We find that institutional ownership in publicly traded companies is associated with more innovation(measured by cite-weighted patents). To explore the mechanism through which this link arises, webuild a model that nests the lazy-manager hypothesis with career-concerns, where institutional ownersincrease managerial incentives to innovate by reducing the career risk of risky projects. The datasupports the career concerns model. First, whereas the lazy manager hypothesis predicts a substitutioneffect between institutional ownership and product market competition (and managerial entrenchmentgenerally), the career-concern model allows for complementarity. Empirically, we reject substitutioneffects. Second, CEOs are less likely to be fired in the face of profit downturns when institutionalownership is higher. Finally, using instrumental variables, policy changes and disaggregating by typeof owner we find that the effect of institutions on innovation does not appear to be due to endogenousselection.
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Paper provided by Centre for Economic Performance, LSE in its series CEP Discussion Papers with number
dp0911.
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