An Empirical Study On The Prudent Stock Preferences Of Chinese Institutional Investors

Since 1980s there is a trend of Equity Institutionalization in matured markets which makes institutional investors the main entities with abundant capital and great market power. Meanwhile western countries pay more attention to the prudent stock preference of domestic institutional investors. Because mutual fund, pension fund and some other products are main investments of residents. If they can't fulfill their duties of prudent investment, the public benefits will be in danger. When risky assets hold by institutional investors encounter huge loss, benefits of the public will be badly hurt, even the domestic security market will be shocked. Taking this into account, all the western countries put lots of duties on domestic institutional investors. Especially about the duty of prudent investment, many countries require institutional investors to provide the care, skills and prudence just as specialized merchants dealing with their own affairs.The analysis of institutional investors'definition and characteristics shows that institutional investors are playing important roles in cutting trading costs and slicing market risks. Their characteristics are totally different from individual investors and should tilt towards reasonable and prudent investments. After reviewing the development of prudent investment duties, we see that the duty of prudent investment stemmed from the trust law rooted in Anglo-American law system. Its connotation which developed with the prudent man law has gradually evolved into the combination of external legal system and internal cultural value, and it has great impact on institutional investors'activities in common law countries.Foreign scholars did some studies on the prudent stock preference of institutional investors, and two of them are very important. Firstly, S.G. Badrinath et al (1989) studied the prudent stock preference of institutional investors for the first time. By choosing prudent determinants and making cross-sectional regressions, they find that American institutions preferred stocks with prudent characteristics in the end of 1985. Secondly, S.G. Eakins et al (1998) used quintile method to study the stock preference of institutional investors, and they concluded that American institutions were prudent because they avoided holding stocks with extreme values. Some other scholars have done some studies on it. Although their subjects, sample ranges, test methods and the final results are slightly different, they can basically get the conclusion that institutional investors are prudent.Chinese institutional investors have developed for less than 20 years. For improving the investor composition of our security market, advocating the concept of value investment and market stabilization, our decision-makers have tried many ways to encourage the development of Chinese institutional investors since 1999. Those ways consist of strengthening the open-ended funds, expanding the proportion of social security funds and insurance funds, increasing the specified amount of QFII and so on. Pushed by our decision-makers, Chinese institutional investors enjoyed a very fast development. Especially from the middle of 2005, pushed by the reform of equity division, the investment value of our security market rises quickly, and the market is becoming better and better. Now Chinese institutional investors are in their golden time. We can see a prosperous scene that mutual funds, QFII, social security funds, Insurance Companies and other entities develop together.Chinese institutional investors have more and more impact on our stock market, and more and more public benefits are involved. Considering negative effects incurred by imprudent investments on individual investors'benefits, the value investment and market stabilization, we should pay more attention to the regulation on their activities and the study on their stock preference. However, our supervision is still somewhat vacant. There aren't any practicable laws which specify investment activities of such institutions. What's more, however, the studies on stock preferences of Chinese institutional investors are particularly inadequate. And there is no paper mainly about the prudence of Chinese institutional investors'stock preferences. It's obvious that both the regulation system and the academic circle haven't paid enough attention to this problem. Studies on the prudence of their stock preference will provide help to forming the prudent investment concept for Chinese institutional investors, and to giving some useful suggestions to our decision-makers and regulation system. So this paper is practically and theoretically important.Guided by above objectives, we make an empirical study on stock preferences of Chinese institutional investors. Our study is based on models and methods designed by S.G. Badrinath et al (1989) and S.G. Eakins et al (1998). The empirical examination is organized as follows. Firstly, we put forward two assumptions about stock preferences of Chinese institutional investors. Secondly, we choose the proportion of shares held by institutions as dependent variable, and we use log of the total asset, volatility, beta, Jensen Index, debt-to-asset ratio, dividend yield, turnover ratio, years listed in exchange and HS300 Index dummy as explanatory variables. Then we set up a multiple regression model. Finally, we use the cross-sectional data from the end of 2006 to the end of 2007Q3 to test the relationship between the explanatory variables and the proportion held by institutions. After entire sample regression and grouping regressions, we find that:1. Chinese institutional investors prefer low turnover ratio and young stocks, and the coefficients of Ln(TA), SIGMA, LEV and DY are all insignificant. It is obvious that Chinese institutional investors have no preference for stocks with prudent characteristics. Meanwhile, they show significant preference for extreme values of five variables, which shows that Chinese institutional investors do not avoid stocks with extreme values. These results indicate that stock preferences of the Chinese institutional investors are not prudent, in other words, they are not"prudent men"as called by foreign scholars.2. Chinese institutional investors have a significant preference for HS300 component stocks. It shows that Chinese institutional investors are willing to transmit a signal that they are prudent. Because holding those stocks are easier to obtain identifications from market and to escape from lawsuits when they encounter huge losses. The results of grouping regression show that, among the HS300, institutions tilt highly towards stocks with low turnover ratio and few years listed. It's clear that those institutions only pretend to be prudent but actually not.To sum up, from 2006 to 2007Q3, there are some problems with Chinese institutional investors, such as lack of risk sensitivity and pursuing short-term benefits. Therefore, there will be some hidden dangers in the benefits of the trustee and the future development of our security market. If we fail to make some corrections, those dangers will finally turn out to be huge losses and then result in a series of lawsuits and cause damages to the prestige and the image of the whole investment industry. So, in the end of this paper, we put forward some suggestions which may provide help to monitor investment conducts of institutional investors and to lead them to prudent investments.