Successful investment by companies creates shareholder value and drives firm growth. However,
firms may fail to invest efficiently due to conflicts of interest between managers and shareholders.
Several managerial agency problems have been identified as leading to either over‐investment (e.g.,
Jensen & Meckling, 1976; Richardson, 2006; Shleifer & Vishny, 1997) or under‐investment (e.g.,
Aghion, Reenen, & Zingales, 2013; Bertrand & Mullainathan, 2003; Porter, 1991). As less efficient
investment is associated with lower firm future stock performance (Cai & Zhang, 2011; Titman,
Wei, & Xie, 2004), understanding the governance of firm investment efficiency in publicly traded
companies is of great importance to firms’shareholders.
In this paper we examine the role of motivated monitoring by institutional investors in
improving corporate investment efficiency. Given the trade‐off between the costs and benefits of
active monitoring, institutional investors will not have the same incentive to monitor the
activities of every firm in their portfolios. First, institutional investors are not homogeneous:
their monitoring roles are related to institution type, their investment horizon, and their
preference for trading (Bushee, 1998; Chen, Harford, & Li, 2007; Schmidt & Fahlenbrach, 2017).
Second, it is not optimal for institutional investors to equally monitor all the firms held in their
portfolios, because their capacity to monitor is not unlimited (Kempf, Manconi, & Spalt, 2017);
the motivation of institutional monitoring would rationally depend on the relative importance
of an individual stock in their portfolios (Fich, Harford, & Tran, 2015). Previous studies have
focused on the heterogeneity of institutional investors, and how their institutional
characteristics might affect firm performance. In contrast, we follow Fich et al. (2015) and
focus on the variety of monitoring attention that would be expected within institutions on firms
held in their portfolios, and how this divergence can affect managerial decision‐making.
When economic agents have a limited capacity for processing information, it is rational for
them to vary the attention they give to different sources of information when making decisions
(Sims, 2003). Based on the assumption of limited attention, Kacperczyk, Van Nieuwerburgh,
and Veldkamp (2016) develop an attention allocation model to predict optimal information
choices for mutual funds. Kempf et al. (2017) find that an institutional investor’s monitoring
attention to the firms it holds may become distracted if an exogenous shock affects the stock
returns of unrelated firms in its portfolio. Fich et al. (2015) posit that when an institution has
only limited monitoring attention, a greater proportion of its portfolio that is represented by a
firm will be associated with greater benefits of monitoring that firm. They use the relative
importance of a firm in institutional investors’portfolios as a proxy for the motivation of
institutional monitoring in mergers and acquisitions (M&As) and find that targets with more
motivated monitoring institutional ownership (IO) have higher deal premiums and deal
Motivated by these studies, we measure an institutional investor’s
motivation to monitor a firm by the fraction of the institution’s portfolio represented by the
firm. If the optimal level of monitoring attention is determined by the trade‐off between
monitoring benefits and costs, an institutional investor will be more motivated to monitor firms
which are relatively more important in its portfolio.
We extend Fich et al.’s (2015) study to
In practice, it is costly for investors to collect firm‐specific information, analyze the information with professional expertise, monitor firm activities, and
intervene through shareholder activism.
Motivated monitoring IO is the ownership of institutional investors with high motivation to monitor the firm. Masulis and Mobbs (2014) also find that
directors who have multiple directorships are motivated to monitor firms in which their directorships are relatively more prestigious.
The opportunity costs of monitoring may not be ignored in the trade‐off given the limited investors’attention.
WARD ET AL.EUROPEAN