Cross-border Portfolio Investment Research Articles

Foreign Direct Investors as Change Agents: The Swedish Firm Experience

AbstractManuscript TypeEmpiricalResearch QuestionPrior studies examine corporate governance either at the firm level, with limited attention paid to societal culture and norms, or at the nation‐state level, with limited attention paid to the management practices of firms. In this study we examine the impact on the corporate governance of Swedish firms brought about by foreign investors. We argue that in countries like Sweden with strong culturally embedded norms and control exercised by dominant domestic shareholders, control‐seeking foreign investors can act as agents of change to improve firm performance through more efficient capital utilization and labor productivity.Research FindingsWe find that the entry of foreign equity investors over the years 1992–2008 surrounding Sweden's formal admission to the European Union in 1995 enhanced the financial performance of large publicly traded, domestic owner‐controlled firms in Sweden. The heightened performance of Swedish firms was not simply a result of cross‐border portfolio investments by institutions as the literature on shareholder activism implies. Rather, significant advancements in firm performance occurred only when an increase in voting participation by foreign direct investors was coincident with a decrease in the excess voting power of the largest domestic shareholder, which gave foreign equity investors a critical “voice” in the management of the firm.Theoretical ImplicationsInformal institutions influence corporate governance by aligning corporate goals with socially acceptable outcomes. Corporate governance practices, if culturally embedded, cannot be easily displaced even when the gains in economic efficiency are large. Corporate owners stand to benefit from the maintenance of the status quo and may not welcome radical changes that can lead to a “creative destruction” of their market power and political dominance. Foreign portfolio investors who focus solely on cash flow rights of the firm cannot effectively change decision making in the boardroom. Foreign direct investors, who actively seek voting shares and control rights, will have the utmost potential to effect change in corporate governance by advocating for new corporate priorities and objectives at board meetings.

WHAT HINDERS CROSS-BORDER PORTFOLIO INVESTMENT IN EAST ASIA?

We examine statistical importance of a number of institutional factors, which have been alleged by market investors and policy commentators as significant barriers on cross-border portfolio investment in East Asian economies, but never been put to empirical tests yet. Taking advantage of the novel data set constructed by the ABMI-GoE, we empirically investigate the explanatory power of such institutional factors as market access-hindering regulations, foreign exchange controls, credit controls, taxation and inefficient post-trading infrastructure. We find that these alleged barriers indeed have significantly negative impacts on cross-border portfolio investment in East Asian economies. In addition, we find some support for the "pecking order" hypothesis in barriers on cross-border portfolio investment in the sense that barriers on post-trading efficiency and cost barriers are not effective unless barriers on market access are significantly lowered.

Proposal: Does Institutional Ownership Matter for International Stock Return Comovement?

The study of the determinants of stock return comovements is central to the international finance literature. In a classical contribution, Heston and Rouwenhorst (1994) argue that country-specific factors are more important drivers of volatility than cross-country industry factors. While international capital and trade barriers have fallen in the last decades, many other studies confirm these findings (Griffin and Karolyi (1998), Rouwenhorst (1999), Bekaert, Hodrick and Zhang (2009), among others). In this paper, we directly examine the increasing role of institutional investors, which invest worldwide, as potential agents of financial globalization. We test whether the rise of institutional investors as shareholders of corporations worldwide has been associated with increased cross-country correlations. For this purpose, we use new 2001-2010 data from FactSet/LionShares with portfolio holdings from over 5,700 institutions in over 20,000 stocks in 49 countries, with positions exceeding a total of US$18 trillion as of December 2010. As these professional investors pursue more industry or global focused portfolio strategies, we expect that asset pricing factors become more integrated across country boundaries. Thus, we test whether global and industry factors matter more for firms with higher institutional ownership, and conversely country factors matter less. We expect to find that the effect to be stronger for stocks held by foreign-based institutions which, by definition, exhibit less “home bias” (French and Poterba (1991)). The overall objective of this research project is to examine whether cross-border portfolio investment by institutional investors is a force of international capital markets integration.

What are the Challenges and Problems Facing China's Outward Portfolio Investment: Evidence from the Qualified Domestic Institutional Investor Scheme

Since their inception in late 2007, the Qualified Domestic Institutional Investor (QDII) funds, which help Chinese investors to invest in foreign capital markets, have experienced significant portfolio losses and persistent fund outflows. While these losses are large in absolute terms, QDII funds, on average, performed better than Chinese A-share funds, but slightly worse than a group of foreign mutual funds. Our study focuses on the QDII industry, and asks three interrelated questions: 1) why have there been large fund outflows from the industry? 2) What explains QDII funds’ poor performance? And 3) why have QDII funds been so heavily exposed to the Hong Kong market? Our empirical analysis shows that the persistent capital outflows were primarily a result of disappointing fund performance. This poor performance can, in turn, be explained by the deficiency of knowledge required of QDII fund managers to successfully invest in foreign capital markets and manage global portfolios. Finally, our study goes some way to explain the phenomenon of QDII funds’ large asset allocation in the Hong Kong market. This ‘Hong Kong bias’ is shown to be consistent with the well-documented ‘home bias’ behaviour in cross-border portfolio investment, but is greatly exacerbated by the lack of global investing experience of QDII managers.

Cross-border portfolio investment in the APEC region

This paper aims to establish a firm understanding of the structure and determinants of bilateral portfolio investment among APEC economies. The paper demonstrates that APEC membership has a significantly positive relationship with financial transactions among members. That is, as compared with non-members, APEC member economies purchase more equities and long-term bonds from other APEC member economies. However, the APEC membership effect is not uniform: the positive effect of APEC membership is mainly due to the overshadowing role of East Asian countries. This finding is especially evident for equities, rather than for long-term bonds. This paper also shows that a large part of the regional financial market integration in the APEC region is due to strong linkages of intra-regional goods trade in the region.

Achieving capital account convertibility in China1

China has been delaying the plan of achieving capital account convertibility since the Asian financial crisis, although restrictions on capital flows have been reduced steadily, confirmed by the falling Capital Account Control Index. Current restrictions exist mainly for cross-border portfolio investment, debt financing and outward direct investment (ODI). Effectiveness of these restrictions, however, has been declining over time. While capital controls probably helped support domestic financial stability in the past, their potential costs are rising quickly, evidenced by losing independence of the monetary policy. China already possesses a range of favorable conditions for capital account liberalization, including stable macroeconomic situation, healthy fiscal and financial systems, and strong external accounts. Some of these conditions may be reversed in the coming years. Therefore, China should probably try to achieve basic capital account convertibility within the next three to five years. This requires, among others, establishment of market-based interest rates and exchange rates. The authorities could probably remove restrictions on debt financing and ODI quickly. For the more volatile portfolio investment, they could retain the existing qualified foreign institutional investor and qualified domestic institutional investor schemes, with significantly increased quotas but substantially reduced restrictions during the transition period.

Open Society, Closed Market?

It appears that Japan pursues a lopsided internationalization strategy—keeping foreign companies out while at the same time investing massively in foreign markets. This paper examines whether this is an appropriate position. First, we look into the foreign direct investment issue and try to understand the current situation in Japan. In particular, we analyze the underlying two-fold assumption: (a) that there are international companies willing and able to make large investments in Japan, and (b) that they cannot do it because the Japanese market is closed. The ratio of inbound FDI (foreign direct investment) to GDP is considerably lower in Japan than in other major industrialized nations, and Japanese companies directly invest four times as much abroad as foreign companies invest in Japan. This does not mean, however, that the Japanese market is closed. In fact, companies are deciding to invest in other countries where conditions are (or are perceived to be) more conducive to penetration. Second, we compare FDI with cross-border portfolio investments. Compared to FDI, portfolio investments in listed companies in Japan are relatively high. Foreign investors hold around one-fourth of the shares at listed companies. This figure has been rising continuously for 20 years, interrupted only in 2001–02 and in 2008–09. Third, we take a closer look at Japan's international trade and the overseas business of Japanese companies. Japan's industrial sector has integrated itself very actively in global trade (45 % of its sales are posted overseas), but the Japanese economy is not “export-driven”. Its degree of integration into world trade is rather low. We assume that this can be explained by qualitative, HR-related factors. Finally, we ask what the chances are that ongoing internationalization will succeed amid and after the global recession of 2008–09.

The patterns of cross-border portfolio investments in the GCC region: do institutional quality and the number of expatriates play a role?

In this paper, we document the determinants of portfolio investments to Gulf Cooperation Council (GCC) economies by bringing up the role played by market forces, cultural affinities, and institutional quality. We classify the GCC economies as host to 35 countries as per the Coordinated Portfolio Investment Surveys (CPIS) of the IMF for the period 2001–2006. Using the CPIS data and data from various other reliable sources and appropriate panel data analysis techniques, we find a number of interesting results: 1) the relatively higher quality of institutional set up in GCC in comparison to other countries; 2) the relative volume of expatriates across source countries in GCC soil; and 3) bilateral factors such as trade linkages between GCC and source countries, all statistically and significantly explain portfolio investments to the GCC region. Additionally, we uncover the existence of a portfolio “GCC bias”. That is, GCC investors exhibit a strong preference towards their own markets when allocating their cross border financial asset holdings.

Shareholders at the Gate? Institutional Investors and Cross-Border Mergers and Acquisitions

We study the role of institutional investors in cross-border mergers and acquisitions (M&As). We find that foreign institutional ownership is positively associated with the intensity of cross-border M&A activity worldwide. Foreign institutional ownership increases the probability that a merger deal is cross-border, successful, and the bidder takes full control of the target firm. This relation is stronger in countries with weaker legal institutions and in less developed markets, suggesting some substitutability between local governance and foreign institutional investors. The results are consistent with the hypothesis that foreign institutional investors act as facilitators in the international market for corporate control; they build bridges between firms and reduce transaction costs and information asymmetry between bidder and target. We conclude that cross-border portfolio investments of institutional money managers and cross-border M&As are complements in promoting financial integration worldwide.

Domestic Economic Policies, Political Institutions, and Transnational Portfolio Investments

For many, transnational capital is one of the most important driving forces of economic globalization; yet, we know little about what determines cross-border portfolio investments. In addition to recent economic literature's focus on information asymmetries as one key determinant of cross-border investment, this study brings in a political aspect to the field of international trade in assets. The –race to the bottom’ thesis connects domestic economic policies to investment decisions and argues that capital is more likely to move towards economies characterized by economic liberalism; political institutions are also relevant for portfolio investments, because democratic institutions often provide more credible protection against predatory practices. In this study, I model bilateral portfolio investments as a function of economic policies, political institutions, and levels of transparency of sending and receiving countries as well as important international connections. Empirical findings indicate the importance of transparency to attract portfolio investments. Moreover, transnational portfolio investments are only sensitive to some fiscal policy indictors and only within the OECD countries. Therefore, for non-OECD countries, there is still ‘room to move’ in maneuvering different aspects of fiscal policies. Finally, I find that investors care about the nature of political institutions as democratic institutions tend to be associated with higher levels of portfolio investment inflows. This is good news for developing countries that have undergone or are in the process of democratization. In addition to democratizing for peace, increased foreign capital further incentivizes a progression towards democratization.

Shareholders at the Gate? Institutional Investors and Cross-Border Mergers and Acquisitions

We study the role of institutional investors in cross-border mergers and acquisitions (MA they build bridges between firms and reduce transaction costs and information asymmetry between bidder and target. We conclude that cross-border portfolio investments of institutional money managers and cross-border M&A are complements in promoting financial integration worldwide.

Home bias among institutional investors: a study of the Economist Quarterly Portfolio Poll

I study the home bias pattern in international portfolios recommended by global financial institutions. These recommended portfolios from the Economist Quarterly poll provide an interesting research opportunity because transaction costs and other observable barriers in cross-border portfolio investments do not interfere with asset allocation decisions of the polled institutions. Thus, an examination of this poll data can shed light on the role of unobservable factors in international portfolio investments. I find that the institutions tilt recommendations towards their home markets; they change home market weights more frequently relative to other market weights or relative to institutions from other countries; and they change weights of geographically distant markets less often than other market weights. Overall, the evidence from the analysis suggests that home bias can arise from unobservable factors such as information asymmetry and investor optimism. J. Japanese Int. Economies 19 (1) (2005) 72–95.

The Co-ordinated Portfolio Investment Survey – A model to follow?

In recent years, countries have experienced difficulty in adjusting their data collection systems to the growth in the scale and complexity of international financial transactions. For portfolio investment, this may have resulted in a significant underreporting of both transactions in and holdings of portfolio investment assets. Concern over this development led the IMF Committee on Balance of Payments Statistics (IMF Committee) to promote the idea of an internationally co-ordinated benchmark survey of cross-border portfolio investment asset holdings broken down by the country of residence of the issuer. This paper reviews experience in conducting the first Co-ordinated Portfolio Investment Survey (CPIS) for end-December 1997 (in which twenty-nine mostly industrial countries participated), and the second CPIS for end-December 2001 (in which sixty-seven countries participated, covering all groups except some oil-exporting countries). The paper notes that the CPIS has achieved many of the objectives envisaged by the IMF Committee, including (i) the development and implementation by national compilers of best practices in conducting benchmark surveys of portfolio investment asset positions; (ii) provision of partner country data sources to national compilers for portfolio investment liability positions; (iii) creation of a global database for portfolio investment asset and liability positions (the latter from creditor sources). The paper discusses further work that is planned to fill gaps in the coverage of the CPIS database, reviews the role of the IMF in facilitating the efforts of participating countries, and draws lessons from the CPIS that can be applied to other projects in which an international agency can play a facilitating and co-ordinating role in working directly with interested national compilers to improve national and global statistics.

Creation of a Global Capital Market: Evolution of International Commercial Law in Cross-border Portfolio Investments

Creation of a Global Capital Market: Evolution of International Commercial Law in Cross-border Portfolio Investments

Creation of a Global Capital Market: Evolution of International Commercial Law in Cross-border Portfolio Investments

Creation of a Global Capital Market: Evolution of International Commercial Law in Cross-border Portfolio Investments

FINANCIAL LIBERALIZATION AND FOREIGN PORTFOLIO INVESTMENT IN THE UNITED KINGDOM

In recent years, cross-border portfolio investment has become an increasingly important feature of global capital markets, with capital controls being relaxed and transactions costs declining in many securities markets. This paper contains an empirical analysis of aggregate foreign portfolio investment in U.K. equities and bonds over the period since the middle of the 1970s. The stock of such investments is shown to be related to expected relative returns; world financial wealth; and measures of financial liberalization, notably a constructed exchange control index based on the freedom of Japanese financial institutions to invest overseas. Copyright 1993 by Royal Economic Society.