Innovation and Institutional Ownership

TLDR

The lazy‑manager hypothesis predicts a substitution effect between institutional ownership and product‑market competition, whereas the career‑concern model allows for complementarity. The study seeks to explore how institutional ownership influences innovation by modeling the lazy‑manager hypothesis with career concerns. The authors construct a model that nests the lazy‑manager hypothesis with career concerns, showing that institutional owners raise managerial incentives to innovate by reducing career risk. Institutional ownership is associated with more innovation, the data supports the career‑concern model, rejects substitution effects, shows CEOs are less likely to be fired during profit downturns, and IV, policy changes, and owner‑type disaggregation indicate the effect is not due to endogenous selection.

Abstract

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, we build a model that nests the lazy-manager hypothesis with career-concerns, where institutional owners increase managerial incentives to innovate by reducing the career risk of risky projects. The data supports the career concerns model. First, whereas the lazy manager hypothesis predicts a substitution effect between institutional ownership and product market competition (and managerial entrenchment generally), the career-concern model allows for complementarity. Empirically, we reject substitution effects. Second, CEOs are less likely to be fired in the face of profit downturns when institutional ownership is higher. Finally, using instrumental variables, policy changes and disaggregating by type of owner we find that the effect of institutions on innovation does not appear to be due to endogenous selection.