Background

Data, variables and model specification

Main empirical tests

Endogeneity issue

Robustness check

Conclusion

References

Abstract

We investigate whether foreign institutional investors facilitate firm-specific information flow in the global market. Specifically, using annual institutional ownership data from firms across 40 countries, we find that foreign institutional ownership is negatively associated with excess stock return comovement. Our results are more pronounced when foreign institutional investors originate from common-law countries and hold a large equity stake in invested firms; and when the invested firms are located in civil-law countries. Overall, the evidence suggests that foreign institutional investors from countries with strong investor protection play an important informational role in mitigating excess stock return comovement around the world.

Background

There has been dramatic growth in foreign institutional investment in global capital markets over the past few decades (Karolyi, 2006). Researchers have so far focused on the monitoring role played by foreign institutional investors in firms in which they invest. For example, foreign institutional investors are credited with promoting domestic firms’ corporate governance (Gillan and Starks, 2003). Foreign institutional investors play a more active monitoring role than domestic institutional investors, because foreign institutional investors are less likely to seek business relationships with local firms (Ferreira and Matos, 2008). Aggarwal et al. (2011) find a positive relation between foreign institutional ownership and firm-level governance efficacy. However, an unexplored but equally important question is whether foreign institutional investors play an informational role in influencing firms’ information environment. To fill this gap, we investigate whether foreign institutional investors facilitate firm-specific information flows in the global market, thereby mitigating excess stock return comovements. A growing body of research has established firm-specific return variation as an effective measure of firm private information impounded into stock price. French and Roll (1986) and Roll (1988) show that neither market returns nor public news explain stock return variation, suggesting that firm-specific return variation captures the impounding of private information into stock price. An influential study by Morck et al. (2000) finds that stock returns are less synchronous in developed markets with relatively strong property rights protection (and thus fewer impediments to informed trading) than in emerging markets with relatively poor protection, supporting the notion that firm-specific return variation is associated with the intensity of information-based trading. Empirical studies have largely supported their conclusions (Brockman and Yan, 2009; Durnev et al., 2003; Gul et al., 2009; Hutton et al., 2009; Kim and Shi, 2012). Piotroski and Roulstone (2004) show that insider trading reduces stock return synchronicity. Fernandes and Ferreira (2009) show that the enforcement of insider trading laws encourages informed risk arbitrage, which in turn facilitates the impounding of firm-specific information into stock prices. Ye (2012) shows that active institutional investors mitigate excessive stock return comovement caused by noise traders