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Review of Quantitative Finance and Accounting

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01.04.2013 | Original Research

Public pension fund ownership and firm performance

verfasst von: Yawen Jiao, Pengfei Ye

Erschienen in: Review of Quantitative Finance and Accounting | Ausgabe 3/2013

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Abstract

Equity ownership by public pension funds (PPFs) is widely used in the literature (see, e.g., Cremers and Nair 2005; Dittmar and Mahrt-Smith 2007) as a measure of the strength of shareholder monitoring/governance. This paper raises caution on such practices by illustrating an inverted-U shape relationship between PPF ownership and firms’ future performance, measured by stock returns and operating performance: during 1985–2005, future performance first increases, then declines in aggregate equity ownership by PPFs. Our results suggest that PPFs’ presence is consistent with shareholder value maximization when they have moderate influence on firm management, whereas excessive PPF ownership may facilitate PPF managers’ pursuits of political interests and destroy shareholder value. Therefore, it is important to impose an upper bound to PPF ownership when measuring the strength of shareholder monitoring/governance.

Vorheriger Artikel Dividend tax signaling and the pricing of future earnings: a case of taxable stock dividends

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Institutional investor activism is launched by Jesse Unruh in 1985, who oversaw the performance of two of the largest public pension funds, the California Public Employee Retirement System (CalPERS), and the California State Teachers Retirement System (CalSTRS). The then state treasurer of California was joined by New York City Comptroller Harrison J. Goldin and State of Wisconsin Investment Board Chair John Konrad in forming the Council of Institutional Investors (CII), which aims to provide more oversight to firms. CII has evolved into an organization consisting more than 140 public, labor, and corporate pension funds that controls in excess of $3 trillion in assets. It pursues its activism functions through various channels such as proxy votes, pressure on regulators, discussions with companies, and in some scenarios, litigation.

Discussions on the growth in pension fund assets are provided by Sias and Starks (1998).

For example, Carleton et al. (1998) show that TIAA-CREF indexes approximately 80 % of its domestic portfolio. Gillian and Starks (2000) document that CalPERS’ annual turnover rate is about 10 %, and New York Retirement Fund’s turnover rate is even lower at 7 %.

For example, in July 2008, the former Chief Investment Officer of the Education Retirement Board New Mexico, Frank Foy, filed a complaint alleging that appointees of Governor Bill Richardson pressured him toward making investment based on “political considerations” from 2003 to 2007. Foy’s attorney said in a press conference “…it had become apparent to the staff at ERB that in some cases state investments were being steered based on political considerations and political contributions.” Other anecdotal evidence also suggests that in many occasions, public pension funds invest in local firms because of political pressures rather than value considerations. See Romano (1993) for a review of some of such cases.

See Gillian and Starks (2007) for a survey on the existing studies on institutional investor activism. More broadly, our paper is also related to the literature on how corporate governance affects firm performance (e.g., Brown and Caylor 2009; Cheng et al. 2008; Gompers et al. 2003; Lee and Lee 2009).

Woidtke (2002) finds a negative relationship between public pension fund ownership and industry-adjusted Q for a sample of Fortune 500 firms in the 1989–1993 period. This paper differs from Woidtke (2002) in three dimensions: (1) we examine the effects of public pension fund ownership on a variety of performance measures including stock returns and operating performance, while Woidtke (2002) centers around its effect on industry-adjusted Q; (2) we allows for a non-monotonic relationship between public pension fund ownership and firm performance, whereas Woidtke (2002) imposes a simple linear relationship between public pension fund ownership and industry-adjusted Q; and (3) we study firms in CDA/Spectrum 13F filings from 1985 to 2005 in our sample, while Woidtke (2002) focus on the Fortune 500 firms from 1989 to 1993.

These public pension funds are collectively identified in Cremers and Nair (2005), Larcker et al. (2005), and Dittmar and Mahrt-Smith (2007).

A regression with market capitalization as the weight for each stock can avoid biases in computing returns from rebalancing and avoid placing too much weight on extremely small stocks. This is also the method used in Gompers and Metrick (2001).

To gauge the robustness of our results, in untabulated analyses, we also conduct piecewise regressions of future stock returns on public pension fund ownership and other stock characteristics using 3.5 % as the ownership threshold.

In unreported analyses, we follow Gompers et al. (2003) and Core et al. (2006) and include only log book-to-market ratio and log market capitalization as control variables to account for the expected cross-sectional difference in ROAs, and find our results remain qualitatively unchanged.

In unreported analyses, we repeat all regressions in Sect. 4 using the Fama–MacBeth methodology as that employed in Sect. 3, and find very similar results.

The public pension fund ownership in regressions in Table 6 is that at the end of a firm’s fiscal year.

Using piecewise regressions similar to those describe in footnote 9 leads to qualitatively similar results.

We use Hausman’s (1976) test for simultaneity to examine whether public pension fund ownership should be treated as exogenous variable in a two-stage least square analysis and it rejects the null hypothesis of no simultaneity.

See Greene (1997) for a detailed description for two-stage least square estimations.

We use this indicator variable for past earnings as an instrument for public pension fund ownership because it is related to stock quality, which affects public pension fund ownership (Del Guerio 1996), yet it has little relationship with future industry-mean adjusted ROA as it does not capture firms’ future performance. See Woidtke (2002) for details.

This model of transaction cost is developed by Keim and Madhavan (1997) and employed by Wermers (2000) for mutual funds and Woidtke (2002) for pension funds.

All public pension funds in our sample are very large in size, and their holdings in firms may be sizable and thus the transaction costs may be an important factor in their investment strategy. Therefore, we use the transaction costs as our second instrument variable for public pension fund ownership. See Woidtke (2002) for details.

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Titel: Public pension fund ownership and firm performance
verfasst von: Yawen Jiao
Pengfei Ye
Publikationsdatum: 01.04.2013
Verlag: Springer US
Erschienen in: Review of Quantitative Finance and Accounting / Ausgabe 3/2013
Print ISSN: 0924-865X
Elektronische ISSN: 1573-7179
DOI: https://doi.org/10.1007/s11156-012-0288-x

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