Financial globalization, governance, and the evolution of the home bias

Bong-Chan Kho, René Stulz and Francis Warnock

No 12, Globalization Institute Working Papers from Federal Reserve Bank of Dallas

Abstract: Standard portfolio theories of the home bias are disconnected from corporate finance theories of insider ownership. We merge the two into what we call the optimal ownership theory of the home bias. The theory has the following components. In countries with poor governance, it is optimal for insiders to own large stakes in corporations and for large shareholders to monitor insiders. Foreign portfolio investors will exhibit a large home bias against such countries because their investment is limited by the shares held by insiders (the \"direct effect\" of poor governance) and domestic monitoring shareholders (\"the indirect effect\").> ; Foreigners can also enter as foreign direct investors; if they are from countries with good governance, they have a comparative advantage as insider monitors in countries with poor governance, so that the relative importance of foreign direct investment in total foreign equity investment is negatively related to the quality of governance. Using two datasets, we find strong evidence that the theory can help explain the evolution of the home bias. Using country-level U.S. data, we find that on average the home bias of U.S. investors towards the 46 countries with the largest equity markets did not fall over the past decade, but it decreased the most towards countries in which the ownership by corporate insiders decreased, and the importance of foreign direct investment fell in countries in which ownership by corporate insiders fell. Using firm-level data for Korea, we find evidence of the additional indirect effect of poor governance on portfolio equity investment by foreign investors.

JEL-codes: F36 G15 G30 (search for similar items in EconPapers)
Pages: 46 pages
Date: 2008
Note: Published as: Kho, Bong-Chan, René M. Stulz, and Francis E. Warnock (2009), "Financial Globalization, Governance, and the Evolution of the Home Bias," Journal of Accounting Research 47 (2): 597-635.
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Related works:
Journal Article: Financial Globalization, Governance, and the Evolution of the Home Bias (2009)
Working Paper: Financial globalisation, governance and the evolution of the home bias (2006)
Working Paper: Financial Globalization, Governance, and the Evolution of the Home Bias (2006)
Working Paper: Financial Globalization, Governance, and the Evolution of the Home Bias (2006)
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