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| Common Institutional Ownership and Corporate Litigation Risk |
| DAI Jingwen, XU Rong, ZHU Tianqi, LU Chao
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School of Finance, Renmin University of China;
School of Economics and Management, Beijing Jiaotong University |
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Abstract Following the revision of the Securities Law in December 2019 in China, the minority investor protection and the enforcement practices within Chinese legal system have gradually strengthened. The litigation risk faced by listed firms arising from false disclosures, illegal guarantees, or market manipulation is becoming increasingly prominent, triggering great uncertainty for corporate operations. Although institutional investors have been proven effective in mitigating corporate litigation risk, the impact of their shareholding networks, a social attribute, on litigation risk, remains poorly understood in China.
With the establishment and merger of a large number of financial institutions, the prevalence of common institutional ownership, formed by institutional investors simultaneously holding shares in firms within the same industry, has substantially increased in China. This trend has been on the rise since 2016. Particularly, those common institutional investors with Chinese characteristics, embodying both governmental and market attributes, bear multiple responsibilities such as compensating for market resource allocation failures and preventing financial risks. In the emerging Chinese market, where the formal legal system is relatively weak, extensive shareholding networks are likely to strengthen the incentives and capabilities of common owners, enabling them to play pivotal roles in mitigating corporate litigation disputes. But there is also a possibility that common owners exert a collusive tunneling effect, exacerbating corporate litigation risk.
Utilizing the data of Chinese A-share listed companies from 2016 to 2020, this paper empirically examines the impact of common institutional ownership, a special shareholding mode, on corporate litigation risk. Our evidence reveals that common institutional ownership significantly reduces corporate litigation risk, supporting the synergy governance view. We address potential endogeneity concerns by adopting methods like propensity score matching, difference-in-difference, and instrumental variables. Specifically, we use whether other companies in the same industry held by the same common owners have been removed from the CSI 300 Index or the CSI Smallcap 500 Index as instrumental variables that trigger exogenous changes in a firm's common institutional ownership.
Our mechanism tests indicate that the breadth (i.e., information economies of scale) and depth (i.e., industry power) of within-industry shareholding networks endow common institutional shareholders with sufficient motives and capabilities to implement shareholder activism. Common institutional ownership reduces corporate litigation risk by leveraging interest synergy and risk governance effects, with information disclosure, monitoring, and compliance serving as key channels. Further analyses unveil that common ownership is an effective alternative governance mechanism for internal and external corporate governance. The role of common institutional ownership in reducing litigation risk is more significant in private enterprises. Heterogeneity tests document that non-pressure-sensitive, transactional, and stable common institutional investors significantly reduce corporate litigation risk. Common institutional ownership mainly affects litigation risks closely associated with corporate capital (creditors and shareholders) and operations (partners and competitors).
Our study documents that common institutional ownership acts as an effective informal governance mechanism for mitigating the litigation risk faced by micro-enterprises, compensating for the deficiencies of formal macro systems in regulating corporate behavior. In addition to expanding the literature on factors influencing litigation risks, our research extends the branch of research on law and finance to the informal micro-institutional dimension represented by equity arrangements. From the perspective of stakeholder protection, this study highlights the synergy governance effect of common institutional ownership, providing insights tailored to the Chinese context. By emphasizing the social attribute of institutional investors' shareholding networks, we contribute to the existing literature on common institutional ownership and social networks.
Our findings have several practical implications. Firstly, regulatory authorities should cultivate mature common institutional investors and encourage them to expand shareholding breadth and depth appropriately. This will enable them to fulfill roles in rectifying corporate governance failures, meeting the demands of stakeholders, and stabilizing the capital market. Notably, regulators need to closely monitor and be vigilant against the potential for collusive monopolistic practices driven by common owners. Secondly, listed companies can leverage the professional expertise of common institutional shareholders to compensate for internal and external governance deficiencies, mitigate conflicts of interest, avoid cutthroat competition, and prevent litigation risks. Thirdly, minority shareholders and other stakeholders can identify well-governed enterprises with low litigation risk by observing and learning from common owners' investment behavior, thereby reducing transaction risks through improved screening of portfolio targets.
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Received: 29 January 2023
Published: 02 May 2024
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