Overseas Monitors in Emerging Financial Markets: Evidence from Foreign Ownership in Taiwan

Abstract

The literature on foreign portfolio ownership in developed markets suggests that investors minimize their informational disadvantage when making foreign investments. We examine Taiwan, an emerging financial market where news of foreign institutional portfolio ownership is closely and widely scrutinized by the market participants. Our empirical analyses reveal that foreign institutions have pronounced valuation effects in Taiwan. We find a startling foreign ownership effect whereby stocks with high foreign ownership outperform stocks with low foreign ownership. Although foreigners tend to own export-oriented and large firms, the foreign ownership effect is present even after controlling for exports, size, or transparency levels. Foreign portfolio ownership is also strongly and positively associated with firm performance. Finally, foreign investment levels can explain the performance of long-term foreign investment flows. Our formal empirical results and market observations are consistent with foreign institutions that use their informational advantage to select and invest in local stocks and to monitor them afterwards.