Aurora Borealis
1 December 1997 Research Foundation

Blockholdings of Investment Professionals

  1. Sanjai Bhagat
  2. Bernard S. Black
  3. Margaret M. Blair
Blockholdings of Investment Professionals View the full book (PDF)

Suppose you asked 100 practicing money managers the following question: What is the most important function you perform for your clients? Undoubtedly, many would quickly respond that selecting good stocks and bonds is the most fundamental decision they make on a day-to-day basis. Alternatively, some managers would argue that determining the proper asset and sector class allocations is (and should be) their primary focus. Still others might go so far as to say that educating investors about the nature of risk—and its relationship to promised return—is the true purpose of any investment counselor and that the actual investing is just a matter of details once the client's expectations have been properly managed.

Although reaching any sort of consensus on this seemingly simple query might be difficult, one response that you probably would not hear is that portfolio managers can best serve clients by cooperating with the companies in which they invest. If anything, the historical model of the financial services industry suggests that money managers should be advocates for investors to an extent that might require them also to be adversaries of corporations. The premise for this traditional view is that by centralizing control of capital among several investors, portfolio managers can serve as more-efficient monitors of corporate managers than if the individual investors performed this function separately. In this manner, the theory holds, many of the principal-agent costs that attend investing in the stock market—such as the payment of excessive perquisites—can best be controlled.

Notice that this view of money-manager-as-monitor carries with it the implied threat that a firm might be "disciplined" by having large blocks of stocks liquidated if it does not perform as expected. Indeed, the proliferation of hostile takeovers in the 1980s is often cited as compelling evidence of this trend toward investor activism. What if, however, institutional investors performed their monitoring role in a less threatening, more proactive manner? In particular, what if investors acquired large stock positions for long periods of time in an effort to work with firm management to increase organizational efficiency? In this monograph, Sanjai Bhagat, Bernard Black, and Margaret Blair examine whether this type of commitment—which has been called "relational" investing—actually does add value for the money management client by increasing firm value.

Specifically, the authors focus on the size and length of the stock positions investment advisors, investment companies, and broker/dealers take in various corporations and attempt to correlate these blockholdings with subsequent firm performance. At the end of this research, Bhagat, Black, and Blair summarize their findings as follows: "A conclusion that we can legitimately come to [is that] relationship investing is, at worst, neutral, and most probably adds value in many situations." If this seems a tepid judgment, the reader should bear in mind that the statistical methods the authors used are designed to be extremely conservative and protect against making strong statements prematurely. The problem in this case is not that the evidence supporting relationship investing is weak; rather, the significance of the myriad correlations reported varies greatly with the time period examined and how the investor is defined. In short, despite not being easily summarized, these findings do support the efficacy of investor-corporate partnerships.

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