Institutional ownership and corporate governance of public companies in China

Using information on the identity and percentage ownership of the ten largest shareholders in Chinese nonfinancial firms during the period of 1999-2010, we examine institutional investors' preferences for specific firm characteristics and investigate how institutional ownership affects firm value. We classify institutional investors under two dimensions: (1) pressure-sensitive (or grey) institutions versus pressure-insensitive (or independent) institutions, and (2) state-owned versus privately-owned institutions. We find that institutional ownership is positively associated with company Tobin's Q, and the effect is mainly driven by the ownership of independent institutions, rather than driven by the ownership of privately-owned institutions. Moreover, this positive relation gets stronger after 2005, when significant progress has been made in strengthening the legal and institutional foundation of the capital markets in China. In contrast, ownership by grey institutions is in general negatively associated with firm performance, manifesting the value-destructive consequences of the conflicts of interest these investors cultivate. The significant change after 2005 suggests that the enhanced external legal and corporate governance environment is critical for independent institutions' monitoring role to strengthen.