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Publisher : Elsevier - Science Direct (الزویر - ساینس دایرکت)
Journal : Journal of Comparative Economics, , Volume 41, Issue 2, May 2013, Pages 506-526
Different investor classes are endowed with different rights, and conflicting interests among them can make protection afforded to one party detrimental to another. We find that investor protection laws have sizeable “cross” effects on foreign portfolio investment and the direction of these effects supports the conjecture that foreign investors are particularly sensitive to the perceived riskiness of assets. Specifically, we find that strong protection of creditor rights – limiting excessive risk taking – positively affects foreign shareholders, whereas strong protection of shareholder rights – potentially shifting firms toward riskier projects – negatively impacts foreign bondholders. These findings, on the one hand, emphasize that strengthening investor protection is not a universally desirable policy; on the other hand, they provide a rationale for the failure of convergence toward any successful standard of effective investor protection. The degree of protection enjoyed by investors in each country is indeed endogenously determined by the balancing of many forces. Among them, the political choice to promote inward investment and to favor particular categories of investor may play an important role.
This paper investigates the impact of investor protection rights on cross-border investment. Since domestic sources of outside finance are limited in many countries around the world (Giannetti and Koskinen, 2010), foreign capital has become increasingly important (Bekaert et al., 2002). In this respect, corporate governance, with its peculiar role of facilitating access to external finance through reduction of information asymmetry (La Porta et al., 1998; LLSV, 1998, henceforth), can be critical in attracting foreign portfolio investment. Indeed, in the presence of information barriers, domestic investment appear, other things equal, more attractive to investors that indeed display a strong preference for domestic assets. Corporate governance can partially offset this lack of information by signaling the quality of the institutions in terms of rights guaranteed to the investor and thereby foster international diversification. Standard asset pricing models using a representative agent predict that differences in investor rights and financial development should be capitalized in share prices such that investing in any given nation’s stocks will be a fair investment regardless of that nation’s level of investor protection (Dahlquist et al., 2003). However, as noted by Leuz et al. (2009), the key question is whether this price discount is sufficient for foreign investors that plausibly face information problems and monitoring costs beyond those of domestic investors. Indeed, the prevalence of disproportionate investment in domestic assets – the so-called “home bias” puzzle – can be read as evidence of the asymmetric perception of asset characteristics by home and foreign investors thus breaking the representative agent hypothesis (Gehrig, 1993 and Kang and Stulz, 1997). Dahlquist and Robertsson, 2001 and Kang and Stulz, 1997 emphasize that large, financially solid, well-known firms are preferred by foreigners, thereby underlining the asymmetry between resident and foreigner investors. Chan et al. (2005) investigate the determinants of foreign and domestic investment, finding that familiarity and variables capturing investment barriers have a significant but asymmetric effect on domestic and foreign bias. This evidence is consistent with the conjecture that foreign investors are more vulnerable to information asymmetry than domestic investors; hence, they might be more influenced by governance rules that reduce information costs. In this work, we are interested in the impact of investor protection laws on stock and bond portfolios held by foreign investors.1 This effect cannot be directly observed from market price or total market capitalization, since these indicators capture only aggregate equilibrium behavior. Previous work originating from LLSV (1998) underlines how investor protection affects financial market development, that is, the supply of equity, leaving the demand side mostly unexplored.2 This latter perspective is relevant insofar as we account for heterogeneity across investors. For instance, Giannetti and Koskinen (2010) show that investor protection impacts financial market development by influencing the demand for equity, because different classes of investor can differ in the benefits accruing to them and therefore in their willingness to pay for stocks. Specifically, controlling shareholders can gain access to both private and security benefits and thus be willing to pay more for a stock than investors who can enjoy only security benefits. These authors’ theoretical model provides valuable testable implications with respect to home bias and stock market participation rates. However, they assume that domestic and foreign outside investors face the same cost of participation in both domestic and foreign markets. This hypothesis is quite strong and at odds with the prolific empirical literature emphasizing the role of asymmetric information as a potential explanation for the home bias puzzle. Our contribution can be viewed as complementary to Giannetti and Koskinen (2010): while they split the universe of investors into inside and outside investors we focus on outside investors only, in order to test how corporate governance affects foreign portfolio investors. A perspective closer to ours, though at the firm-level, is taken by Leuz et al. (2009). They maintain that foreign investors are at an informational disadvantage relative to local investors and that these information asymmetries are particularly pronounced when it comes to evaluating firms’ governance and ownership structures. They find indeed that foreigners invest less in firms with poor outsider protection and opaque earnings because firms with potentially problematic governance structures are particularly taxing to foreign investors in terms of their information and monitoring costs. We depart from previous works in that we investigate the effect of investor protection laws on foreign portfolio investment – debt and equity portfolios – accounting for the interaction of various governance mechanisms on stakeholders endowed with different rights and interests. More specifically our analysis accounts for the conflicting interests of the various stakeholder groups. Within the corporation, the distinct interests of managers, stockholders and creditors coexist and are often in conflict with one another. As a consequence, legislation particularly favorable to one type of stakeholder turns out to be detrimental to others. Shareholder-manager conflicts have received much attention in the literature, but important sources of conflict can also arise between shareholders and bondholders. The corporate governance literature has analyzed the complex mechanisms of conflicts of interest between shareholders and creditors, suggesting that the potential conflict between equity and debt claimants lies primarily in wealth expropriation and risk shifting (Jensen and Meckling, 1976). These conflicts can give rise to intricate effects on portfolio decision making on the part of foreign investors that are particularly sensitive to information asymmetry issues. Specifically, strong shareholder rights protection are likely to benefit foreign shareholders (“direct” effect) but may also deter foreign bondholders (“cross” effect) as shareholders are more prone to risk-taking activities than is optimal for creditors (Myers, 1977 and Jensen and Meckling, 1976). Creditors might indeed be more in line with managers, who may be more concerned with their own job security and so choose to undertake less risky projects. On the other hand, strong creditor rights are likely to attract foreign bondholders (“direct” effect) but may deter stock investments (“cross” effect) if firms are induced to engage in risk-reducing processes such as acquisitions that are likely to be value-destroying (Acharya et al., 2011). Ultimately, the question of the impact of investor protection provisions on foreign investors, the focus of the present paper, is an empirical one and depends on foreigners’ perception of the balance among various interests. Our results highlight that laws protecting the interests of different types of investors asymmetrically affect foreign stakeholders and, more specifically, that foreign portfolio investors highly value corporate governance practices that are risk-reducing. Foreign shareholders appear to appreciate strong creditor rights that potentially mitigate the riskiness of projects, while bondholders are negatively affected by strong shareholder rights that could induce the firm to engage in risky asset investments. Finally, our findings also contribute to the literature that investigates the failure of convergence in investor protection legislation. Djankov et al. (2008) find no convergence in creditor rights scores. La Porta et al. (2000) reject the hypothesis of legal convergence of rules and enforcement mechanisms toward some successful standard of effective investor protection. These authors claim that this is due to the dominance of interest group politics: extensive legal, regulatory and judicial reforms are needed but governments are reluctant, as the first order effect is a tax on insiders. Mansi et al. (2009), focusing on the heterogeneity across US states’ legislation, critically discuss the evidence of no polarization toward a system of stronger or weaker investment protection. Different states compete also on legal dimensions in terms of their effectiveness in attracting investment but competition does not necessarily induce a “race to the bottom” or a “race to the top”. Firms, in fact, sort themselves either away from binding payout restrictions that reduce financial flexibility and value, or toward greater restrictions that reduce debt financing costs. Not all jurisdictions then need or should converge to the single best or worst alternative. Rather, the existence of a variety of jurisdictions and different economic environments allows firms to maximize value by choosing a set of laws most appropriate to their own situation. Our findings contribute to this debate by providing an indirect rationalization of the evidence of no convergence toward the strongest investor protection setting: investor protection can be beneficial to one type of investor and detrimental to another. Accordingly, the level of investor protection in each country is endogenously determined by many conflicting forces, among which are the political choice to promote inward investment and to favor some classes of investors over others. The remainder of this paper is organized as follows. After describing the conceptual framework and its main implications in Section 2, we present our empirical analysis in Section 3. Sections 4 and 5 summarize the main findings and Section 6 addresses the potential policy implications of our analysis.
نتیجه گیری انگلیسی
We investigate the impact of investor protection laws on foreign investment, namely foreign equity portfolio investments and foreign bond portfolio investments. Our results show, first, that investor protection laws have a significant impact on foreign investments. These findings are consistent with results in Leuz et al. (2009) relative to outward equity investment by US firms. We generalize their results to different investing countries and to debt securities. Specifically, we find that strong shareholder rights (creditor rights) stimulate foreign equity (bond) portfolio investments. Since foreign investors are mostly affected by information asymmetry issues, these findings can also be interpreted as corporate governance rules serving as a means to overcome information asymmetries and thereby to enhance international diversification. Secondly, our findings highlight how investor protection asymmetrically affects foreign investment. These results, obtained controlling for relevant dimensions of countries’ institutional quality, represent the most innovative contribution of the paper to the extant literature. More specifically, we highlight that foreign shareholders appreciate strong creditor rights, which potentially mitigate the riskiness of projects, while bondholders are negatively affected by strong shareholder rights, which might induce the firm to engage in excessively risky behavior. Importantly, our results are robust to an updated specification of shareholder rights and reveal that the negative cross-effect on foreign bondholders can be plausibly ascribed to antitakeover legislation asymmetrically influencing inward bond and stock investment. The immediate implication to draw from this picture is that strengthening investor protection is not a universally desirable policy. Specifically, our results suggest that stronger creditor rights are helpful in attracting foreign investment, while stronger shareholder rights are effective in attracting foreign equity investment but may deter foreign bond investment in equal measure. Thus, the choice to reinforce shareholder rights can be read as a choice to benefit foreign shareholders to the detriment of foreign bondholders. It is worth stressing now that our work investigates the effects of investor protection rights on cross-border investments, while a more comprehensive analysis is needed to derive general welfare conclusions on the desirability of stronger or weaker investor protection. Moreover, we consider the determinants of foreign investments, leaving unexplored effects on domestic investors that are harder to investigate due to both the limited number of available observations (one for each investing country for each available year) and to difficulties in removing all sources of familiarity bias. With the above-mentioned caveats in mind, our findings also contribute to the literature on convergence in investor protection legislation. A large body of literature comparing financial systems, especially among capitalist economies, has produced a renewed interest in institutional economics (Djankov et al., 2003).48 On the one hand, the classical distinction between bank-based and market-based systems is less relevant than in the past (Rajan and Zingales, 2003 and Hlzl, 2006), on the other hand, domestic financial markets remain heterogeneous despite integration and globalization.49Djankov et al. (2008) find no convergence in creditor scores. La Porta et al. (2000) reject the hypothesis of legal convergence of rules and enforcement mechanisms toward some successful standard of effective investor protection. Mansi et al. (2009) claim that competition on legal dimensions in terms of their effectiveness in attracting investment does not imply that all jurisdictions need to or should converge to the single best or worst alternative. Consistently, our findings provide a rationale for the evidence of no convergence toward the strongest investor protection setting as the level of investor protection in each country is endogenously determined by the balancing of many forces. Among them, the political choice to promote inward investment and to favor particular categories of investor may play an especially important role.