Importance of Institutional Investors for Financial Markets Essay - 2

Importance of Institutional Investors for Financial Markets - Essay Example By 2005, institutional investors contributed 65% of the equity of firms listed in New York Stock Exchange. The importance of institutional investors in the financial market is that they enhance reduced information asymmetry, promote quality corporate governance, improve liquidity, and increase share prices and value in the financial markets (Sias et al, 2006). Institutional investors act as intermediaries in the financial market (Chen et al, 2007). They intermediate between lenders and borrowers, just like banks. They have a significant function in financial markets because they provide economies of scale by increasing returns on investment and reducing costs of capital for business firms (Chen et al, 2007). They pool savings from lenders and give the money to companies who act as borrowers, enhancing smooth operations between borrowers and lenders in the financial markets. They also encourage diversification by pooling savings from many investors (Demirgà ¼Ãƒ §-Kunt and Levine, 1996). They also play a crucial role in reducing agency costs by monitoring corporate behavior and selecting the profiles of investors. Institutional investors play a big role in the financial markets as highly specialized investors who invest on behalf of others (Chen et al, 2007). A retail investor with a few earnings may not have enough money to purchase a sub stantial amount of securities. Institutional investors may pool funds from many of such individuals and purchase securities on their behalf (Chen et al, 2007). For example, an employee may have a pension plan with his employer. The employer then uses that person’s pension as an investment in a fund, which then buys shares or any other financial product from a company trading in the financial market. These funds hold a broad portfolio of investments in several companies.