This study examines the effect of corporate insiders’ (referring to directors, supervisors, and CEO) psychological bias, which is overoptimism or overpessimism, on institutional investors’ monitoring function. This is an empirical study combining behavioral finance and institutional investors’ corporate governance functions. Focusing on R&D activities and its long-term performance, the study is able to examine whether institutional investors can prevent managers from myopia and invest appropriate R&D expenditure. Using all stock-listed companies’ panel data in Taiwan from 1996 to 2013 and regression analyses, the study finds that overall institutional shareholders have different monitoring effects on insiders with overoptimism and overpessimism. There is no monitoring effect for institutional shareholders on insiders with overoptimism; R&D expenditure overly increases and cannot be suppressed, and therefore reducing long-term performance. Institutional investors are able to effectively monitor insiders who are overly pessimistic; R&D expenditure does not reduce unduly and increasing R&D can improve performance. Monitoring effects between domestic and foreign institutional shareholders are significantly different: for over-optimistic insiders, only domestic institutions have monitoring effects; for over-pessimistic insiders, only foreign institutions exert monitoring effects. If considering from the viewpoint that overoptimistic insiders have self-attribution bias and are more difficult to monitor, domestic institutions exert monitoring functions on such insiders and thus seemingly have stronger monitoring capacity than domestic institutions have.
