Abstract

Previous studies of corporate governance and the likelihood of business failure have focused on the role of large shareholders as owners; especially on the role that institutional shareholders play in management control. However, scant attention has been paid to the role of institutional shareholders as board members. To contribute towards an understanding of this issue, our study examines experimentally the role of institutional shareholders in business financial distress likelihood within the contexts of ownership concentration. We study not only the different roles of institutional shareholders as owners and board members, but also consider the diverse set of institutional shareholders’ interests, categorised into pressure-resistant and pressure-sensitive. We find that directors appointed by pressure-resistant institutional shareholders, such as investment funds, pension funds, venture capital and holding firms, have a negative impact on the likelihood of business failure. This result indicates that institutional owners insist on directorships when the firm is important to them or when they judge they can keep a firm from going into distress, particularly in the context of concentrated ownership. In particular, the risk of failure acts as a catalyst to trigger reactions from the pressure-resistant institutional shareholders in the form of organizational changes in the firm. In contrast, directors appointed by pressure-sensitive shareholders have no impact on the likelihood of business failure.

This finding supports the debate on the diversity of corporate governance structures, and particularly the role of pressure-resistant shareholders in the avoidance of the firm’s financial distress.

Introduction

In the context of the economic crisis of recent years, the literature and declarations by international organizations have highlighted the influence of firms’ governance structure on financial distress. This question is important because differences in corporate governance appear to have important implications for business decisions (Judge & Zeithaml, 1992), especially when the business has a high risk of failure (Dowell, Shackell, & Stuart, 2011). In fact, previous researchers have shown that corporate governance attributes, such as ownership and board structures, have a different impact on financially distressed firms compared with firms that are not in financial distress (Chaganti, Mahajan, & Sharma, 1985; Chang, 2009; Daily & Dalton, 1994a, 1994b; Deng & Wang, 2006; Donker, Santen, & Zahir, 2009; Fich & Slezak, 2008; Lajili & Zeghal, 2010; Manzaneque, Priego,
& Merino, 2015).