The effects of institutional investors and their contestability on firm innovation: Evidence from Chinese listed firms*

We investigate the effects of institutional investors and their contestability with controlling shareholders on firm innovation. Using a large sample of Chinese listed firms from 2003 to 2017, we find that when the ownership of domestic mutual funds is comparatively larger, their contestability with controlling shareholders is strengthened, which enhances business innovation. However, Qualified Foreign Institutional Investors do not have such significant contestability effects on firm innovation. These results are robust after correction for potential endogeneity issues. Furthermore, the effects of domestic mutual funds' contestability are weaker for short-term mutual funds and quasi-indexers, and for firms where the controlling ownership is higher. The effects of domestic mutual fund contestability are stronger in firms with less analyst coverage. Overall, our findings suggest that the influence of institutional investors is subject to their identities as well as their contestability with controlling shareholders.