Where do Local and Foreign Investors Lose Their Edge? The Mediating Role of State Ownership in Shaping Their Relative Informational Advantage

Abstract

Extant evidence is mixed on whether local investors or foreign investors are better informed. In this paper, we shed light on this debate by investigating how state ownership of listed firms shapes the information environment facing institutional investors. Prior research documents that state ownership is associated with worse information asymmetry stemming from poor governance structures and financial transparency, implying that investing in firms with state ownership requires more local knowledge and experience. In analyzing Chinese listed firms, we find strong, robust evidence that the information advantage of local versus foreign institutional investors hinges on the extent of state ownership: in state-owned enterprises (SOEs), local institutional ownership strongly predicts future stock returns while foreign institutional ownership does not, whereas in non-SOEs, foreign institutional ownership strongly predicts future stock returns while local institutional ownership does not. In additional analysis consistent with expectations, we find that stronger monitoring, as reflected in board independence and auditor choice, narrows (widens) the information disadvantage (advantage) of foreign institutional investors in SOEs (non-SOEs).

Keywords: State Ownership; Local Institutional Investors; Foreign Institutional Investors; Information Asymmetries; Monitoring

JEL Classification: G14; G15