1. Introduction
Institutional investors maintain a notable presence and exercise growing influence over global capital markets. The increasing growth of their worldwide investments affords them the potential to influence the behavior of investee firms through their monitoring activities (
Aggarwal et al. 2011;
Gillan and Starks 2003;
Mallin 2016). Generally, institutional investors who are dissatisfied with company performance or with the governance structure of an organization may choose to sell their company shares (“exit”) or opt to engage with their investee firms (“voice”) (
Ferreira and Matos 2008;
Martin et al. 2007). Since the “exit” option is considered costly, large institutional investors choose to engage with their investee firms in order to change unfavorable governance structures and to correct undesirable performance (
McCahery et al. 2015;
McNulty and Nordberg 2016). The engagement between institutional investors and their investee firms can assume many forms, such as one-to-one meetings, voting, shareholder proposals and resolutions, focus lists and corporate governance rating systems (
Mallin 2016;
Martin et al. 2007). In addition, behind-the-scenes one-to-one meetings may be held; such meetings are considered an effective approach that is regularly used by institutional investors to enhance the governance structure of their investee firms (
Holland 1998;
McCahery et al. 2015). Moreover, the stewardship codes and guidelines issued by several institutions in various countries are a significant move towards improved interactions between institutional investors and their investee firms, as they aim to promote positive governance structures (
Haxhi et al. 2013;
McNulty and Nordberg 2016). More recently, several studies have also found that the institutional investors have the ability to play an effective role in enhancing corporate governance mechanism in a stakeholders-oriented corporate governance system like Japan (
Sakawa and Watanabel 2020;
Sakawa et al. 2021).
The corporate board is considered to be the main governing mechanism that mitigates the agency costs that arise from the separation of ownership and control (
Fama and Jensen 1983). Given that the board exists as the nucleus of decision making processes, great attention has been paid to its attributes (
Solomon 2010;
Mallin 2016). Regarding the importance that the corporate board attributes hold for institutional investors,
Useem et al. (
1993) have provided evidence that the composition and functionality of the board are crucial considerations for US-based institutional investors. Furthermore, following a global survey of 200 institutional investors,
Coombes and Watson (
2000) have stated that most institutional investors consider the attributes of a corporate board to be as important as an organization’s financial performance. Furthermore,
Chung and Zhang (
2011) also found that institutional investors favor firms with higher board independence, thus indicating that these firms are associated with lower monitoring costs. As yet, few studies have examined the role of institutional investors in the improvement of corporate governance around the world (
Goranova and Ryan 2014). However, single-country studies, largely based on US data, have found that institutional investors can influence antitakeover amendments (
Brickley et al. 1988), CEO turnover decisions (
Parrino et al. 2003;
Helwege et al. 2012), the selection of auditing firms (
Kane and Velury 2004), managerial compensation schemes (
Hartzell and Starks 2003;
Almazan et al. 2005), dividend pay-outs, operating performance and CEO turnover (
Brav et al. 2008), earnings management (
Hadani et al. 2011), CEO pay and the introduction of shareholder proposals (
Chhaochharia et al. 2012), corporate risk taking (
Sakawa et al. 2021). Of these studies, most focus on overall governance levels (
Aggarwal et al. 2011), firm performance (
De-la-Hoz and Pombo 2016;
Ferreira and Matos 2008), and CEO compensation (
Croci et al. 2012) and earnings management (
Kim et al. 2016). Little is known about the role of institutional investors in the improvement of board governance structures across the globe. Therefore, this study aims to augment the recent work of
Aggarwal et al. (
2011) by considering the comprehensive characteristics—such as composition, entrenchment and busyness—of corporate boards and their key sub-committees using a cross-country sample.
Several corporate governance studies have highlighted the importance of national institutional factors in explaining corporate governance phenomena (
Aguilera et al. 2008,
2012;
Aslan and Kumar 2014;
Iannotta et al. 2016;
Kim and Ozdemir 2014). One such institutional factor is the economic condition of a country (
Essen et al. 2013;
McNulty et al. 2013). The weakness of corporate governance in many countries is largely considered to have been a main contributor to the onset of the recent financial crisis (
Akbar et al. 2017). Several studies have suggested that both institutional investors and corporate boards are to blame for their inability to prevent that crisis from occurring (
Conyon et al. 2011;
Reisberg 2015). In response to such a devastating crisis, several countries introduced or revised their corporate governance codes in an attempt to strengthen their governance practices (
Adams 2012;
Cuomo et al. 2016). Moreover, in the wake of the recent financial crisis, several countries issued stewardship codes and guidelines (beginning with the UK in 2010) in an effort to encourage and enhance engagement between institutional investors and their investee firms (
ICGN 2017). However, we still know little about the role played by institutional investors in efforts to improve corporate governance with respect to the recent financial crisis. Therefore, this study also aims to examine the role of institutional investors in the improvement of corporate board characteristics in light of various economic conditions (pre-crisis, crisis and post-crisis periods).
Additionally, the bundle perspective of comparative corporate governance (
Aguilera et al. 2008,
2012;
Kim and Ozdemir 2014) argues that differences between board attributes across countries cannot be studied without also considering at least two other governance characteristics—legal system and ownership structure—as each of these characteristics is contingent upon the strength and prevalence of the other. Previous studies have shown that the legal system of a country (i.e., common or civil law) affects its accepted levels of investor protection (strong versus weak) (
La Porta et al. 1998,
2000). To this end,
La Porta et al. (
1998) argued that in countries where investor protection rights are weak, investors may seek other means of protection. As a board of directors is entrusted with the protection of shareholder interests, institutional investors can improve corporate board characteristics to a greater degree in countries where shareholder protections are weak. Thus, this study complements previous empirical findings (
Aggarwal et al. 2011) by investigating the capacity of institutional investors to improve a wide range of board characteristics within various legal systems (common versus civil law systems).
Moreover, previous studies on this topic (see, for example,
Aggarwal et al. 2011;
Ferreira and Matos 2008) have failed to consider a firm’s controlling shareholders when examining the role of institutional investors in the improvement of corporate governance. However, ownership structures are an important component of the bundle perspective of global corporate governance practices (
Aguilera et al. 2012). Corporate governance practices and outcomes cannot be properly investigated without also considering the pivotal function of a firm’s ownership structure (
Aguilera and Crespi-Cladera 2016;
Desender et al. 2013;
Judge 2011,
2012;
Sur et al. 2013). Indeed, ownership structures vary across countries; widely-held firms are more common in the US and the UK, while firms with concentrated ownership structures are more common in continental European countries (
La Porta et al. 1999). On the one hand, the presence of controlling shareholders might be beneficial; this might be because they have the incentive to better monitor managers’ actions due to their ownership interests. On the other hand, controlling shareholders might expropriate the interests of minority shareholders in favor of their own (
Shleifer and Vishny 1997). In such a context, this research aims to examine the role of institutional investors in improving the governance structures of companies with various ownership structures (concentrated or dispersed ownership systems).
Using a sample collected from 15 countries (Australia, Belgium, Canada, Denmark, Finland, France, India, Ireland, Italy, Netherlands, Norway, Spain, Sweden, Switzerland and the UK) for the period 2006 to 2012, the results suggest that the association between institutional ownership and board governance structure is positive and significant and that foreign institutional investors play a more crucial role in the improvement of board governance structures than do their domestic counterparts. Concerning the individual attributes of corporate boards and their key sub-committees, the study demonstrates that institutional investors are most effective in improving the composition of boards and their key sub-committees (with the exception of nomination committees). Furthermore, while institutional investors are found to reduce board entrenchment, they do not appear to reduce board busyness. The results also suggest that the role of institutional investors in the improvement of governance outcomes is dependent on economic conditions (pre-crisis, crisis and post-crisis), legal systems and ownership structures. In particular, the findings show that institutional investors take on larger and more effective roles when it comes to improving the governance structures of firms during and after a crisis period compared to their roles and influence before a crisis begins. This is also true referring to boards of directors’ attributes, such as the independence of audit committees. Furthermore, in civil law countries, institutional investors enhance the boards’ independence and that of their key sub-committees (though nomination committees seem to be an exception). In common law countries, instead, institutional investors have the effect of reducing boards’ levels of busyness. Despite these findings, the study found no evidence about the institutional investors’ role in reducing boards’ entrenchment in these legal systems. The results also reveal that institutional investors have the ability to improve boards’ attributes (such as their composition, entrenchment and busyness) but only in non-family firms. The results are robust after performing a variety of robustness checks for endogeneity and reverse causality.
This paper contributes to the existing literature in various ways. To begin, this study is—to the best of my knowledge—the first to investigate the role of institutional investors in the improvement of governance attributes via the consideration of a comprehensive range of characteristics (to include composition, entrenchment and busyness) that are related to boards of directors and their key sub-committees (audit, compensation and nomination). From the viewpoint of agency theory, larger institutional shareholdings are expected to improve board governance structure in order to mitigate the agency and asymmetric information problems (
Jensen and Meckling 1976). Therefore, this study investigate to which extent institutional investors can improve board governance structure by considering the comprehensive characteristics—such as composition, entrenchment and busyness—of corporate boards and their key sub-committees, using international sample. Second, this study contributes to the growing body of literature on comparative governance mechanisms (
Aguilera et al. 2008;
Kim and Ozdemir 2014). From the perspective of institutional theory, the external environment surrounding the entities and organizations may affect the way they behave (
Scott 2004). In particular, this study explores the role of institutional investors in the improvement of board governance structures by examining various institutional settings, to include several economic conditions (pre-crisis, crisis and post-crisis periods), legal systems and ownership structures.
This paper is structured as follows. The first section discusses the literature and the hypothesis development. I then illustrate the study’s methodology, present the empirical analysis and summarize my findings. In the final section of this paper, I discuss the research implications and present potential avenues for future research.
4. Empirical Analysis
This section outlines the findings of my empirical analysis. First,
Table 1 summarizes the descriptive statistics and the correlation matrix of the main variables. The results demonstrate that the board attributes index (GOV
14) has an average score of 10, while the independence of a board and its key sub-committees (audit, compensation and nomination) have average values of 64%, 85%, 80% and 71%, respectively. For the entire sample, CEO tenure has an average value of 5 years, while the average score for board tenure is 6 years. Furthermore, the average number of directorships held by each director in my sample is 2.6, and an average of 43% of the boards in my sample are busy.
Table 1 also demonstrates that the average values for institutional ownership (total, foreign, domestic, common and civil) are 36%, 20%, 16%, 28% and 8%, respectively. The results also show that none of the independent variables are significantly correlated (above 0.80) (
Gujarati 2003), with the exception of IO Total and IO Common. However, these two variables are not combined in any of the regressions in my analysis.
Turning to the regression results, I applied firm fixed effects panel regressions to investigate the role of institutional ownership in corporate governance (see
Table 2). Models 1 and 2 of
Table 2 illustrate that there is a positive and significant association between total and foreign institutional ownership and the board attributes index (GOV
14) at 5% and 1%, respectively (with coefficient = 0.006 and 0.009,
p-value = 0.033 and 0.008, and R-Squared value = 0.098 and 0.101, respectively). However, Models 3, 4 and 5 demonstrate that the coefficients are mixed and insignificant for domestic, common and civil institutions (with coefficient = −0.001, 0.005 and 0.008,
p-value = 0.758, 0.110 and 0.313, and R-Squared value = 0.095, 0.097 and 0.096, respectively). Overall, the results are partially consistent with H1 and are consistent with the agency theory. The findings particularly contribute to the literature of corporate governance that corporate board attributes are important for the institutional investors and that they enhance these attributes when they engage with their investee firms, with the foreign institutional investors playing a lead role in the improvement of board attributes. The results also imply that attributes of the corporate board are deemed to be crucial for the institutional investors, as the attributes of the corporate board reflect its effectiveness in the reduction of agency cost and in fulfilling its duties (
Zahra and Pearce 1989;
Aguilera et al. 2012;
Mallin 2016).
Notably, these results were wholly consistent with the findings of
Aggarwal et al. (
2011), who argued that foreign institutional investors promote favorable governance outcomes as compared to their domestic counterparts. This also reflects previous studies (e.g.,
Gillan and Starks 2003;
Ferreira and Matos 2008;
Beuselinck et al. 2017;
Luong et al. 2017) that contended that foreign institutional investors have fewer ties to their investee firms 6because of their independent positions and therefore are expected to exert greater pressure over the management of an investee firm in an effort to establish a strong governance structure. The results are also consistent with the previous studies which stated that foreign institutional investors can effectively promote growth opportunities (
Sakawa and Watanabel 2020) and corporate risk taking (
Sakawa et al. 2021) in a stakeholders-oriented corporate governance system like Japan.
Table 2 also shows that the role of institutional investors operating within various economic conditions is significant only during crisis and post-crisis periods, but not during pre-crisis periods (see
Table 2, Panels B–D). This is consistent with previous studies that claim that institutional investors took excessive risks before the crisis (
Erkens et al. 2012;
Díez-Esteban et al. 2016). This may also explain why institutional investors did not enhance board attributes (GOV
14) in their investee firms prior to the financial crisis.
Adams (
2012) also found that the governance structure of non-financial firms is weaker compared to their financial counterparts prior to the recent financial crisis. Several scholars have blamed both the institutional investors and the corporate boards alike for their inability to mitigate the aforementioned crisis (
Conyon et al. 2011;
Reisberg 2015). The results also reveal that during crisis periods, only foreign institutions have a positive and significant relationship at 10% (with coefficient = 0.010,
p-value = 0.072, and R-Squared value = 0.111). After the crisis passes, however, all types of institutional investors have positive and significant associations with the board attributes index, with the exception of foreign institutional investors (with coefficient = 0.022, 0.015, 0.033, 0.018 and 0.070,
p-value = 0.005, 0.112, 0.012, 0.059, 0.000, and R-Squared value = 0.090, 0.072, 0.083, 0.076 and 0.100, respectively). Overall, the results are consistent with the institutional theory, and they indicate the institutional investors’ awareness of the importance of corporate board attributes after the recent financial crisis. Following the crisis, the OECD published a report on governance lessons learned from the recent financial crisis that clearly illustrates that the weaknesses of corporate governance was one of the key reasons the crisis occurred (
Kirkpatrick 2009).
Furthermore,
Table 2 reports the results of the firm fixed effects regression of the board attributes index (GOV
14); these results indicate that the role of institutional investors in the improvement of governance structures is dependent on the legal system of the country in which a firm is listed (see
Table 2, Panel E). In common law countries, total and foreign institutional investors have positive and significant relationships at the 10% and 1% significance levels, respectively (with coefficient = 0.005 and 0.011,
p-value = 0.069 and 0.001, and R-Squared value = 0.146 and 0.154, respectively). Conversely, in civil law countries, these associations are mixed but insignificant. Drawing from the institutional theory, the results complement the other studies that ascertained that the legal system should be considered when investigating the adoption of corporate governance practices across countries (
Aguilera et al. 2008;
Aguilera et al. 2012;
Kim and Ozdemir 2014). In particular, the findings reveal that the activism of institutional investors towards improving board attributes in their investee firms is also attributed to the legal system of a particular country. The results also show that total and foreign institutions have positive and significant associations at 1% in non-family owned firms (with coefficient = 0.008 and 0.013, and
p-value = 0.008 and 0.000, respectively); this result does not stand for family owned firms, however (see
Table 2, Panel F). Drawing from the institutional theory, these results also complement the other studies that emphasized the contingency of ownership structure when investigating the adoption of corporate governance mechanisms in a particular firm (
Desender et al. 2013;
Judge 2011,
2012;
Sur et al. 2013) by showing that the role of institutional investors in improving board attributes is determined by the ownership structure (family vs. non-family-controlled firms).
In
Table 3,
Table 4 and
Table 5, I repeat the same analysis by considering the composition of a corporate board and of its key sub-committees, board entrenchment and board busyness. In this study, the independence of the board is measured by the proportion of independent directors on the board (
Osma 2008;
Sharma 2011). The results indicate a positive and significant association between board independence and total institutional ownership at the 5% significance level (with coefficient = 0.001,
p-value = 0.036 and R-Squared value = 0.077). Drawing from the agency theory, the results are consistent with those who ascertained that institutional investors are attracted by firms whose board independence is high (
Useem et al. 1993;
Chung and Zhang 2011). Several scholars emphasised the importance of corporate board independence in the reduction of the agency costs (
Anderson and Reeb 2004;
Bebchuk and Weisbach 2010). However, this coefficient is positive but insignificant for foreign and domestic institutions (see
Table 3, Panel A). I also find that total institutional ownership promotes the improved independence of audit and compensation committees (with coefficient = 0.001 and 0.001,
p-value = 0.003 and 0.002, and R-Squared value = 0.054 and 0.039, respectively). Conversely, total institutional ownership has a negative but insignificant relationship with nomination committee independence. Results also reveal that domestic and foreign institutions promote the independence of audit committees (with coefficient = 0.001 and 0.001,
p-value = 0.082 and 0.027, and R-Squared value = 0.049 and 0.051, respectively), while foreign institutions promote the independence of compensation committees (with coefficient = 0.001,
p-value = 0.009 and R-Squared = 0.038). Both types of institutional investors (domestic and foreign) have an insignificant association with the independence of the nomination committee (see
Table 3, Panel A), however. Collectively, these results support the agency theory and are consistent with H2a and H2b. Given the monitoring role of institutional investors, these results reflect other studies that emphasized the importance of the composition of audit and compensation committees in mitigating the agency costs (
Newman and Mozes 1999;
Abbott and Parker 2000;
Klein 2002;
Abbott et al. 2003;
Zaman et al. 2011).
The study further finds that during pre-crisis periods, institutional investors have mixed but insignificant influence over the independence of a board and its key-sub-committees. However, during times of crisis, total institutional investors have positive and significant relationships with the independence of audit committees at 5% (with coefficient = 0.001,
p-value = 0.020 and R-Squared = 0.071), and negative and significant relationships with the independence of nomination committees at 1% (with coefficient = −0.001,
p-value = 0.068 and R-Squared = 0.067). Furthermore, foreign institutional investors have positive and significant associations with the independence of a board and its audit committee at 10% and 5%, respectively (with coefficient = 0.001 and 0.002,
p-value = 0.054 and 0.014 and R-Squared = 0.080 and 0.075, respectively). The results support the institutional theory and are consistent with those who found that board independence may bring fruitful governance outcomes during crises. For instance,
Francis et al. (
2012) and
Yeh et al. (
2011) found that board independence and audit committee independence improved firm performance during the time of the crisis, respectively. Finally, the results indicate that during post-crisis periods, only domestic institutional investors have positive and significant associations with the independence of audit and nomination committees at 5% and 10%, respectively (with coefficient = 0.004 and 0.003
p-value = 0.030 and 0.092 and R-Squared = 0.123 and 0.108, respectively).
With regard to whether legal systems affect the role of institutional investors in improving the composition of a board and that of its key sub-committees (see
Table 3, Panels E and F), the results show that institutional investors promote the improved composition of boards and their key sub-committees (with the exception of nomination committees) in civil law countries, but not in common law countries. The results revealed that total institutional investors have a positive and significant association with the independence of the board and audit and compensation committees at a 5% significance level (with coefficient = 0.001, 0.002 and 0.002,
p-value = 0.020, 0.016 and 0.016, and R-Squared value = 0.101, 0.089 and 0.062, respectively). The findings are explained by the institutional theory perspective, in that institutional investors improve the composition of the board and its key subcommittees in civil law countries in order to mitigate the weak shareholder protections in civil law countries compared to their common law counterparts (
La Porta et al. 1998).
Gaitán et al. (
2018) showed that board independence is among the factors leading to firm productivity in civil law countries. This is consistent with
Yeh et al. (
2011), who argued that the influence of the audit committee’s independence on firm performance is greater in civil law countries compared to their common law counterparts. The results also indicate that institutional investors can indeed improve the composition of a board and of its key sub-committees (with the exception of the nomination committee) in non-family owned firms. In family owned firms, however, the results illustrate that institutional investors (foreign and total) improve the independence of audit committees only (see
Table 3, Panel G).
Concerning board entrenchment, the results indicate that total, foreign and domestic institutional investors have positive but insignificant relationships with CEO tenure. In contrast, institutional investors (total, foreign and domestic) have negative associations with board tenure; this association, however, is only significant with respect to domestic institutions at the 10% significance level (with coefficient = −0.011,
p-value = 0.053, and R-Squared = 0.100), (see
Table 4, Panel A). The findings, therefore, partially support H3. Drawing from the theoretical framework of agency theory, the results are consistent with those who argued that long-tenured directors may become less effective in monitoring the firm, as they are likely to form friendships and become closer to the managers (
Vafeas 2003;
Barroso et al. 2011). Others also argued that firms with long-tenured boards are likely to be more resistant to change, and associated with a lower degree of international diversification, fewer patents and research and development (
Musteen et al. 2006;
Barroso et al. 2011;
Jia 2017).
The results show that during pre-crisis periods, institutional investors (total and domestic) promote board entrenchment (CEO duality) (with coefficient = 0.063 and 0.172,
p-value = 0.082, 0.069, and R-Squared value = 0.125 and 0.148, respectively); this aspect wanes, however, during crisis and post-crisis periods (see
Table 4, Panels B, C and D). Upon a comparison of this relationship under different legal systems, the results indicate that institutional investors have mixed but insignificant associations with board entrenchment measures (CEO tenure and board tenure) in common law countries. In civil law countries, however, domestic institutional investors have negative and significant associations with board tenure at 5% (with coefficient = −0.026,
p-value = 0.016, and R-Squared value = 0.133) (see
Table 4, Panels E and F). Furthermore, the results reveal that the association between institutional investors and board entrenchment is mixed and insignificant in both family and non-family owned firms (see
Table 4, Panel G). Finally, the findings indicate a negative and significant association between domestic institutions and board tenure at the 10% significance level in non-family owned firms (with coefficient = −0.010, and
p-value = 0.090).
The study also investigated whether the institutional investors play a role in the reduction of board busyness. Board busyness is measured by two proxies; average directorships held by INEDs, and the proportion of INEDs who hold three or more directorship in public firms (
Cashman et al. 2012). The results indicate that institutional investors (total, foreign and domestic) have mixed but insignificant associations with board busyness measures (see
Table 5, Panel A). Therefore, H4 is rejected. Interestingly, results indicate that institutional investors behave differently according to different economic conditions. For example, total institutional investors promote board busyness in times of crisis in both measures (with coefficient = 0.004 and 0.001,
p-value = 0.039 and 0.061, and R-Squared value = 0.077 and 0.060, respectively), while during pre-crisis and post-crisis periods, this influence is not evident (see
Table 5, Panels B, C and D). The results are consistent with those who found that busy directors may be beneficial to the firm, as their experience and connection with other firms makes them competent compared to their non-busy counterparts on the board. For instance, firms with a busy board have been found to perform better (
Pombo and Gutiérrez 2011;
Field et al. 2013), bargain better deals and acquisitions of other firms (
Benson et al. 2015;
Harris and Shimizu 2004), and meet at a higher frequency (
Baccouche et al. 2014). As far as legal systems are concerned, the results illustrate that the tendency of institutional investors to reduce board busyness is mixed and insignificant within both systems (see
Table 5, Panels E and F); however, total institutional investors have negative and significant associations in common law countries at 10%. The results also suggest that the role of institutional investors in reducing board busyness is shaped by the ownership structure of a given firm. The results reveal that foreign institutional investors reduce board busyness in non-family firms as the relationship with foreign institutions is negative and significant at 10% (with coefficient value = −0.003 and −0.001, and
p-value = 0.064 and 0.057, respectively) (see
Table 5, Panel G).