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Do Shareholder Preferences Affect Corporate Policies?

This paper examines the revealed preferences of institutional investors for firm policies. I find that institutional investors are a heterogeneous group as they exhibit systematic differences in terms of the financial and investment policies of their shareholdings. The null hypothesis that the preferences for leverage of all institutional investors are the same is strongly rejected both for the raw debt ratios and when the debt ratios are adjusted for industry and firm characteristics. Furthermore, I find an interesting relationship between these revealed preferences and the corporate decisions of the firms they do hold. I find that these preferences are related to subsequent changes in the financial and investment policies of firms. In particular, a firm is more likely to decrease (increase) its leverage ratio if its current leverage is higher (lower) than the aggregated preference of its institutional shareholders. Quantitatively, about 17% of the gap between the firm's current debt ratio and the debt ratio preferred by its institutional shareholders is closed in one year. Similarly, a firm is more likely to increase its investment if its current investment ratio is lower than the preferences of its shareholders. I find systematic evidence that corporate policy changes related to shareholder preferences are more likely to be incorporated when firm managers are more likely to accommodate the preferences of institutional shareholders due to firm characteristics (e.g., smaller and younger firms) or managerial characteristics (CEOs with stronger career concerns, e.g., younger CEOs who do not hold joint CEO-chairman appointments). These corporate policy changes are consistent with an implicit threat of "voting with their feet" from institutional shareholders: I find evidence that policy changes in the opposite direction of institutional investors' aggregated preference are accompanied by heavier selling activities by current institutional shareholders and negative stock market performance. Overall, the evidence suggests that the (revealed) preferences of institutional shareholders are important determinants of corporate policies.