When it comes to how Australian companies structure their capital, what level of influence do institutional investors actually have?
New research from Monash Business School together with Alliance Manchester Business School is the first to explore the role of institutional investors in influencing capital decisions – such as whether a company issues new shares or debt – within corporate Australia.
The research, sponsored by CPA Australia and the Australian Centre for Financial Studies (ACFS), finds that more than 82 per cent of institutional investors believe they significantly influence the corporate capital structure decisions of the firms they invest in or are considering investing in.
And more than 84 per cent believe that they have a strong influence on the actual amount of finance these firms raise.
Companies that are particularly under the sway of institutional investors are found to be smaller, newer, and more financially constrained.
“We found it interesting how institutional investors believe they have a big impact on how companies finance themselves, it is an important issue for them, and how they believe that the companies take their advice on board,” says Professor Chris Veld.
“A lot of surveys have asked Chief Financial Officers about their influence on capital structure decisions. No one has explored this topic from the other side before.”
Investors wield their influence through talks with management, and indirectly through talks with the investment banks assisting with issuing securities.
“It’s all about balance when it comes to capital structure choices,” says Professor Veld.
“What institutional investors don’t want is a company to be taking on more debt when it already has a lot on its balance sheet – especially if they themselves have already invested in the company’s bonds.”
The study is a joint project by Emeritus Professor of Finance from the Stern School of Business at New York University and Monash Business School, Professor Stephen Brown; Professor Veld and Professor Yulia Veld-Merkoulova from Monash Business School; and Professor Marie Dutordoir from the University of Manchester.
The study surveyed 275 Australian institutional investors across 47 institutions, with 25 questions. The majority, 83 per cent of these institutions, are headquartered in Australia, with the remainder incorporated in the United States (11 per cent) or the United Kingdom (4 per cent).
Professor Veld says the biggest obstacle to the research was working out how to reach these investors as no comprehensive database exists.
“We had a list of institutions from Morningstar Direct,” he says. “And then we really used LinkedIn to look up fund managers within these funds and make contact and issue invitations.”
The majority of respondents work within the mutual fund or superannuation fund sector.
Institutional investors estimate that their influence on how a company is structured is around 45 per cent, with the company itself and the broader financial environment accounting for the remainder.
One-third of investors only talk directly with corporate management, with one-fifth of investors only talk with investment banks, not with the company. Half of the institutional investors use both conversations with the company and investment banks to influence outcomes.
Size determines influence
They also believe they have a large impact on the actual amount of capital raised.
“A sizeable number of investors argue that the magnitude of their shareholdings in the firm determines their channel of influence,” says Professor Veld. “Not unexpectedly, larger shareholdings are more likely to result in direct influence, while smaller shareholdings are associated with indirect influence through the investment bank.”
The size of a company is the largest factor determining the strength of the influence.
“We received feedback such as ‘smaller is always more open — have fewer investment bankers chasing them, and they are open and receptive to all ideas’,” says Professor Veld.
Hedge funds and investors based in the United States were less concerned about capital structure, whereas investors who had their holdings in bonds rather than equities were more concerned about capital structure.
“Straight bond investors lose out from companies being levered too strongly, while unlike stock investors, they do not benefit from the gains of using too much leverage,” says Professor Veld.
The complete study is published in the Journal of Corporate Finance, October 2019.