The relationship between institutional investors’ holding in public firms and the level of corporate solvency

Institutional investors are considered experienced, professional investors who also have the know-how to monitor and guide the companies in which they invest with regard to financial decisions that impact the firms’ solvency and corporate governance. We investigate whether there is an empirical relationship between the level of institutional investors’ holdings in publicly traded firms and the firms’ solvency. Using 9-years worth of data about 207 healthy and distressed American and Canadian public companies, we demonstrate a significant positive relationship between the firms’ solvency and the level of institutional investors’ holdings in the firms. This relationship is bidirectional. If the firm’s solvency level decreases, the institutional shareholders “vote with their feet” and reduce their ownership in the firm. Thus, changes in the level of institutional investors’ holdings in publicly traded firms provide other stakeholders with a signal about the potential solvency risks of these firms. Our study is the first to our knowledge that investigates empirically the direct relationship between the level of institutional investors’ holdings in a publicly traded firm and its odds of encountering financial distress.