Where do Local and Foreign Investors Lose Their Edge? The Mediating Role of State Ownership in Shaping Their Relative Informational Advantage
Posted: 15 Sep 2010 Last revised: 7 Feb 2012
Date Written: September 14, 2010
Extant evidence is mixed on whether local investors or foreign investors are better informed. To help shed light on this issue, we separately examine two market segments within one country that differ in the importance of local knowledge. Prior research documents that state ownership is associated with higher information asymmetry stemming from poorer governance structures and financial transparency, implying that investing in firms with state ownership requires more local knowledge and experience. We provide strong, robust evidence that the informational role that local and foreign institutional investors play in China hinges on the extent of state ownership: in state-owned enterprises (SOEs), local institutional owners have strong forecasting power for future stock returns but foreign institutional owners fail to exhibit this ability, whereas in non-state-owned enterprises (non-SOEs) foreign institutional ownership strongly predicts future stock returns but local institutional ownership does not. Additional analysis reveals that the return-predictive ability of local institutional investors dissipates in SOEs with better corporate governance structures. Overall, our results help reconcile the opposing perspectives in the literature by indicating that local (foreign) institutional investors have an informational advantage that is concentrated in SOEs (non-SOEs), supporting that their relative performance in forecasting varies systematically with the relevance of local knowledge.
Keywords: Local Institutional Investors, Foreign Institutional Investors, State Ownership, Information Asymmetries
JEL Classification: G14, G15
Suggested Citation: Suggested Citation