Nations (ASEAN). Accordingly, Heaney and Hooper recommend that in- vestors diversify outside regions rather than outside countries.
Against this background of increasing integration of international mar- kets, recent research is focusing on the benefits of diversification across industries rather than countries. Ehling and Ramos (2003) examine the European Union countries before, during and after the convergence period and find that diversification based on countryandindustry portfolios is su- perior, although a country-based strategy in itself is not preferable to an industry-based strategy.
Despite the well-documented benefits from international diversification, the take-up of international investments has been relatively slow.3A signifi- cant ‘home bias’ therefore exists, particularly in the US market (e.g., French and Poterba, 1991; Coval and Moskowitz 1999). This home bias ‘puz- zle’ has been partially attributed to information asymmetries arising from foreign investors being less well-informed than domestic investors (e.g., Gehrig, 1993; Kang and Stulz, 1997; Brennan and Cao, 1997). Frost and Pownall (2000) provide evidence of such asymmetries. They find that com- panies disclose information unequally between local and foreign investors, even though this often contravenes stock market requirements. However, Brennan and Cao (1997) speculate that information asymmetries may be weaker for financial institutions.
In summary, the literature demonstrates that because of the benefits both to companies and investors, equity markets have become increasingly inter- nationalised in recent years. Moreover, due to the significant levels of funds still held in domestic funds, the trend is set to continue. The following sec- tion examines the increasing involvement and importance of institutional investors, which has accompanied the growth in institutional investment on major stock markets.
2.4 THE GROWTH IN INSTITUTIONAL INVESTMENT
of institutional assets held in equities (OECD, 2000). The Myners Report on institutional investment in the UK (Myners, 2001) documents the reduc- tion in individual share ownership, which has fallen from 50% of the market in the early 1960s to under 20% at the present time.
Table 2.4 reports figures for the growth in institutional ownership of UK equities over the period 1963 to 1998 and shows a substantial rate of growth in institutional ownership from 29 to 52.3%, and a simultaneous decline in individual ownership, from 54 to 16.7%. In addition, while the proportion of equity held by institutions fell between 1989 and 1998, this was attributable to a growth in holdings by foreign investors (from 12.8 to 27.6%) rather than individual holdings, which fell from 20.6 to 16.7%.
Although traditionally seen as the bastion of the private investor, institu- tional investors are also becoming increasingly important equity holders in the US, where the proportion of institutional investors’ ownership of the top companies is already around 60%. Bricker and Chandar (2000) argue that the traditional view understates the historical significance of institutional investors in the US. They provide evidence that investment banks played a key role in the investment in, and control of, large companies in the early twentieth century. Bricker and Chandar point out that due to institutional investors’ ability to mobilise large amounts of capital (via their control of bank deposits and insurance funds) these institutions were ‘pivotal’ in the development of early capital markets.
Financial institutions therefore play a vital role in the stock market and their decisions often have a substantial impact upon the share prices of large
Table 2.4 Percentage of total UK equity owned
1963 1975 1989 1998
Insurance companies 10.0 15.9 18.6 21.6
Pension funds 6.4 16.8 30.6 21.7
Unit/investment trusts 1.3 4.1 7.5 4.9
Other financial institutions 11.3 10.5 1.1 4.1
Total financial institutions 29 47.3 57.8 52.3
Rest of the World 7.0 5.6 12.8 27.6
Charities 2.1 2.3 2.3 1.4
Private non-financial firms 5.1 3.0 3.8 1.4
Public sector 1.5 3.6 2.0 0.1
Banks 1.3 0.7 0.7 0.6
Individuals 54.0 37.5 20.6 16.7
Total 100 100 100 100
Source:Office for National Statistics (2000).
and medium-sized public companies. Their increasing dominance means that they are among the most important users of financial reporting and ac- counting information. However, these institutions are not a homogeneous group. In the context of equity investment, a distinction can be drawn be- tween fund managers and investment analysts.
2.4.2 The role of fund managers and investment analysts
While fund managers are important users of accounting information in their own right, they are assisted in capital markets by investment analysts (Schipper, 1991). These analysts do not make investments themselves;
rather they act as information intermediaries between companies and in- vestors (Moizer and Arnold, 1984). Schipper (1991, p. 106) notes that it may be useful to distinguish between buy-side and sell-side analysts, not least because they may face dissimilar incentives due to the nature of their employers:
While both make recommendations about which stocks to buy, sell and hold, sell-side analysts are the primary producers of earnings forecasts. Buy-side analysts tend to be employed by money management firms or institutional investors while sell-side analysts tend to be employed at broker/dealer firms that serve institutional investors.
Sell-side analysts provide information on the companies that they follow to institutional investors, particularly to individual fund managers, who ultimately make the investment decision. This information may include recommendations of whether to buy, sell or hold company shares, forecasts of company earnings, and research reports (Michaely and Womack, 1999).
The demand for the services of sell-side analysts from fund managers arises from differences in the degree of specialisation between the two groups.
Sell-side analysts cover fewer companies, as unlike fund managers, they do not have to spend time constructing and monitoring portfolios. As such, they are able to provide more detailed and comprehensive analyses (Moizer and Arnold, 1984). Fund managers, by contrast, follow a greater number of companies, have to construct and monitor portfolios and thus spend significantly less time than analysts appraising shares.
Recent academic research is beginning to challenge the conventional views of analysts as purely intermediaries and question the independence of analysts’ advice to fund managers. Investment banks and brokerage firms (i.e., the employers of sell-side analysts) have three sources of income. These are first, corporate financing, issuance of securities and merger advisory ser- vices; second, brokerage services; and finally, proprietary trading (Michaely
and Womack, 1999).4 Analysts must maintain an external reputation in or- der to add credibility to the reports, recommendations and forecasts that they produce and thus stay employed.5However, as Michaely and Womack (1999, p. 654) point out, ‘When analysts issue opinions and recommenda- tions about firms that have business dealings with their corporate financing divisions, this conflict may result in recommendations and opinions that are positively biased’. Lin and McNichols (1998) also provide evidence that the recommendations and growth forecasts of analysts affiliated with the company being analysed are significantly more favourable than those of unaffiliated analysts. Increasingly, therefore, the view of analysts as disin- terested intermediaries has come under increasing pressure, although most research has been conducted in the US; it is noteworthy, however, that the UK financial regulatory authorities appear to be concerned about this issue following law suits against US financial institutions where analyst indepen- dence was jeopardised (FSA, 2002).