Local effects of foreign ownership in an emerging financial market: evidence from qualified foreign institutional investors in Taiwan - IV

We check the robustness of our results by investigating many additional specifications. We repeat all the regressions in Tables V, VI, and VII with domestic individuals in place of domestic institutions. The findings reported above for domestic individuals carry over to that for domestic institutions. We also repeat the tests with various firm fixed effects and alternative instruments. The additional analyses strongly support the positive foreign ownership-performance relation. The evidence suggests the presence of foreign owners who are able to influence management to make value enhancing decisions.
A. Discussion
The results of this section indicate that foreign ownership is associated with improvement in firm performance. These results further document the local effects of foreign ownership in Taiwan. The positive association between foreign ownership and firm performance may be due to foreign institutional investors' stock screening ability or their ability to influence management. The former may arise from their ability to choose stocks that better diversify their global portfolios. For example, they may select domestic firms that are more likely to benefit from risk sharing between foreign and domestic investors. The ability of foreign institutions to influence domestic firms may simply reflect an attempt to own stocks that they can influence. Domestic investors may view foreign ownership levels as a proxy for the extent to which foreign institutions are committed to monitoring firm management. Domestic investors may do so because QFIIs may have the knowledge and capability to help firm management.
The local press contains numerous examples of how foreign investors monitor and influence local firms. In 2002, foreign investors' criticism of one of Taiwan's biggest firms, Taiwan Semiconductor Company, led to a change in its compensation program, an event that attracted the attention of local academicians and practitioners. When local firms began converting from paying stock dividends to cash dividends in 2001, foreign investors were regarded as being responsible for initiating the conversion. The press has also attributed the preference for foreign owners to the ability of foreigners to monitor corporate strategy, capital usage, and personnel.
There are also examples of the influence of foreign institutional investors on R&D expenditures. On June 22, 2001, the Commercial Times reported that the president of Winbond announced a forthcoming meeting with its institutional investors, most of whom are foreigners, to discuss business strategy in response to heavy stock sales by foreign investors. It mentioned that it would consider increasing R&D expenditures at the meeting. That same newspaper on August 17, 2002 reported that two foreign institutional investors of MediaTek, Morgan Stanley, and Smith Barney, announced lower earnings forecast for the firm. However, they simultaneously announced that they believed the firm would "outperform" because MediaTek had increased its R&D expenditures.
Ownership of domestic firms by QFIIs may provide an alternative governance mechanism that could well be effective and important in emerging markets. Foreign institutional investors may promote international standards of accountability and expertise so as to help reduce a firm's cost of capital or increase its stock price. In the process, they may better integrate domestic firms with the global market through better adherence to best practices.
B. Seemingly Genuine Foreign Ownership and Firm Performance
A characteristic of the Taiwan financial market is the presence of domestic firms who make a substantial effort to court foreign portfolio investors in various ways, including road shows outside Taiwan. They may do so for several reasons. Foreign institutional owners tend to have longer investment horizons than Taiwanese individual investors, which decreases stock turnover. Foreign investors may engage in information acquisition or provide guidance. The presence of foreign owners in the firm is highly valued by the market.
The positive association between stock price and foreign ownership also raises the possibility of a disturbing outcome. Some domestic firms have been alleged to generate their own homemade foreign investments (see Wealth Magazine, July 2004). The domestic press contains numerous accounts of such seemingly genuine foreign investments that may mislead individual investors. There are claims that domestic investors have established overseas companies, registered them with the Taiwan Securities and Futures Commission as foreign investment companies, and then used them to invest in the Taiwan stock market.
This section provides some evidence regarding whether our results are biased by the presence of seemingly genuine foreign investments. We hypothesize that this problem is more severe for small firms than for large ones, since small firms are more illiquid and attract less public scrutiny. These characteristics make it easier for seemingly genuine foreign investors to manipulate the stock price of small firms. If the small firms are affected by seemingly genuine foreign investment, then they will not show a positive association between foreign ownership and firm performance since the locals lack the foreigners' know how and resources.
To examine whether the foreign ownership-performance relation is affected by seemingly genuine foreign investments, we divide our sample into big and small firms. Big firms are those with market equity larger than the median size firms. Small firms are those with market equity smaller than the median size firms. Table VIII reports the estimation results for both the robin's Q (Panel A) and accounting performance measures (Panel B). We also control for the endogeneity between performance and foreign ownership by using a two-stage least squares estimation.
The first-stage estimation results are used to obtain the predicted foreign ownership variable included in the second stage. In the second stage, we regress the performance measures on the predicted foreign ownership (the predicted foreign ownership multiplied by an indicator variable that is one for big firms and zero otherwise) and the control variables used earlier. The results for Tobin's Q show that foreign ownership performance effects are significantly positive for both big and small firms. Additionally, the effects are stronger for bigger firms. The net income results for ROA and EBITD also show significantly positive associations between foreign ownership and firm performance. For the accounting results, the outcomes for small and big firms are insignificantly different from one another. In short, the evidence supports a positive foreign ownership-performance relation for both small and big firms.
V. Conclusion
We have analyzed the local effects of equity ownership by QFIIs in an emerging financial market, Taiwan. The analyses yield two major results. First, foreign institutional ownership of Taiwanese stocks has huge local effects. We discover a dramatic foreign ownership effect whereby stocks with high foreign ownership outperform stocks with low foreign ownership. As in the KS study on a developed market, we find that foreign institutional owners in Taiwan prefer well-known firms. However, we find that their preferences are not exclusively for these firms; the foreign ownership effect is present even after controlling for firm export, size, or transparency levels. Second, foreign institutional ownership is associated with improved firm performance. This result holds for firm performance as measured by R&D expenditures, Tobin's Q, and accounting measures. The result cannot be attributed to various firm characteristics, including differences in risk, leverage, size, growth opportunity, and incidence of firm insiders.
Out evidence on the profound effects of foreign ownership on local stocks is consistent with the local attitude toward foreign institutional investors that may have been fostered by the prevailing market environment. As is typical of emerging financial markets, there are frequent accounts in Taiwan of excessive managerial perquisites, abuses of shareholder rights, and market manipulations. The standard corporate governance mechanisms are undeveloped or ineffective. The Taiwan stock market is highly volatile and is dominated by individual investors who are uninformed and trade frequently. In such a setting, domestic individual investors may have turned to information about foreign ownership of Taiwan stocks. The QFII data are closely and widely scrutinized by the media, regulators, market participants, and the general public. Foreign investors are actively courted by domestic firms, and there are even allegations of homemade foreigner investments.
The issue of whether domestic or foreign investors know more can be examined in the short run or in the long run. Our paper focuses on the long run, which leads us to attribute our finding of a foreign ownership effect and strong foreign ownership-performance relations to a monitoring or disciplinary role played by foreign investors. Unlike domestic individual investors, foreign institutional investors have the resources to conduct fundamental research, can invest for the long term, and are more credible and reputable--all advantages that foreign owners can parlay into positively affecting firm performance.
Our evidence has implications for emerging capital markets that are transitioning to more open, transparent, and efficient markets. We provide evidence of the case where foreign institutional owners have a long-run information advantage over domestic investors in Taiwan. By providing expertise, experience, and resources that are unavailable to domestic individual investors, foreign institutional owners may contribute to domestic economic growth.
We are grateful to an anonymous referee for detailed comments. We also thank Robert Battalio, Suzanne Bellezza, Utpal Bhattacharya. Long Chen, Edward Chow, Shane Corwin, Laura Field, Amar Gande, Andrew Ellul, Craig Holden. Jun-Koo Kang, Naveen Khanna. Wei-Lin Liu, Tim Loughran, Jennifer Marietta-Westberg, Chris Muscarella, Paul Schultz, Mark Seasholes, Rich Sheehan, Ann Sherman. Hans Stoll, Charles Trzcinka. seminar participants at Indiana University, Michigan State University, Penn State University, the 12th Conference on the Theories and Practices of Securities and Financial Market in Kaoshiung, Taiwan, the University of Notre Dame, the Vanderbilt University Financial Markets Research Center Conference, and the Western Finance Association Conference for their suggestions.