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Role of Institutional Shareholders' Activism in Enhancing Firm

Performance: The Case of Pakistan

Article  in  Global Business Review · October 2015

DOI: 10.1177/0972150915581100

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Article

Role of Institutional Shareholders’ Global Business Review

16(4) 557–570
Activism in Enhancing Firm © 2015 IMI
SAGE Publications
Performance: The Case of Pakistan sagepub.in/home.nav
DOI: 10.1177/0972150915581100
http://gbr.sagepub.com

Talat Afza1
Mian Sajid Nazir1

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Abstract
Globalization and financial breakdown of many corporate conglomerates in the developed world

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engrossed the attention of researchers and policy makers towards the need and importance of an
effective corporate governance system for resolving the agency conflict between the stakeholders and

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managers, and hence a firms’ success. Among corporate governance mechanisms, how ownership is

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structured between all the shareholders of a firm is considered to be of much importance. The purpose

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of this article is two-fold: first, to analyze the impact of institutional ownership on firm performance
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and, second, to throw some light on the two scenarios of institutional ownership prevailing in Pakistan’s
capital market. In the first scenario, financial institutions have a board representation (active finan-
cial institutions), while in the second scenario, financial institutions do not have board representation
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(passive financial institutions). Using the data of 200 non-financial Pakistani firms listed at the Karachi
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Stock Exchange (KSE) from 2005 to 2011, the results revealed that institutional ownership significantly
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impacts a firms’ performance. It is also found that the firm performance can be enhanced through
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effective monitoring by active financial institutions that have long-term stakes in firms through board
nomination.
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Keywords
Active investors, passive investors, ownership structure, institutional ownership, firm performance,
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Pakistan
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Introduction
The researchers in corporate finance have long recognized that separation of ownership and control
in firms has created the potential for the agency phenomenon which may be costly. The managers
have substantial freedom to pursue their personal benefits at the expense of shareholders’ wealth due to
limited incentive for shareholders to monitor the behaviour and performance of their agents. The wealth

1
COMSATS Institute of Information Technology, Lahore, Pakistan.

Corresponding author:
Mian Sajid Nazir, Department of Management Sciences, COMSATS Institute of Information Technology, Lahore, Pakistan.
E-mail: sajidnazir2001@yahoo.com
558 Global Business Review 16(4)

maximization of shareholders will not motivate corporate decision making in the absence of an effective
corporate governance mechanism (Afza and Nazir, 2012). Since the publication of The Modern
Corporation and Private Property by Berle and Means (1932), a rich body of literature has focused on
the ownership separation theory of principal and agent. Since then, researchers in finance have tried to
explore the potential adverse effects of absence of effective control mechanism and misalignment of
shareholders and managers interest. A considerable debate has been generated on the issue of whether
managers maximize shareholder wealth or instead they focus on their personal objectives (Hubbard
and Palia, 1995), or perquisites (Jensen and Meckling, 1976).
During the last couple of decades, regulators, investors, policy makers and other capital market par-
ticipants have been increasingly focusing on the need for firms of having an effective monitoring and
accountability system of corporate governance in order to minimize this misalignment of interests
between shareholders and managers, commonly known as the agency problem (Epps and Ismail, 2009).

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Corporate governance is a set of policies and mechanisms that affect how a firm is operated efficiently
and profitably. This system of corporate governance ranges from practices and institutions, from account-

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ing standards and laws concerning financial disclosure, to executive compensation and shareholdings,
to size and composition/independence of corporate boards as well as patterns of shareholdings in the

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corporation (Javid and Iqbal, 2007). Corporate governance focuses on the issue of bringing accountabi-

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lity and transparency into the operations of firms with an overall objective of welfare of all stakeholders

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including managers, shareholders, regulator, society and the economy as a whole.
Academic researchers around the globe agree on the fact that corporate governance is a yardstick of
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success and add value to corporates in developed as well as developing economies. However, it is also
clear that need for effective implementation of corporate governance is manifold in developing countries
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as compared to their developed counterparts. The awareness of corporate governance in Pakistan is not
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very old and the first code of corporate governance was implemented in 2002 and revised in 2012 by
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Securities and Exchange Commission of Pakistan with the collaboration of Institute of Chartered
Accountants of Pakistan and now it has become a crucial element of listing requirements of firms for all
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stock exchanges of Pakistan. However, Pakistan is still in developing phase due to its immature capital
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markets (Afza and Anwar, 2012) and this development needs to be done in an effective way in order to
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bring Pakistan into the list of developed economies. Although corporate governance mechanisms are set
of solutions for eliminating this problem, the quantity of research on corporate governance in Pakistan
is, however, far less than the developed countries, particularly in the area of external ownership structure
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as a monitoring mechanism. Therefore, this study focuses on one of the robust mechanisms of corporate
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governance (i.e., institutional ownership) and attempts to investigate its impact on firm performance in
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Pakistan by segregating the active and passive financial institutions.

The statement, ‘Bigger is better’ seems very much true in case of institutional investors as the role
played by them in corporate performance is a phenomenon accepted worldwide (Oliveira et al., 2012).
Institutional investor is different from atomistic investor in many aspects such as: size of shareholding,
proficiency in monitoring as well as incentive to keep an eye on managers with low cost of monitoring.
Therefore, institutional owner’s influence on firm performance is much significant as compared to atom-
istic owner. Two scenarios determine the influence asserted by financial institutions on firm performance.
In the first scenario, a financial institution has its nominee on board, who may have a bird’s eye view on
all activities of the firm, thus hindering managers from any exploitation of external shareholders’ rights.
In the other scenario, a financial institution just holds stock and ‘stays behind the wall’, and does not
interfere in any firm activity. The former is named as active institutional investor while the latter is
known as passive institutional investor.
There is another concern regarding the motivation for institutional investors to actively monitor
the management. There are some institutional investors which are temporary and interested only in
Afza and Nazir 559

short-term performance of corporations. The focus of these institutional investors is short-term because
their own performance is to be evaluated on the short-term profits they generate. So, there is no incentive
for these investors to be present on the board of directors of firms where they have invested a bulk of
money. Contrary to this, active investors with board representation have selected to exercise efficient
monitoring and hence, their ownership stake is more likely to be associated with the value of the
firm. So, it can be predicted that the extent of shareholdings of passive institutions may be unrelated
to the corporate value and any relationship could be found may only be for shareholdings of active
institutional investors.
Institutional ownership has been in researcher’s domain since many years and a lot of research work
has been conducted on their role in firm performance (Sinha, 2006). However, as per the available litera-
ture, there are very few researches which analyzed the segregated effect of financial institutions that
are active and having their nominee on the boards in which they have invested ceteris peribus, and

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the firm performance. Consequently, this research is considered as the forerunner to analyze the relation-
ship between firm performance and institutional shareholders with long-term goals in the case of Pakistan

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and is expected to contribute significantly in the ownership structure and firm performance literature
in Pakistan with specific implications for practitioners, policy makers and researchers. The rest of this

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article is organized as follows: the next section discusses previously conducted studies in the same area;

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the third section provides details of the research design, followed by the empirical results in the fourth

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section. At the end, the fifth section concludes the article.
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Literature Review
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Governance and performance goes side by side. Improved governance leads to improved performance,
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which results in corporate success. This relation gained enormous attention by scholars and a lot of
C

research has been conducted on the relationship between corporate governance and performance of
firms (Hermalin and Weisbach, 2003; Shleifer and Vishny, 1997). Ownership structure is considered
R

as a significant mechanism in corporate performance and its importance cannot be overlooked in boost-
FO

ing up the firm performance. Its roots can be traced back to the publication of The Modern Corporation
and Private Property by Berle and Means in 1932. As the concept that owner manager separation leads
to agency problem because of their distinct interest is first discusses in that study. Since then, there is an
T

ongoing debate in the literature to study the impact of ownership structure on performance.
O

Institutional investors, or should be called giant investors, have maximum interest as well as incentive
N

to monitor firm activities. Shleifer and Vishny (1986) first argued that presence of institutional investor
leads to superior market performance of firms because of their effective monitoring role. Pound (1988)
was the pioneer in discussing the two-dimensional role of institutional investors in performance of firms.
The first dimension focuses on the positive influence when managers are monitored in an effective
manner by the institutions (effective monitoring hypothesis). The second dimension focuses on the nega-
tive aspect as when institutions have personal benefits or when they want to sustain good relations
with firm then they do not interfere in managers’ work (conflict of interest and the strategic alliance
hypothesis). Plenty of empirical research drew multiple conclusions such as linear and non-linear rela-
tionships, and some also proved that shareholding by financial institutions does not have any effect on
firm performance (Barclay and Holderness, 1991; Navissi and Naiker, 2006).
McConnell and Servaes (1990) provided evidence of positive influence of extent of shares held
by institutions on performance of firms (Tobin’s Q), by taking cross sectional sample of 1173 firms for
the period of 1976 and 1093 firms in the period of 1986. This positive influence was attributed to the
560 Global Business Review 16(4)

monitoring by institutions in an effective manner. Afterwards, Han and Suk (1998) analyzed 301 firms
for the period 1988–1992 and concluded that stock returns were strongly influenced by the fraction
of shares held by institutional investors. Contrary to this, Craswell, Taylor and Saywell (1997) analyzed
the relationship between structure of ownership and performance of 349 corporations in Australia and
the analysis did not reveal any significant relationship between shareholdings by institutional investors
and performance of firms (Tobin’s Q). In addition to this, Kumar (2004) conducted the study in India for
the period 1994–2000 by taking 2478 firms as a sample and found a non-linear relationship between
institutional ownership and firm performance. He proved that when financial institutional ownership
increases beyond a certain threshold level, firm performance is positively impacted. A notable contri-
bution in this regard was made by Afza and Slahudin (2007), who aimed to find any association between
institutional shareholders and firm performance in Pakistan for a sample of 100 listed firms. The results
did not indicate any association between institutional shareholding and firm performance. These results

SE
were similar to another study conducted in an emerging economy of India (Sarkar and Sarkar, 2000).
Furthermore, Navissi and Naiker (2006) supported the nature of a non-monotonic relationship

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between institutional ownership and value of firm in New Zealand by taking 123 firms as sample.
This was the first study which divided institutional investors into two groups: the first were active insti-

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tutional investors (having nomination and participation in board of directors) and the second were

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passive institutional investors (do not have nomination and participation in board of directors). Their

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findings showed that active institutional shareholders have a non-linear relation with firm performance,
and up to 30 per cent ownership stake, firm value increases whereas above this level, firm value decreases.
ER
On the other hand, passive investors’ shareholding did not prove to have any significant relationship
with firm performance. Furthermore, Cornett et al. (2007) proved that a firm’s operating cash flows are
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positively influenced by institutional stockholding. Moreover, Mizuno (2010) studied the role played by
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institutional investors in corporate governance and examined the relationship between institutional
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investors and performance of firms in Japan. Findings revealed that institutional investors play a signi-
ficant role in enhancing corporate governance in any firm but it was found that their ownership stake in
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the firm did not put any impact on performance of corporation. Recent work is done by Salehi et al.
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(2011) to examine the role of institutional investors in corporate value. This study proposed two hypoth-
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eses, the first assumed the positive influence of level of institutional investors and value of the corpora-
tion, while the second assumed the negative influence asserted by concentrated institutional investor
ownership and firm value. The results revealed that the first hypothesis was accepted and findings sup-
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ported the effective monitoring theory of institutional investors. The second hypothesis was also accepted
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and authors attributed this finding to the profit theory.

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From the past few years, corporate governance has been a significant and important area of research
in Pakistan. Many researchers have carried out different studies on the area of corporate governance but
still there is need of research to identify and explore some uncovered areas in order to contribute to
Pakistani literature. The cross sectional study of Mir and Nishat (2004) could be considered as the
pioneer empirical research to check the role of effective corporate governance on 248 Pakistani firms
by incorporating board composition and block-holding structure on return on assets (ROA), return on
equity (ROE) and Tobin’s Q. They found a positive relationship with external/family block-holding and
firm performance and a negative relationship with internal block-holding and firm performance.
In another study by Javid and Iqbal (2007), the authors proved that ownership concentration is the
outcome of weak legal protection of investors in Pakistan. Similar results have also been produced by
Javid and Iqbal (2008) focusing on a 23-item corporate governance index and firm performance on a
limited sample of Karachi Stock Exchange (KSE-100) index firms. Nazir et al. (2009) took a different
approach and studied the impact of board mechanism on the firm value. Their study investigated the
board structure related variables like board composition, size and CEO duality, and firm performance
Afza and Nazir 561

related measurements of ROA and Tobin’s Q. They have used the sample of 53 Pakistani cement and
sugar manufacturing corporations from the phase 2005 to 2007. Results revealed that moderate board
size is positively linked with the firm performance, whereas performance was badly affected if the
same person worked on both seats (CEO and board chairperson). In addition, outside directors on the
board could play an important role in the firm’s better performance, particularly in Pakistan.
In contrast, Javid and Iqbal (2010) examined the relationship between ownership structure, need of
external financing and corporate valuation by taking the sample of 60 non-financial firms listed on KSE
from the period of 2003 to 2008. Results showed that larger firms need more external financing and
external financing requires good practices of corporate governance. Moreover, concentrated ownership
has negative relation with external financing and good corporate governance practices improve the
overall firm valuation.
Furthermore, Shah et al., (2011) used cluster analysis on 67 firms on 2005 data; Abdullah et al. (2011)

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studied ownership structure of 158 firms for the period 2003–2008; Bajwa and Bashir (2011) did a cross-
sectional study of 200 firms for the year 2009 to investigate the role of ownership structure; Yasser

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(2011b) investigated 132 family and non-family controlled firms for the period 2003–2008; Azam et al,
(2011) used oil and gas sector companies for 2004–2005; Yasser (2011a) analyzed 10 communication

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sector firms; Shahab-u-Din and Javid (2011) looked into the effect of managerial ownership on firm

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performance; Khan et al. (2011) evaluated the role of corporate governance on firm performance for

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three tobacco sector firms; Afza and Nazir (2012) examined the role of corporate governance in enhanc-
ER
ing post-merger performance in the financial sector of Pakistan; and Jabeen et al. (2012) tested the
impact of family ownership and firm performance. A recent work in Pakistan is done by Shah et al.
(2012), who studied the impact of ownership structure on firm performance. Panel data estimation is
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employed by taking only 40 firms listed at KSE for the years 2006–2010. Results supported a positive
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relationship between firm performance and fraction of shares held by institutions. However, research
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on institutional shareholding activism and firm performance in Pakistan is very limited in academic
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literature of corporate governance. All above studies have confirmed the positive and significant role
of corporate governance variables on firm performance. However, almost all of the studies have used
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a small sample from a specific sector and these results cannot be generalized to all firms in Pakistan.
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Moreover, most of the studies have focused on only one dimension of corporate governance (that
is, ownership structure) while omitting the role of financial institution as active monitors of firm opera-
tions. So this creates a significant research gap still available to be researched and generalized. Table 1
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summarizes the empirical corporate governance studies in Pakistan focused on ownership structure in
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any form.
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Keeping in view the above discussion, the present study is expected to fill the research gap in literature
and explore the relationship between institutional shareholders’ activism and firm performance in
Pakistan by formulating the following hypotheses:

H01: There is no relationship between ownership of financial institutions and firm performance
Ha1: There is a relationship between ownership of financial institutions and firm performance
H02: There is no relationship between active financial institution ownership and firm performance
Ha2: There is a positive relationship between active financial institution ownership and firm
performance
H03: There is no relationship between passive financial institution ownership and firm performance
Ha3: There is a negative relationship between passive financial institution ownership and firm
performance
562 Global Business Review 16(4)

Table 1. Summary of CG-Performance Studies in Pakistan

Sr No. Authors Years Study Window Sample CG Variables

 1 Javid and Iqbal 2007 2003–2005 50 firms Board, OS
 2 Javid and Iqbal 2008 2003–2008 60 firms CGI, OC
 3 Afza and Slahudin 2009 2003–2006 63 firms Insider OS
 4 Abdulla et al. 2011 2003–2008 158 firms OS
 5 Bajwa and Bashir 2011 2009 200 firms OS
 6 Yasser 2011 2003–2008 132 family firms Family OS
 7 Azam et al. 2011 2005–2010 14 Oil and Gas Board, OS, Audit
 8 Shahab-ud-Din and Javid 2011 2000–2007 60 KSE firms Managerial OS
 9 Khan et al. 2011 2004–2008 3 Tobacco firms Board, OC
10 Afza and Nazir 2012 1996–1998 71 M&A Board, OS

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11 Jabeen et al. 2012 2006–2009 62 firms Family OS
Source: Authors’ own.

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Note: OS= Ownership Structure; CGI=Corporate Governance Index; OC=Ownership Concentration.

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Research Design

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Population of the current research is 574 firms listed on the KSE as on 31 December 2012. The objective
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is to include firms from non-financial sectors representing higher market capitalization. The final sample
of the study consists of 200 firms for the period of 2005 to 2011 making 1400 firm year observations.
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The data for these sample companies was obtained from the annual audited financial reports. Date has
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been obtained from the annual financial reports of firms and KSE. A thorough review of literature and
hypothesis development opened the way to empirically investigate how institutional ownership is
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integrated with performance. In order to facilitate the study, ownership by associated/related company
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and joint stock company are also added in the empirical models to be estimated. In order to test our
hypotheses formed in the previous section and to capture the impact of institutional ownership on firm
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performance the following regression models have been estimated:

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ROA it = b 0 + b 1FIN it + b 2Ass it + b 3Joint it + b 4Size it + b 5Lvrg it + fit(1.1)

T
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Tobin’s Q it = b 0 + b 1FIN it + b 2Ass it + b 3Joint it + b 4Size it + b 5Lvrg it + fit (1.2)

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where
b0 = Intercept
FINit = Shares held by financial institutions in company i for year t
Assit = Fraction of share held by Associated company of company i for year t
Jointit = Fraction of share held by Joint stock company of company i for year t
Sizeit = Log of total assets of company i for year t
Lvrgit = Total debt/total assets of firm i for year t
ROA = Net Income/Total assets of the company
Tobin’s Q = Market value of equity + book value of debt/book value of its assets
fit = Error term.
Afza and Nazir 563

Empirical Results and Discussion

Table 2 reports descriptive statistics about the variables of study for the whole sample. The size of
respondent firms ranges from 0.065 billion to 263 billion Pakistan rupees with an average of 16.53
billion showing that the sample firms are of moderate size in terms of total assets. However, the skew-
ness of the firm size variable indicates that most of the firms are of a larger size with a few small-sized
firms. Moreover, the sample firms are reasonably profitable in terms of accounting performance, that is
average ROA is 6.8 per cent, and market performance, that is, average Tobin’s Q is 1.47. The low level
of standard deviation of firms’ performance shows stable profits for the sample period. Leverage is quite
high for the firms listed on the KSE, that is, 54 per cent of the total assets are financed by external
sources of funds. The institutional ownership structure of the Pakistani firms is also quite interesting.
The share ownership by the associated and related firms is averaged at 30 per cent with a standard devia-

SE
tion of 29.5 per cent, whereas the combined ownership of unrelated parties (that is, financial institutions
and joint stock companies) is less than those of firms which are associated with sample firms. The finan-

U
cial institutions own only 13 per cent of the total shares of sample firms whereas joint stock companies
have 8.5 per cent shares of the companies under study. Although the fraction of shares owned by finan-

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cial institutions is quite small, their role in efficient monitoring, however, cannot be denied. Despite the

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lower ownership stake in companies, financial institutions are investing with a long-term approach and

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they have nominated their representatives in board of directors.
ER
The relationship between institutional ownership and performance of firms has been examined by
estimating Equations 1.1 and 1.2 and the results are reported in Table 3. In order to obtain the empirical
M

results, we have used the panel data regression analysis which is usually preferred upon pooled
regression. The numbers of cross sections were seven years with 200 firm year observations. Further, the
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selection between fixed effect and random effect model has been made with the help of Hausman test
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which indicated that fixed effect model is more appropriate for our data set. Model 1 narrates the results
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of performance measure of ROA and model 2 shows the findings for market performance of firms i.e.
Tobin’s q. Both the models are mathematically appropriate and F-values are statistically significant at
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1% level. In model 1, independent variables explain 30% of the total variation caused in response
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variable as indicated by adjusted R2 whereas in case of model 2, the value of adjusted R2 is 27%. Further,
the values of Durbin–Watson (D–W) statistic for both the models are demonstrating that there is no
auto correlation between the error terms and dependant variable and errors are randomly distributed.
T
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Table 2. Descriptive Statistics

Variables Mean Median SD Skewness Kurtosis Min Max

Assets (billion PKR) 16.53 4.39 32.751 3.896 18.111 0.065 262.673
Equity (billion PKR) 6.711 1.961 16.947 5.295 41.832 −78.01 201.566
Profit (billion PKR) 1.172 0.168 5.711 5.465 54.716 −36.139 63.527
ROA (%) 0.0682 0.0598 0.1003 −2.141 30.633 −1.2139 0.4425
Tobin’s Q 1.4746 1.0785 2.4175 13.501 110.087 0.1310 43.1216
Lvrg 0.5411 0.5511 0.2310 0.301 0.8010 0.0069 1.6148
FIN OS 0.1317 0.0992 0.1235 1.081 1.038 0 0.6989
Active IO 0.7207 0.6801 0.5784 1.121 1.012 0 1
Ass. 0.3045 0.229 0.2952 0.52 −1.09 0 0.9765
Joint 0.0853 0.0133 0.1534 2.243 4.344 0 0.721
Source: Authors’ own.
564 Global Business Review 16(4)

Furthermore, the issue of multi-colinearity has been checked by variance inflation factors and found
that all predictors are independent of each other.
Model 1 reports the relationship between the institutional ownership and ROA. The shareholding by
financial institutions has a positive and significant impact on the accounting performance of our sample
firms. These results are in accordance with the Pound (1988)’s effective monitoring hypotheses which
narrates that as share ownership by financial institutions increases, they get motivated to monitor the
actions of corporate managers. This positive result can be attributed to the financial institutions’ incen-
tive for monitoring corporate managers because of their higher stake in firms as well as they have exper-
tise, resources and opportunities to do so. This monitoring role aligns the managers’ interests with those
of other stakeholders and hence results in enhanced firm’s accounting performance. Similar results are
also reported by Fazlzadeh et al. (2011), Navissi and Naiker (2006) and Uwuigbe and Olusanmi (2012)
who proved this positive relationship between financial institution ownership and firm performance.

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Model 2 of Table 3 reports contrary results where financial institutions ownership is negatively
related to firms’ market performance measured by Tobin’s Q. However, this relationship is statistically

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insignificant. It may be argued that this negative relationship may be because of different type of inves-
tors (active versus passive) with difference motives (long-term versus short-term) and they may assign

L
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different values to the firm which may result in insignificant results. In case of accounting performance,
financial institutions can monitor the managers effectively and this threat of monitoring may leads to
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enhanced accounting performance. However, market performance producing insignificant results indi-
ER
cates that there is a need to investigate the role of financial institutions with different goals separately.
The other variables of institutional shareholdings produced expected results in this study. Associated
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companies ownership has a strong positive relationship with both performance measures of ROA
M

and Tobin’s Q. The role of parent/subsidiary company is associated with increased performance. Both
have similar goals and motives, both share technical, human and physical resources, economies of
O
C
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Table 3. Firm Performance and Institutional Ownership

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Variables ROA Tobin’s Q

Intercept −0.014 4.137
T

(−0.398) (4.385)**
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Financial (FIN) 0.069 −0.049

(2.204)* −1.37
N

Associated company (Ass.) 0.152 0.179

(3.716)** (3.868)**
Joint stock company (Joint) 0.009 −0.003
0.291 (−0.090)
Size (Size) 0.138 −0.104
(4.201)** (−2.816)**
Leverage (Lvrg) −0.476 −0.076
(−15.674)** (−2.226)*
Adjusted R2 0.295 0.267
D-W 1.625 1.757
F-value 40.390 ** 8.813**
Source: Authors’ own.
Notes: **Significant at 1 %, *Significant at 5 % t-values are in parenthesis.
Afza and Nazir 565

scale can be achieved and transaction costs can be minimized because of larger size. All these factors
lead to enhance the accounting performance of the firm. Moreover, the perceptions of investors regard-
ing a firm which is backed by a strong parent or group company are always positive and opportunistic
and this also leads to higher market value and increased market performance in terms of Tobin’s Q. The
shareholding by joint stock companies is found to be statistically insignificant in our case. Similar results
are also reported by Bajwa and Bashir (2011). Moreover, leverage is found to be negatively associated
with both firm performance measures due to the fact that increase debt put extra burden of interest costs
on the firm and hence return on assets decreases. Also investors in capital markets perceive that high
leverage firms may have a greater probability to fall in financial distress and they do not give value
to highly leveraged firms. Larger size firms are more resourceful and may achieve cost reduction
through economies of scale and can increase their profits, which is evident from positive relation-
ship between ROA and firm size. However, negative relationship between firm size and market

SE
performance may be attributed to high level of information asymmetry prevalent in large firms which
is rated lower by the investors and thus market performance is negatively related to the large size of

U
firms (Afza et al., 2008).

L
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Institutional Shareholders Activism and Firm Performance
C
ER
An institutional investor is different from an atomistic investor in many aspects such as: size of
shareholding, proficiency in monitoring, as well as incentive to keep an eye on managers with low cost
M

of monitoring. Therefore, an institutional owner’s influence on firm performance is much more significant
as compared to an atomistic owner. There are some institutional investors which may be temporary and
M

only interested in short-term performance of corporations. The focus of these institutional investors is
O

short-term because their own performance is to be evaluated on short term returns they generate. So,
C

there is no incentive for these investors to be present on the board of directors of firms in which they
invest blocks of stock. Contrary to this, the active investors with board representation have selected to
R

exercise efficient monitoring and hence, their ownership stake is more likely to be associated with value
FO

of firm. In this regards, two scenarios determine the influence asserted by financial institutions on firm
performance. In first scenario, financial institution has his nominee on board, who may have a bird eye
T

view on all activities of firm thus hinder managers from any exploitation of external shareholders’ rights.
O

In other scenario, financial institution just holds stock and ‘stays behind the wall’, and does not interfere
in any firm activity. The former is named as an active institutional investor while the latter is known as
N

a passive institutional investor.

Once the role of the general type of ownership held by the financial institutions has been established
with firm performance given in Table 3, now financial institutions are segregated by their activism
for long or short term investment. The total sample is classified into two sub-samples consisting of
firms having a financial institution nominee on their board of directors and firms those do not have
a financial institution nominee. Table 4 reports some descriptive statistics about these sub-samples
based upon institutional shareholders’ activism. There are 492 observations in the data that belong to
active institutional shareholders category which form approximately 35 per cent of the total sample.
These firms are, on average, bigger in size and relatively more profitable in terms of ROA and Tobin’s Q.
Moreover, institutional shareholders’ activism is present in those firms where these financial institut-
ions own quite a substantial percentage of shares which is evident from 22 per cent share ownership
by institutions whereas the average fraction of shares owned by passive financial institutions is less
than 10 per cent in case of our sample firms.
566 Global Business Review 16(4)

Table 4. Descriptive Statistics of Institutional Shareholders’ Activism

Active Passive
Variables Mean Median SD Mean Median SD
Assets (billion PKR) 25.43 6.01 36.25 10.25 4.25 31.31
ROA (%) 0.0699 0.0612 0.1102 0.0614 0.0574 0.0930
Tobin’s Q 1.4848 1.1011 2.4015 1.3289 0.910 2.6521
Lvrg 0.5742 0.5619 0.2410 0.5325 0.5389 0.2210
FIN OS 0.2199 0.1092 0.1192 0.0840 0.0935 0.1035
N 492 (35.14%) 908 (64.86%)
Source: Authors’ own.

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In the empirical analysis of active versus passive financial institutions, the variables of joint stock
company (Joint) and associated company ownership (Ass.) have not been considered to see the activism

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of institutional shareholders. The role of corporate ownership (Joint) was found insignificant in the

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earlier models and the results are reported in Table 3, whereas ownership held by associated companies

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is supposed to have a strong influence on the performance of a subsidiary company, whether or not
a nominee director is present on the board of directors of sample firms (subsidiary company). This makes
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it inoperable to investigate the influence of the activism of institutional shareholders for associated
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companies’ ownership and this effect is examined only in the case of share ownership held by financial
institutions. The Equations 1.3–1.6 have been estimated for two sub-samples separately and results are
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reported in Table 5.
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ROA it = b 0 + b 1F.Active it + b 2Size it + b 3Lvrg it + fit(1.3)

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Tobin’s Q it = b 0 + b 1F.Active it + b 2Size it + b 3Lvrg it + fit(1.4)

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ROA it = b 0 + b 1F.Passive it + b 2Size it + b 3Lvrg it + fit(1.5)

Tobin’s Q it = b 0 + b 1F.Passive it + b 2Size it + b 3Lvrg it + fit(1.6)

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where
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b0 = Intercept
F.Activeit = Share held by active financial institutions of company i for year t
F.Passiveit = Share held by passive financial institutions of company i for year t
Sizeit = Log of total assets of company i for year t
Lvrgit = Total debt/total assets of firm i for year t
ROA = Net Income/Total assets of the company
Tobin’s Q = Market value of equity + book value of debt/book value of its assets
fit = Error term.

Model 1 of Table 5 reports the result of firms with active financial institutions having their nominee
on the board of directors and both performance measures, whereas Model 2 of Table 5 highlights the
relationship of firm performance and passive financial institutions who do not have their nominee on the
board of directors and who are investing with short-term orientation only.
Afza and Nazir 567

Table 5. Firm Performance and Active Versus Passive Institutional Ownership

Model 1 Model 2
Variables ROA Q ROA Q
Intercept 0.078 1.003 −0.028 −3.994
(2.112)* (2.899)** (−0.74) (−3.419)**
FIN. active 0.131 0.106
(2.709)** (1.933)*
FIN. passive −0.029 −0.120
(−0.634) (−3.125)**
Size 0.120 −0.071 0.174 −0.04
(2.434)* (−0.113) (4.124)** (−0.901)
Leverage −0.526 −0.154 −0.495 −0.138

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(−10.504)** (−2.679)** (−13.120)** (−3.012)**
Adjusted-R2 0.25 0.180 0.252 0.190

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D–W 1.563 1.723 1.575 1.548

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F-value 36.458** 4.055** 58.487** 5.590**

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Source: Authors’ own.
Notes: **Significant at 1 %, *Significant at 5 %, t-values are in parenthesis.

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Results reveal that firms with financial institution activism are performing well on both performance
measures. Accounting performance as well as market performance can be enhanced if firms are actively
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monitored by the financial institutions that are present in the board of the directors of firms. The nominee
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director of active financial institutions participates on the board by keeping a close watch on business
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activities performed in the firm and can obstruct managers from any manipulation and misuse of
resources, which reduces agency conflict between managers and shareholders leading to firm perfor-
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mance. Moreover, they have the right to raise voice in firm decisions and force other board members to
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take optimal decisions which are in favour of the firms’ other stakeholders. Therefore, this activism and
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presence on the board positively influences firm performance.

The role of passive institutional investors on return on assets is negative and statistically insignificant.
Passive investors have no significant impact on the firm’s accounting performance as they have no partici-
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pation and monitoring in the business operations of the firm. Moreover, capital market participants per-
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ceive an active investor as a shield between managers and shareholders, which protect the shareholders
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from manager’s exploitation and absence of this activism influencing firm performance in a negative
way. The investors do not feel secure in investing into firms which do not have financial institution
nominee on their board of directors and hence they assign lesser value to stocks of such companies. Our
results are consistent with the study of Navissi and Naiker (2006), who found that active institutions
shareholding have strong positive impact on the firm value, while the passive institutions shareholding
have insignificant impact on firm performance. The impact of other control variable remained same as
previously mentioned in Table 3 which specified by the signs and statistical significance of coefficients.

Conclusion
Corporate governance has been widely considered by academic researchers as a functional tool for
transforming firms’ effectiveness into efficiency and hence creating value for the shareholders on a
continuous basis. Numerous researchers from around the world have attempted to investigate the impact
568 Global Business Review 16(4)

of various mechanisms of corporate governance on firm performance. Among these various mechanisms
of corporate governance, ownership structure is considered to be a dominating one and has been remained
focus of research for the academicians of the world. The capital markets of Pakistan are immature and
developing and hence implementation of corporate governance is still in transition phase. Therefore, this
study primarily focused on this mechanism and the impact of ownership by institutional investor on firm
performance in Pakistan is analyzed.
With every passing day, the behaviour of institutional owners is changing and they are becoming
more active. Firms are no longer in a position to ignore the voice of institutional owners thus their control
on firm results into reducing agency conflict. Our results indicate that effective monitoring hypotheses is
valid for Pakistani firms and firm performance increases with increased level of share ownership by
financial institutions who are active monitor. Financial institutions have block investment in firms thus
their willingness to keep an eye on firms’ activities is much higher than any other investor. Moreover, it

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is also found that firms having financial institution representative on the board outperform their counter-
parts without a representative director on the board. As active financial institutions closely monitor each

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and every operation affairs of firm and moreover, they also enforce managers to take optimal decisions
which are in favour of all stakeholders. This leads to an enhanced performance of firms. Contrary to this,

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firm performance decreases because passive institutions merely hold huge investment and do not partici-

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pate in any firms’ affairs and therefore cannot obstruct the managers from any misuse of firm resources.

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There are certain limitations of this research which future researchers should consider. First, this
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research has only considered the firms form non-financial sector and financial firms are excluded from
the sample. The analysis of financial firms’ institutional shareholder activism may produce different and
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interesting results. Second, the present study employs only two performance variables and other more
modern sophisticated performance measurement can also be analyzed like economic value added (EVA).
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And finally, the endogenous relationship between institutional shareholding and firm performance may
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also exist in case of Pakistan which was not the focus of the present study. Future researchers may
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consider these factors, in order to have more generalized results.

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Acknowledgement
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The authors are grateful to the anonymous referees of the journal for their extremely useful suggestions to improve
the quality of the article. Usual disclaimers apply.
T
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