Working Paper: NBER ID: w12222
Authors: Christian Leuz; Karl V. Lins; Francis E. Warnock
Abstract: As domestic sources of outside finance are limited in many countries around the world, it is important to understand the factors that influence whether foreign outside investors provide capital to a country's firms. This study examines whether and why investor concern about corporate governance results in fewer foreign holdings. We use a comprehensive set of foreign holdings by U.S. investors as a proxy for foreign investment and analyze a sample of 4,411 firms from 29 emerging market and developed economies. We find that foreigners invest significantly less in firms that are poorly governed, i.e., firms that have ownership structures that are more conducive to outside investor expropriation. Interestingly, this finding is not simply a matter of a country's economic development but appears to be directly related to a country's information rules and legal institutions. We therefore argue that information problems faced by foreign investors play an important role in this result. Supporting this explanation, we show that foreign investment is lower in firms that appear to engage in more earnings management.
Keywords: foreign investment; corporate governance; emerging markets
JEL Codes: G3; F3
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Poor governance (D73) | Lower foreign investment (F21) |
| Information asymmetries (D82) | Lower foreign investment (F21) |
| Earnings management (M52) | Lower foreign investment (F21) |
| Weaker disclosure and governance regulations (G38) | More pronounced governance effect on foreign holdings (G38) |
| Country's information rules and legal institutions (P37) | Impact on foreign investment (F64) |