How Are Large Institutions Different from Other Investors? Why Do These Differences Matter?

In this paper, we analyze how large institutions differ from other investors and the implications that these differences have for stock returns, market liquidity, and corporate governance. We find that large institutional investors -- a category including all managers with greater than $100 million in discretionary control -- have nearly doubled their share of the common-stock market over the 1980 to 1996 period, with this increase driven primarily by the largest one-hundred institutions. We show that large institutions, when compared with other investors, prefer stocks that are larger, more liquid, and have higher book-to-market ratios and lower returns for the previous year. Furthermore, the concentration of ownership, measured by the fraction of individual firms' equity held by their five largest institutional blocks, has also increased rapidly over the sample period. We discuss how institutional preferences, when combined with the rising share of the market held by institutions, induces changes in the cross-section of stock returns. We provide evidence to support the in-sample implications for realized returns and derive out-of-sample predictions for expected returns. We also show how rising institutional ownership and concentration has contributed to higher liquidity in public markets and the increased frequency of large-shareholder activism and we discuss the relevance of these findings for theoretical models of large shareholding in corporate governance.