Allocating capital amidst perceived uncertainty: Relative (Not Absolute) ownership matters

Abstract

The need to allocate capital under uncertain conditions is likely to trigger cognitive simplification processes, making the capital allocation decisions error-prone. Improving efficiency of capital allocation amidst this uncertainty calls for cognitive repair. In this paper, we examine how ownership structure could serve as a cognitive repair mechanism and improve capital allocation by enabling organizations to tackle the inherent uncertainty of capital allocation amidst cognitive limitations of decision makers within the organization. In specific, we propose that relative ownership of institutional investors with respect to managers serves as a repair mechanism, provided neither corporate managers nor institutional investors have sufficient voting power to overrule the other. Our results confirm our thesis that when managers and institutional investors work together they tackle the inherent uncertainty of capital allocation better and allocate more efficiently.