanism in that
if institutional investorscan coordinate with ease, they can form a coalition and perform the role of large shareholders to mitigate the free-rider problem in
corporatemonitoring.

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