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Local ownership as private information: evidence on the monitoring-liquidity trade-off

Author: Gaspar, José-Miguel ; Massa, MassimoINSEAD Area: FinanceIn: Journal of Financial Economics, vol. 83, no. 3, March 2007 Language: EnglishDescription: p. 751-792.Type of document: INSEAD ArticleNote: Please ask us for this itemAbstract: Finance literature has demonstrated an increasing interest in local owners (investors geographically close to firms in which they invest), arguing that they exhibit superior returns due to private information. We use local ownership as a proxy for the amount of private information in a stock. Using data on mutual fund holdings, we construct a measure of local ownership for a broad panel of US firms. We show that, depending on the size of their stake, privately informed investors improve the quality of governance of the firm and induce value enhancing decisions (less over-investment and fewer acquisitions). At the same time, their presence in the firm increases the adverse selection discount required by the less informed investors to trade, reducing the firm's liquidity. We provide evidence that both effects are properly factored in by the investors and impounded in the firm's stock price. Our results contribute to the understanding of the liquidity-monitoring controversy and qualify the existing results of the emerging local ownership literature: the illiquidity borne out by the presence of local investors may play a role in the observed abnormal performance uncovered by these studies.
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Finance literature has demonstrated an increasing interest in local owners (investors geographically close to firms in which they invest), arguing that they exhibit superior returns due to private information. We use local ownership as a proxy for the amount of private information in a stock. Using data on mutual fund holdings, we construct a measure of local ownership for a broad panel of US firms. We show that, depending on the size of their stake, privately informed investors improve the quality of governance of the firm and induce value enhancing decisions (less over-investment and fewer acquisitions). At the same time, their presence in the firm increases the adverse selection discount required by the less informed investors to trade, reducing the firm's liquidity. We provide evidence that both effects are properly factored in by the investors and impounded in the firm's stock price. Our results contribute to the understanding of the liquidity-monitoring controversy and qualify the existing results of the emerging local ownership literature: the illiquidity borne out by the presence of local investors may play a role in the observed abnormal performance uncovered by these studies.

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