Returns on stocks are higher for tax-exempt institutions such as pension funds than for taxable institutions such as mutual funds, according to research reported in the National Investor Relations Institute's monthly update.
Stock prices rise as the proportion of the company's tax-exempt institutional base rises, said Paul Seguin, a professor at the University of Michigan, in the report.
"The increase in institutional investors lowers the marginal tax rate. That is, if the investor setting the price is tax exempt and pays a lower rate, then the stock actually appreciates in value," the report said.
Tax rates on dividends vs. capital gains from price appreciation also affect investor decisions and, thus, corporate actions.
Corporations with high institutional share ownership experience more volume, volatility and analyst coverage than those with heavy individual ownership,
While in 1945 about 5% of available share were held by institutions, today the figure exceeds 70%.
Institutions are anything but patient, as evidenced by their high turnover. While individuals turn over 8% of their portfolios per quarter, institutions turn over about 70% per quarter, according to Mr. Seguin.
Such high turnover results in big jumps in trading volume among companies widely held by institutions.
While institutions might be fickle, their heavy trading activity leads to greater liquidity, which can boost a company's share price.
Mr. Seguin said in the update that higher volume, float and liquidity can help increase a stock's price; he called that "good" volatility.
But "bad" volatility occurs when bad news triggers institutional selling. When bad news prompts one institution to sell, others follow. Often there isn't enough liquidity for market makers to absorb the imbalances between sell and buy orders, so prices fall.
The bid-ask spreads are narrower when more institutions are owners. This is due not only to more trading experience and information, but also because institutions "pay brokers handsomely for executing trades with little price disturbance," the report said.
Having more information also produces closer spreads. "With lots of institutions in the stock and analysts following the company, a lot of information is being generated and published and since everyone knows everything, there aren't a lot of asymmetries. These stocks, on average, are more fairly priced."
Indeed, stocks widely held by institutions command greater analyst coverage. Mr. Seguin is not sure whether one leads to the other, but the two go hand in hand. For most companies that's a positive, he said. But too much analyst coverage can lead to what he considers too much institutional ownership.
