Shareholder Coordination, Information Diffusion and Stock Returns

• DOI: http://doi.org/10.1111/fire.12124
• Author: Bin Wang,Christos Pantzalis
• Published date: 01 November 2017
• Date: 01 November 2017

The Financial Review 52 (2017) 563–595

Shareholder Coordination, Information

Diffusion and Stock Returns

Christos Pantzalis

University of South Florida

Bin Wang∗

Marquette University

Abstract

We show that the quality of information-sharing networks linking firms’ institutional

investors has stock return predictability implications. Wefind that firms with high shareholder

coordination experience less local comovement and less post-earnings announcement drift,

consistent with the notion that information-sharing networks facilitate information diffusion

and improve stock price efficiency. In support of the view that coordination acts as an infor-

mation diffusion channel, we document that the stock return performance of firms with high

shareholder coordination leads that of firms with low shareholder coordination.

Keywords: shareholder coordination, information diffusion, return predictability

JEL Classifications: G14, G20, G30

∗Corresponding author: School of Business Administration, Marquette University, 312 David A.

Straz, Jr. Hall, Milwaukee, WI 53201; Phone: (414) 288-7188; Fax: (414) 288-5756; E-mail:

bin.wang@marquette.edu.

We would like to thank Richard Warr (the Editor) and two anonymous referees for their thoughtful

comments and suggestions. We also appreciate the many useful comments we receivedfrom participants

at the 2014 Financial Management Association meeting.

C2017 The Eastern Finance Association 563

564 C. Pantzalis and B. Wang/The Financial Review 52 (2017) 563–595

1. Introduction

Firms with good corporate governance are less prone to information asymme-

tries and should be less difficult for outside investorsto analyze. Institutional investors

are instrumental in shaping corporate governance and are generally regarded as im-

portant promoters of sound corporate policies, transparency (Ajinkya, Bhojraj and

Sengupta, 2005), and stock price informativeness (Piotroski and Roulstone, 2004).

However,since institutional investors are not a homogeneous group, but rather a col-

lection of clusters of institutions with different investment orientations and horizons,

their ability to improve corporate governance and firms’ information environment

relies not just on their mere size and resources, but also on their capacity to share

information with other institutional shareholders.1The transmission of value-relevant

information across the set of a firm’s institutional investors can be greatly facilitated

by the strength of professional and social networks that may exist among institutions.

There is recent evidence (Huang, 2013a,b; Kim, Pantzalis and Wang, 2015) sug-

gesting that coordination among institutions improves corporate governance. What

remains an unexplored question, and the core emphasis of this paper, is whether

the strength of information-sharing networks facilitating coordination among insti-

tutional investors has return predictability implications. The notion that coordination

among institutional investors can help predict returns relies on the premise that in-

stitutional investors’ information-sharing network can be viewed as a flow channel.

This channel allows market value-relevant information to be transmitted to stock

prices of firms lacking shareholder coordination after it has been impounded in stock

prices of peer firms enjoying shareholder coordination.2

Theory suggests that informed investors may have an effect on the speed of

price adjustments to new information. For example, Holden and Subrahmanyam

(1992) and Foster and Viswanathan (1993) extend the classic model of Kyle (1985)

and show that stock prices reflect new information more rapidly as the number of

informed investors increases. Empirical evidence confirms that stocks of firms with

more informed investors adjust to common information faster than stocks of firms

with less informed traders (Brennan, Jegadeesh and Swaminathan, 1993; Badrinath,

Kale and Noe, 1995).

Information-sharing networks play an important role in enhancing market effi-

ciency. Forexample, Colla and Mele (2010) find that price informativeness increases

1The alignment in institutions’ monitoring practices is catching practitioners’ and researchers’ attention.

For example, McCahery, Sautner and Starks (2010) provide survey evidence that 59% of institutional

investors among respondents consider coordination with other institutional investorsto improve monitor-

ing their managers. Huang (2013a,b) finds that shareholder coordination has a positive and significant

impact on the market for corporate control and corporate governance. Kim, Pantzalis and Wang (2015)

find that firms with high shareholder coordination have better earnings quality and stronger stock price

informativeness.

2Throughout this paper, we use the terms “institutional shareholder coordination,” “shareholder coordi-

nation,” and “coordination” interchangeably.

C. Pantzalis and B. Wang/The Financial Review 52 (2017) 563–595 565

in the presence of information-sharing networks among individual traders. Pareek

(2012) finds that strength of information-sharing networks between mutual fund man-

agers affects the response time of stock prices to common information. Therefore, we

conjecture that firms with strong information-sharing networks will adjust to common

information faster than those with weak information-sharing networks. More specif-

ically, we posit that cross-sectional variation in the ability of information-sharing

networks to facilitate coordination among institutional investors reflects differences

in the degree of skill-based information acquisition and processing costs faced by

investors. Intuitively, investor specialization, more often than not, adversely affects

investors’ capability to acquire and process new information, which thereby plays

an important role in the information diffusion (Menzly and Ozbas, 2010). On the

arrival of an information shock, information-sharing networks could break down the

informational barriers among the institutional investors with different specializations

and cause a quick and adequate response to it.

We demonstrate that institutional shareholder coordination improves investors’

information environment. Specifically, we show that firms with high (low) share-

holder coordination experience weak (strong) local comovement and post-earnings

announcement drift. This is consistent with the notion that coordination reduces fric-

tion in public information processing and encourages the collection of and trading on

private information.3

Previous studies utilize the Shapley value of existing shareholders as a proxy

for shareholder coordination. Shapley value was first introduced as a solution to

solve the problem of how to fairly distribute gains and costs among players in a

cooperative game theory (Milnor and Shapley, 1978). Zingales (1994) and Nenova

(2003) use Shapley value to capture the control value of shareholders’ voting rights.

Using shareholder-voting-based Shapley value as a proxy for coordination frictions

among the existing shareholders, Chakraborty and Gantchev (2013) find that private

investmentsin public equity can improve the equity coordination, leading to favorable

debt renegotiation outcomes. In spite of the merits of the Shapley value and given

the research question we try to answer in this paper, we believe that an information-

sharing-network-based measure of shareholder coordination is more appropriate than

a voting-rights-based one. Therefore, to measure the degree of coordination among

institutional shareholders, we follow Huang (2013a,b) and devise two proxies that

rely on the premise that the likelihood and strength of social connections increases

with geographic proximity and similarity of values, attitudes, and beliefs compris-

ing an institutional shareholders’ corporate investment philosophy.4Social network

3Jin and Myers (2006) find that opaque stocks are associated with high stock price synchronicity. Zhang

(2006) argues that investors underreact more to public information when there is more information

uncertainty.

4The first proxy is the inverse of the weighted average of the geographic distance among institutional

shareholders (hereafter COORD_PROX) and the second one is the weighted average correlation among

institutions’ portfolios of stock holdings (hereafter COORD_PORT).