Institutional Investors Research Paper

In order to shed light on how the emergence of these new, powerful actors has reshaped organizational life, researchers have employed a wide variety of research foci and approaches. Research has highlighted how institutional investors can be viewed as a social movement (Davis and Thompson 1994), corporate action is consequentially shaped by lending and other intercorporate relationships (Mintz and Schwartz 1985, Mizruchi and Stearns 1994), institutional investors may shape organizational phenomena such as research and development expenditures, corporate social performance, and CEO compensation, the hostile takeover of corporations requires a good deal of cultural work by institutional investors and other powerful stockholders (Hirsch 1986), the adoption of poison pills can protect managers from corporate raiders (Davis 1991), and how the creation of investor-relations departments has enabled corporations to better manage the demands of institutional investors (Rao and Sivakumar 1999). While this work has been very revealing, it has tended to focus primarily on issues of corporate control in the US, while neglecting questions regarding how institutional investors have contributed to the reshaping of country-specific financial activities as well as global capital formation processes.

To situate this research paper on institutional investors, an account is provided first of the rise of pension plans that motivated the growth of the institutional investor movement in the US. Since the majority of organizational research on institutional investors focuses on problems of corporate control, there follows a discussion of how institutional investors have been conceptualized in competing theories about corporate control and argument for more research on how institutional investors are helping to remake capital formation processes around the world.

1. The Emergence Of Pensions And The Institutional Investor Movement In The US

The growth of pension plans has provided one of the most significant changes in the structure of US retirement and finance in the twentieth century— providing a foundation for the rapid growth of institutional investing in the second half of the century. The first public employer-sponsored pension plan was established by the City of New York in 1850; the first private employer-sponsored plan was created by the American Express Company in 1875. Up until World War II, however, pension coverage was sparse and the plans that did exist were not guaranteed and often ownership was not vested in the pensioned person.

A confluence of factors before and after World War II fostered the development of pensions in the US. Before World War II, the Social Security Act of 1935 boosted employment-related pension insurance by institutionalizing the idea of retirement (Dobbin 1992). Subsequently, the combination of federally mandated wartime wage controls, as well as a war related labor shortage, facilitated the development of benefits such as deferred wages as a way for corporations to compete for scarce labor. Also, due to the high corporate tax rate during war time (peaking at over 90 percent), pension plans became more attractive to employers since contributions to such plans lowered taxable income. In addition, labor union-corporation conflict became more intense after the war. In 1948, the National Labor Relations Board ruled that pensions were to be considered as part of wages, allowing workers to initiate legally a strike over a pension dispute. Pensions became a centerpiece for management–labor negotiations.

Despite worker–manager conflict in major industries such as autos, coal mining, and steel, the emergence of pension benefits came to be associated with a system of management that valued employee commitment to and long career tenures within single organizations. In 1950, fewer than 10 million nonagricultural workers (around 25 percent of the nonagricultural workforce) were covered by private pension plans. By 1970 more than 30 million workers (approximately 50 percent of the nonagricultural workforce) were covered. As pension plans diffused and amassed a considerable amount of assets, however, the management of those assets began to change.

Up until around 1950, most pension plans were constituted as annuities and managed by insurance companies. But in the 1950s, corporate pension plans began to be managed by bank trust departments that were allowed to invest in stocks as well as bonds. At that time, insurance companies were legally limited in the extent to which they could invest in stocks. That migration of pension assets into the stock market represented a major turning point in the development of pension management as an industry. As increasing amounts of money were being directed towards the stock market, there was a corollary growth in financial intermediaries that vigorously competed for the right to manage how other people’s money was to be invested in the stock market—an institutional investor movement was born.

Competition among institutional investors was largely based on performance measured by asset growth, leading to an emphasis on riskier portfolio strategies. Between 1965 and 1969, the turnover (a proxy for risk-taking) of bank managed pension portfolios rose from 13.7 percent to 25.7 percent, of internally managed portfolios from 5.5 percent to 9.6 percent, and of investment advisor managed portfolios from 27.4 percent to 55.9 percent. Corporations began to view pension assets as a profit center from which they could directly enhance their bottom line, while previously in the 1950s, pensions were viewed primarily as a way to reduce tax payments.

The shift towards viewing pension assets as a profit center led to a general restructuring of the money management industry. Bank trust departments, that had dominated pension management until the late 1960s, relied on relatively conservative investment strategies, constructing portfolios that consisted mainly of stocks of established companies that paid steady dividends. In the late 1960s, corporate pension plans began to expand beyond bank trusts, using multiple investment advisors. This effectively broke the bank trust monopoly on pension management. As a result, smaller, independent money managers, including those affiliated with mutual fund companies, became able to compete for pension dollars based on their performance record as opposed to institutional reputation and longstanding relationships.

Alongside these developments, the federal government became more involved in the protection of beneficiaries. In 1974, the Employee Retirement Income Security Act (ERISA) was enacted and the Pension Benefit Guarantee Corporation (PBGC) was created to insure qualified plans. ERISA established minimum standards for vesting, proscribed funding formulas, provided insurance for employees whose plans were terminated without adequate assets, required full disclosure of plan benefits and operations to employees, and declared that pension trustees had a fiduciary responsibility to manage pension assets with only beneficiaries in mind, not a corporation’s bottom line. This federal government involvement stabilized pension practices, enabling the continued growth of pension plans while also providing more safeguards for pension beneficiaries.

Between 1945 and 1996, pension assets have grown steadily from virtually zero percent to 20 percent of all financial intermediary assets. While the growth of pensions was a critical development that facilitated the institutional investor movement, it was also supported and facilitated by broader changes in US capital formation processes. In particular, the growing legitimation of the stock market after World War II provided important momentum for a major transformation from bank lending dominated to market-based capital formation processes. Commercial banks, which had been the dominant financial actors in the US, increasingly lost their hegemonic position in the postwar era. The percentage of financial intermediary assets managed by commercial banks declined from 60 percent in 1945 to 20 percent by 1996. At the same time, new kinds of institutional investors, such as mutual funds, grew dramatically. Mutual funds began their dramatic rise in the 1980s and now constitute 14 percent of all financial intermediary assets. Hence, while the origins of the institutional investor movement are rooted in the development of pensions, the legitimation of the stock market and the concomitant shift towards market-based capital formation processes, as well as the emergence of new kinds of financial organizational forms importantly shaped the contours of that movement.

2. The Study Of Institutional Investors In Organizational Theory: The Problem Of Corporate Control And Other Research Possibilities

Much of the organizational research on institutional investors has focused on the problem of corporate control, grounded in historical analyzes of the emergence and evolution of the corporate form. US Corporations emerged in the mid-nineteenth century under government sponsorship to perform specific services such as banking and the building of railroads, turnpikes, and canals. Individually chartered public infrastructure corporations were predominant until more generalized state incorporation laws arose in the 1870s. By the turn of the twentieth century, large industrial manufacturing companies and Wall Street financiers joined forces to facilitate the broad diffusion of the corporate form (Roy 1997). This ushered in the era of ‘finance capitalism’ and the rise of powerful bankers such as J. P. Morgan.

Along with the birth of finance capitalism was the accelerated growth of financial intermediaries and the construction of the US field of finance. The early part of the twentieth century not only witnessed the accumulation of power by money center banks and investment bankers, but also the birth of new financial organizations such as investment and finance companies. Assets controlled by financial intermediaries grew from $19 billion in 1900 to $167 billion in 1929 and to approximately $560 billion by mid-century. It was in the first half of the 1900s that a truly national field of finance began to take shape. In the early part of the twentieth century, the field of finance was highly centralized with the most powerful actors and majority of asset flows located in New York City. This financial concentration came to be pejoratively known as the ‘money trust.’

Alongside the growth and concentration of private financial intermediaries, the federal government created a central banking structure and became increasingly involved in legislating and sponsoring the formation of regulatory bodies to monitor and restrict intermediary activities. Governmental regulatory activity increased dramatically in the 1930s amid the Great Depression when explicit efforts were made to dismantle the money trust. Finance capitalism had ended.

The emergence and growth of large industrial corporations was shaped importantly by this rapidly developing capital formation infrastructure (field of finance) that supported and made possible increased corporate activity. As large-scale industrial activity became organized by the corporate form in the early part of the twentieth century, ownership became more diffuse and strategic decision-making power became vested in professional managers who had little financial stake in the firm. The publication of The Modern Corporation and Private Property (Berle and Means 1932) proclaimed the rise of managerial capitalism where American corporations came to be theorized as relatively autonomous entities that were unconstrained by outside owners or each other.

The shift from finance to managerial capitalism, however, was not only facilitated by the separation of ownership from control, but also the increased role of the state in capital formation processes, especially after the stock market crash of 1929 and Great Depression. Through the emergence of social redistribution programs and major war mobilization efforts, state-financing activity provided a major impetus for the creation of a stable and reliable field of financiers. In addition, a number of landmark legislative acts and finance regulatory bodies were created. For example, securities and banking legislation between 1933–35 separated commercial and investment banking and created the Securities and Exchange Commission. Also, state regulation and monitoring greatly reduced the scope and power of banks and individual intermediaries.

Up until the mid-1960s, organizational analysis had been dominated by managerial-centered theories which focused on what top executives did given certain constraints having to do with limited time and information as well as intraorganizational political dynamics. Building on Zeitlin’s (1974) critique of the Berle and Means (1932) thesis that nonfinancial corporations had been freed from dependence on financial institutions, however, a number of organizational sociologists began to focus directly on corporate governance issues in the 1970s and 1980s, investigating the extent to which managerial action was indeed constrained by financial actors. In their review of the literature on corporate control, Glasberg and Schwartz (1983) argued that the notion of managerial autonomy has been challenged by four main theoretical camps: resource dependence, class cohesion, bank control, and bank hegemony.

Resource dependence theorists maintain the managerialist premise that top managers dominate corporate decision-making but challenge the notion that such autonomy is free from outside constraint. Proponents of this view argue that organizations are involved in an ongoing interdependent struggle for positional advantage, using interlocking directorates, joint ventures, mergers, diversification, and conglomeration to co-opt, internalize, or otherwise neutralize powerful external constituencies. This line of thought has been particularly prevalent in studies of interlocking directorates among financial and nonfinancial firms. The broader social theoretic imagery which emerges is conflictual and pluralistic. Scholars drawing on this theoretical orientation, therefore, tend to view institutional investors as hostile outsiders that managers need to neutralize in order to maintain relative autonomy.

Arguments drawing on class-cohesion theory, that are inspired by Marxist political economic thought, similarly accept the premise that managers are relatively free to make decisions, but claim that corporate executives comprise a unified class of actors that promote coordination and cooperation at the expense of high-powered market incentives (Davis 1991, Domhoff 1974). The orderliness of societal stratification is emphasized to counter the resource dependence conclusion that intraclass struggle best characterizes the elite strata. Recent writings in this tradition, however, have argued that elite institutional investors may be emerging as a class that controls financial flows and corporate decision-making (Useem 1996). This revised argument seems to move class cohesion arguments closer to the pluralistic imagery of resource dependence arguments though, since institutional investors and managers are viewed as engaged in ongoing conflict over the control of corporations.

Bank-control theory, derived from twentieth-century Marxist financial capital theory, posits that banks and insurance companies, due to their centrality in controlling and allocating capital, are able to use their leverage to dictate corporate policies to serve their own interests. This approach completely rejects all theories that maintain any degree of managerial autonomy. As such, this perspective has been marginalized in organization theory. In addition, recent research has highlighted that the extent to which bank representatives have had formal positions on corporate boards of directors has decreased, indicating a waning bank influence on corporate management (Davis and Mizruchi 1999). This insight dovetails with the more general decline of bank-lending in favor of market-based capital formation processes in the US field of finance.

Bank hegemony theory may be characterized as an effort to try to synthesize bank control and class cohesion theories (Mintz and Schwartz 1985). As opposed to the overt domination proposed by bankcontrol theorists, power is theorized to be embedded in the relations between financial institutions and corporate producers. Hence, research affiliated with this tradition has looked primarily at direct relations between corporations and financial institutions via interlocks or lending relationships (Mizruchi and Stearns 1994) to analyze the extent to which managers are constrained by financial actors. While an underlying consonance of interest between financial and nonfinancial firms is posited, the financial sector is theorized to develop a kind of class cohesion that ultimately allows for financial institution dominance. The expression of power, however, is much more problematic and diffuse than a bank-control theorist would argue, though more coherent than predicted by class-cohesion theory (Glasberg and Schwartz 1983).

While resource dependence, class cohesion, bank control, and bank hegemony were the main perspectives used to address institutional investors and corporate control in the 1970s and early 1980s, research on these issues has since become more analytical and less overtly engaged in these broader theoretical problematics. For example, debates about the relative veracity of resource dependence approaches that envision a more pluralistic society vs. more Marxist class-cohesion arguments have been backgrounded. Nonetheless, corporate control research has continued to usefully contribute to our further understanding of the relationship of institutional investors to corporate governance and change.

One of the main limitations of this line of research, however, has been its almost sole focus on corporate control as a way to understand financial actors such as institutional investors. This has left the practice of institutional investing as well as related areas of money, banking and finance as components of a broader financial field subject to its own logic of operation woefully understudied. Since the deregulation of banking in the US in 1980, the boundaries between previously segregated financial organizational forms have begun to blur. Now insurance, commercial and investment banking, and mutual fund activities are combined under one roof. These developments call out for more detailed investigations of how financial practices and organizations are being remade as a result of these field-wide transformations.

In addition, we should also be studying how institutional investors are driving or are implicated in broader processes of social change. A first step in this direction would be to study how the activities of financial institutions and institutional investors are reshaping capital formation and corporate governance processes around the globe (Davis and Mizruchi 1999). The deregulatory ‘big bang’ that occurred in the US in the early 1980s subsequently has diffused to Europe and Japan and other countries around the globe. As a result of these contemporary developments, new kinds of questions have emerged having to do with whether capital formation and corporate governance processes around the globe are being remade in a way that mimics Western capitalistic countries or whether localized state–society relations exhibit more of a path- dependent quality.

As Zysman (1983) showed, the tendency towards market-based capital formation processes in England and in the US are markedly different from the more bank-and state-dominated systems in Japan, France, and Germany. Is this still the case? Recent research on Germany, France, and England indicate that those national capital formation patterns continue to persist (Mayer and Whittington 1999). We must go beyond more simplistic notions of globalization and convergence and investigate how social actors resist such convergences as well as how economy–society relations are informed by cultural logics that make the US model of finance inappropriate or unthinkable (Biggart and Guillen 1999). This may require more detailed ethnographic studies or historical research that can reveal how societal institutions are constructed locally and rooted in geographically situated meaning systems (Ventresca and Porac 2000). While there have been recent efforts to study corporate governance variation cross-nationally, we still know very little about how capital formation processes are changing in the financial systems of particular countries. There is no doubt that institutional investors are key actors in this unfolding drama.

Another important question has to do with whether the old ‘money trust’ is re-emerging as the boundaries between different financial organizational forms become irrelevant. The consolidation of financial services into conglomerates has the potential to reinvigorate longstanding debates about elite class control versus pluralism, although with a global dimension. Since financial service conglomerates that are being built through mergers, acquisitions, and alliances in this era of deregulation are transnational in scope, the new, emergent money trust may not be a uniquely US phenomenon. Likewise, institutional investors are active participants in securities markets around the world and play a key role in economic development and global monetary flows. Hence, we may want to begin to study whether a new transnational class of capitalists is in the making, or at least probe how large, global investors are shaping the social organization of countries around the world.

3. Conclusion

The rise of institutional investors both in the US and around the globe is a critically important phenomenon that researchers have only just begun to investigate. While we know a good deal about how the rise of institutional investors has challenged managerial autonomy in the US, we know much less about the relationship between institutional investors and corporate governance in other, especially non-Western, countries. More generally, we know very little about how country-specific capital formation processes are changing amid the continuing globalization of financial markets and the emergence of transnational financial conglomerates. We would benefit greatly from detailed cross-national studies of how economy–society relationships may be changing as a result of these developments. Through such research, we may begin to unearth the heterogeneity of practices lumped under the category ‘institutional investors’ and reveal the wide variety of influences these actors have around the world.

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