Institutional investors and the moral hazards of technology investment: Evidence from China

ABSTRACT

This study investigates the impact of institutional ownership on the moral hazards of technology investment in China from 2003 to 2017. We use firms’ patent count data to test the quality and quantity of innovation, and apply a negative binomial regression to the baseline outcomes and a difference-in-difference model to control for endogeneity. The results show a significantly positive relationship between institutional investors and enterprise innovation. Particularly, mutual fund investors and qualified foreign institutional investors actively promote radical innovation, which minimizes the agency risks of enterprise innovation. However, bank and insurance fund investors tend to ignore the noise of technology investment, and instead prefer incremental innovation for enterprise growth. The study also analyzes the potential channels underlying these results. We find that institutional investors control CEOs’ career concerns and offer insurance against earnings sensitivity. Additionally, their supervisory role has a significant impact in controlling the agency risks of managers. Therefore, we propose that high-tech enterprises should consider the advantages of institutional investment in improving their innovation trajectories. The findings offer important policy implications for China’s indigenous innovation plans and indicate that institutional investors’ enthusiasm in enabling radical enterprise innovation is a valuable instrument for economic growth.

KEYWORDS:

• Technology investment
• institutional investors
• ownership structure
• quality innovation
• negative binomial estimation

JEL CLASSIFICATION:

• G34
• O32

Data availability statement

The data support the findings of this study are openly available in CSMAR at http://www.gtadata.com

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

1 In the corporate finance literature, the ‘prudent-man rule’ represents an investment style that restricts financial managers to investments with instant cash flows, and preserves capital under strict investment restrictions (Binay 2005).

2 With the recent name change, the URL of the official website has changed to https://english.cnipa.gov.cn/ (English version).

3 Please refer to Decree No. 306, Chapter 1 of the State Council of People’s Republic of China’s promulgation to understand the rules for the implementation of patent law. http://english.cnipa.gov.cn/col/col2068/index.html

4 Researchers can access this database after receiving official permission. Please visit http://www.gtadata.com/

5 The annual reports were only available on the Shanghai Stock Exchange around 1999 and on the Shenzhen Stock Exchange around 2000. The listed firms do not publicly disclose the appointment date of their CEOs. Moreover, Chinese companies do not report company data before going public; therefore, we determine the CEO's tenure based on whether they were appointed before the company went public.

6 LR tests were also conducted in the subsequent analyses and are reported in Tables 6–8.