The Rodney L. White Center for Financial Research Institutional Investors and Equity Prices

The Rodney L. White Center for Financial Research is one of the oldest financial research centers in the country. It was founded in 1969 through a grant from Oppenheimer & Company in honor of its late partner, Rodney L. White. The Center receives support from its endowment and from annual contributions from its Members. The Center sponsors a wide range of financial research. It publishes a working paper series and a reprint series. It holds an annual seminar, which for the last several years has focused on household financial decision making. The Members of the Center gain the opportunity to participate in innovative research to break new ground in the field of finance. Through their membership, they also gain access to the Wharton School's faculty and enjoy other special benefits. This paper analyzes institutional investors' demand for stock characteristics and the implications that this demand has for stock-market prices and returns. We find that " large " institutional investors-a category including all managers with greater than $100 million under discretionary control-have nearly doubled their share of the common-stock market from 1980 to 1996, with most of this increase driven by the growth in holdings of the largest one-hundred institutions. We find that the level of institutional ownership in a stock can help to forecast its future return, and we provide evidence that this predictive power is due to demand shocks resulting from the compositional shift in ownership towards institutions. Overall, this compositional shift tends to increase demand for the stock of large corporations and decrease the demand for the stock of small corporations. With unit-elastic demand for both types of stock, the compositional shift can, by itself, account for a nearly 50 percent increase in the price of large-company stock relative to small-company stock. This price appreciation translates into an extra return of 2.3 percent over the sample period, and can explain part of the disappearance of the historical small-company stock premium. These results also show how co-movement in stock prices can be driven by a mechanism that has nothing to do with risk or expected cash flows. Richard Zeckhauser, three anonymous referees, and seminar participants at the NBER, Harvard Economics department, Harvard Business School, UC-Berkeley, UCLA's 1998 conference on the " Market Efficiency Debate " , and the 1998 Western Finance Association meetings for helpful comments and suggestions. Dan Maxwell from CDA/Spectrum was helpful in explaining aspects of the …