Do Institutional Investors Non-linearly Affect the Capital Structure of Firms: Evidence from India

Our study examines the non-linear relationship between institutional investors and capital structure of the Indian firms, to understand its applicability in an emerging economy. We find the applicability of a quadratic relationship between leverage and institutional ownership. We notice that at a lower level of institutional ownership, the relationship is negative, because it initially reduces the debt level of the firms; however, as ownership increases, it is more lucrative to increase the leverage in order to magnify the gains. We also classify the institutional investors into two categories – pressure sensitive and pressure insensitive investors. The behaviour of pressure-sensitive investors and pressure-insensitive investors are different from each other. The behaviour of pressure-insensitive investors is similar to aggregate institutional investors, whereas we found contrasting behaviour for pressure-sensitive investors in our study. Investors should understand that simply having more proportion of institutional investors in a firm’s equity is not going to resolve agency conflicts. It is the presence of pressure-insensitive investors that will help mitigate the agency.