Foreign Ownership and Investment: Evidence from Korea

I. Introduction
Ø Korean equity market was opened to foreign investors ion January 1992 → allow foreigner to invest up to 10% of a firm stock
Ø End 1992 → reach 7% → end 2002 → reach 36% of the total market capitalization
Ø Firm’s investment depends on → the availability of internal funds
Ø The importance of financial factors in investment → higher cost of external finance → arising from → information asymmetry and agency cost → in an imperfect capital market.
Ø If financial intermediaries consider that → foreigners favor firms with → low information asymmetry → then → firms with high foreign ownership are able to raise external funds at low costs
Ø If foreign investors have better skills than domestics’, → foreign firms have less agency problems.
Ø →The cash flow sensitivity of investment → is lower in firms with high foreign ownership → than in firms with low foreign ownership
Ø Main empirical findings:
§ First, Cash-flow sensitivity of investment → significantly decreases as foreign ownerships → increases
§ Second, the effect of foreign ownership on financial constrains became stronger after he complete opening of the Korean equity market to foreigners in 1998
Ø These findings imply → open financial markets help relax financial constrains faced by firms

II. Relevant Literature and Hypothesis Formulation
Ø Firm’s investments depend solely → on the profit opportunity
Ø Firm’s investment decisions are depend on financial factors → such as the availability of internal funds
Ø Why investment is sensitive to internal funds in imperfect financial market?
§ First → focused on a lemon premium that firms must pay on external finance → the cost of external funds are higher → than that of internal funds → due to the asymmetry of information → between borrowers and lenders
§ Second → studies attribute the importance of internal funds to managerial agency problems → managers tend to spend all available funds on investment projects at their own discretion.
Ø Imperfections in financial markets influence a firm’s investments
Ø The dividend-payout ratio → as a measure of the financial constrains → faced by firms that → investment of more financially constrained firms → respond more sensitively to changes in cash flow
Ø Ownership structure → affects investment → Canadian Firms → Concentrated ownership leads to less liquidity-constraint
Ø As managers’ ownership stakes in their firms increase → investment-cash flow sensitivities also rise → however → cash flow sensitivities decrease slowly after a certain level of insider holding
Ø As financial market begin to open → developing countries have recently experienced an increase in the equity share of foreigners
Ø FDI → increase the credit constrains by bringing in capital → also reduces firm-level financing constrains
Ø Foreign investors prefer → equity shares in firms with low information asymmetry → than those with higher information asymmetry
Ø Foreigners prefer large firms with good performance, low risk, low leverage, paying low dividends, and firms with large cash positions → it is expected → this kind of firms can raise funds at low cost → because high foreign ownership → is a sign that → these firms are in good financial condition → under imperfect information.
Ø Foreign investors have a tendency → demand better corporate governance → in order to protect their investment
Ø Foreign investors → seek safe and profitability firms → where they can exert influence on corporate governance
Ø We can say → cash-flow sensitivity of investment → lower in financial owned firms → than in domestically owned firms

III. Model and Method
Ø Method
Ø Ordinary Least Square (OLS) → likely to result in biased estimated because of endogeneity and heterogeneity problems
Ø Potential differences across firms in their investment behavior may also result in a heterogeneity problem
Ø Generalized methods of Moment (GMM) → estimation is widely used for dynamic panel models → the success of this model depends → mainly on the adoption of elimination of unobserved firm effect
Ø If there are NO strong unobserved individual effects → firm can apply the GMM technique to the investment equation in levels
Ø Data and Definition of Variables
Ø Firm-level panel data → constructed from Korea Investors Service-Financial Analysis System (KIS-FAS) database → consist of 5084 observation of the 371 firms
Ø High foreign ownership based on two criteria
§ First → more than 5.88% foreign ownership
§ Second → more than upper quartile foreign ownership

IV. Empirical Results
Ø Avalability of internal funds does affects investment levels
Ø Persistence also found in a firm’s investment → from significant estimates in the lagged investment-to-capital ratio
Ø Sales play role of increasing the investment-capital ratio
Ø Financial constrains faced by firms decrease → as foreign ownership increases
Ø Since foreigners’ shareholding plays a role in diminishing information asymmetry in financial markets → firms with high foreign ownership seem to → capable of raising external funds → at lower cost.
Ø Firms with high foreign ownership → les likely to use cash flow at their discretion due to improving corporate governance system
Ø Opening of the stock market → one of the factors in the mitigation of financial constrains
Ø Liquidity constrains are reduced → in firms with low foreign ownership

V. Concluding Remarks
Ø Foreigners tend to favor with firms with low information asymmetry → conclude → higher the foreign ownerships → lower the asymmetry information
Ø Cash flow sensitivity decreases as → foreign ownership increases
Ø Foreign ownership play role → reducing the financial constrains → and improves accessibility of external financing for investment