Importance of institutional investor

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  • Publié le : 7 mai 2010
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Institutional Investors became more and more important over the years. This is reported by the Institutional Monetary Fund (2005); in their report, IMF shows that Institutional Investors managed more than $45 Trillion in financial assets (including more than $20 Trillion in equities). However, this is not the solely evidence of the exponential growth of Institutional Investmentssince the past few years. Thereby, according to the Office of National Statistics (2000), the size of institutional investments has massively increased between 1970 and 1998 (Appendix I). For instance, in the UK, the value of Institutional Investments has increased from 42% in 1970 to 199% in 1998. Moreover, the development of Institutional Investments is not sticked in developed markets but alsoreached emerging countries Khorana, Servaes, and Tufano (2005).
Those arguments and figures being exposed, it becomes evident that Institutional Investments became incontrovertible players on the financial markets. This raises the question of their importance for such markets. Nevertheless, before tackling the question of the importance of Institutional Investors on financial markets, the mainterms have to be defined:
_First, an Institutional Investor is _an organization such as investment companies, mutual funds, pension funds, investment banks_ etc. that trades securities in large enough share quantities that they qualify for preferential treatment and lower commissions (Investopedia 2010)_.
Then, financial markets are markets_ for _sale_ and _purchase_ of _shares, bonds, bills_of exchange, _commodities, derivatives, foreign currency, etc., which work_ as _exchanges_ for _capital_ and _credit_ (BusinessDictionary 2010)_.
The main terms being defined and being understood, the importance of Institutional Investors can now be assessed. This paper is divided into three main parts:
The first part is dedicated to the issue of price volatility relating to InstitutionalInvestors, then the role of Institutional Investors on price equity will be discussed and finally, the impact of the Institutions on Firm’s Corporate Governance will be examined.
There is the implication that the advent of Institutional Investors has increased the stock market volatility. This is supposed to be the result of the specific behaviour ofInstitutional Investors which therefore destabilize the stock markets. Malkiel and Xu (1999) found out that there are consistent evidences that the institutionalisation of the market has a responsibility in the volatility of stock market prices and more precisely on individual stocks. This is mostly achieved by the dominance of trading volume from Institutional Investors. Indeed, they get the sameinformation from the same sources and therefore react in the same way and change their minds about the market all together. Essentially, this means that most of Institutional Investors coordinate their actions, thus selling and buying from those Institutions will be done in huge volume and so market prices will be more volatile due to those movements. Gabaix et al. (2006) presented a theory inwhich trade by large Institutional Investors in illiquid markets is one of the most important explanations (along with news) of important spikes in returns and volumes. Apart from the econometrical demonstration in which they show that trading by large investors is correlated with market volatility, they also illustrate their point as follows: if news makes a large investor to trade a particularstock, the trading volume will represent an important proportion of daily turnover and the optimal volume will be large enough to provoke a significant price change (due to the relation between demand and offer). Redhead (2008a) explains that “the presence of Institutional Investors could serve to magnify both upward and downward movements in stocks indices”. His argument is based on Pepper and...