On The Relationship between Institutional Investors and Leverage

Abstract

Background: This study aims to examine the two-way relationship between institutional ownership and the capital structure of a firm. Methods: The analysis is based on a two-step generalized method of moments with instrumental variable estimation. Results: We find that a firm’s debt level is low when the level of institutional ownership is high, implying that a firm employs low leverage when institutional monitoring is a substitute for external debt monitoring. The results further show that the level of institutional ownership is high when a firm’s debt level is high. Conclusion: Overall, the findings suggest that institutional investors prefer firms with high leverage because debt monitoring lowers their own monitoring costs.