Institutional Investors, Capital Market Frictions and Capital Structure: (A Review)

This paper reviews and assesses the studies on the relationship between institutional investors and capital structure. The objective is to show how institutional investors influence capital structure and why the results of different studies are different. The institutional investors can influence firm's capital structure by mitigating capital market frictions (agency costs and asymmetric information). However, two main theoretical views are found as regard to the relationship between institutional ownership and capital structure. One considers substitute relationship between debt with institutional ownership for mitigating agency costs and asymmetric information. According to this view, there is a negative relationship between institutional investors and capital structure. The second view considers complementary relationship between institutional ownership and debt and proposes a positive relation. The results of empirical studies are also different. There are two possible reasons that have caused the differences in the results. The first reason might be because institutional investors act differently in different countries because, the level and also type of capital market frictions are not same. The second reason might be because the different types of institutional investors have the different level of monitoring ability.