This thesis examines the extent to which the investment horizons of institutional investors influence the risk of US banks. Four market-based measures of risk are used (total, systematic, idiosyncratic and systemic) and the investment horizons of institutional investors are gauged by their portfolio turnover. This empirical investigation of the US banking industry over the 1991-2013 sample period suggests that short-term institutional investors increase bank risk and long-term institutional investors decrease bank risk. This is especially the case after deregulation and at banks with strong corporate governance.
The results are robust to accounting-based measures of bank risk and alternate proxies for the horizons of institutional investors. Two identification strategies are used to suggest that these relations are causal, and fixed-effects regressions indicate that the results are not driven by unobservable time-invariant factors. The business policy channels affecting these various risk levels are then investigated. In contrast to short-term investors, long-term investors are associated with less exposure to riskier non-interest income activities, stricter lending standards, more stable funding sources and substantially better stock performanceduring the crisis.
Overall, this paper is the first to empirically validate that in terms of bank risk, the horizons of institutional investors do make a difference. In particular, bank managers face a trade-off between acquiescing to short-term shareholders who are committed
to increasing risk and meeting the demands of long-term shareholders.