Are Foreign Investors 'Locusts'? The Long-Term Effects of Foreign Institutional Ownership

1. Are Foreign Investors ‘Locusts’? The Long-Term Effects Of Foreign Institutional Ownership Jan Bena, University of British Columbia Miguel Ferreira, Nova SBE Pedro Matos, University of Virginia – Darden Pedro Pires, Nova SBE

2. 1. INTRODUCTION 2. DATA 3. RESULTS 4. CONCLUSIONS Do foreign institutional investors foster or hinder long-term investment? • Fixed capital • Intangible capital • Employment and human capital ‘Locust’ Hypothesis: Foreign portfolio flows are “hot money” seeking short-term gains, with no concern for the long-term prospects of local firms. Increase career concerns and show less tolerance for failure by managers. ‘Monitoring’ Hypothesis: Foreign institutions are better at monitoring managers—less constrained by ties with local management—and can tolerate risks more—thanks to their better diversification

3. 1. INTRODUCTION 2. DATA 3. RESULTS 4. CONCLUSIONS Corporate ownership structures worldwide are changing • Closely held firms & “Stakeholder capitalism” in Europe & Asia (Tirole (01), Stulz (05): insiders impose “limits of globalization”) • Financial globalization = surge in FDI and foreign portfolio investments Foreign Institutional Investors: Long-term Institutional Investors: “We support those companies, who act in interest of their future and in the interest of their employees against irresponsible locust swarms, who measure success in quarterly intervals, suck off substance and let companies die once they have eaten them away.” Franz Müntefering, German SPD Chairman (2005) “The effects of the short-termist phenomenon are troubling (...) In the face of these pressures, more and more corporate leaders have responded with actions that can deliver immediate returns to shareholders, such as buybacks or dividend increases, while underinvesting in innovation, skilled workforces or essential CAPEX necessary to sustain long-term growth.” Laurence Fink, CEO, BlackRock (2015) “THE GREED OF BIG MONEY Financial investors reach for German companies”

4. 1. INTRODUCTION 2. DATA 3. RESULTS 4. CONCLUSIONS Foreign Institutional Investors: “We support those companies, who act in interest of their future and in the interest of their employees against irresponsible locust swarms, who measure success in quarterly intervals, suck off substance and let companies die once they have eaten them away.” Franz Müntefering, German SPD Chairman (2005) “THE GREED OF BIG MONEY Financial investors reach for German companies”

5. 1. INTRODUCTION 2. DATA 3. RESULTS 4. CONCLUSIONS Long-term Institutional Investors: “The effects of the short-termist phenomenon are troubling (...) In the face of these pressures, more and more corporate leaders have responded with actions that can deliver immediate returns to shareholders, such as buybacks or dividend increases, while underinvesting in innovation, skilled workforces or essential CAPEX necessary to sustain long-term growth.” Laurence Fink, CEO, BlackRock (2015)

6. 1. INTRODUCTION 2. DATA 3. RESULTS 4. CONCLUSIONS Deutsche Bank Research (May, 2014) “Shareholder Activism: Battle for the Boardroom”

7. 1. INTRODUCTION 2. DATA 3. RESULTS 4. CONCLUSIONS Role of foreign institutional investors as “agents” of globalization • Monitoring (Ferreira and Matos (2008)) • Facilitate foreign takeovers (Ferreira, Massa, and Matos (2009)) • Export shareholder-centric corporate governance (Aggarwal, Erel, Ferreira, and Matos (2011)) Prior (U.S.) evidence on institutional investors and long-term investing • Are institutional investors myopic? • Mixed evidence: less R&D cuts (Bushee (1998)), more patents (Aghion, Van Reenen, and Zingales (2013)), less CAPEX (Harford, Kecskes, and Mansi (2015))

8. 1. INTRODUCTION 2. DATA 3. RESULTS 4. CONCLUSIONS ► Main Results: • First stage: MSCI addition => +3% in Foreign IO • Second stage: +3% in Foreign IOis positively associated with ... +0.3% long-term investment(CAPEX + R&D) +12% employment +11% innovation output (Patent counts) IV and Diff-in-diff (additions) MSCI index suggest causal effect • Foreign IO positively linked to productivity and shareholder value • Evidence in support of monitoring role of Foreign IO

9. 1. INTRODUCTION 2. DATA 3. RESULTS 4. CONCLUSIONS ► Data: • Worldscope: 30,952 publicly-listed firms across 30 countries, period 2001-2010 (exclude financial and utilities) • Proxy 1 - Long-Term Investment: (source: Worldscope) Physical + Intangible Capital = CAPEX + R&D • CAPEXt = (Capital Expenditures / Total Assets) • R&D t = (R&D Expenses / Total Assets) … IAS 38 (1998) & IFRS (2005-2010) Hall & Oriani (2006): “The conclusion is that even though reporting R&D is not required in Europe, in fact a fairly large share of major R&D-doers actually reports it.”

10. 1. INTRODUCTION 2. DATA 3. RESULTS 4. CONCLUSIONS ► Data (Cont.): • Proxy 2 – Human and Organizational Capital (source: Worldcope) EMPLOYEESt = number of employees results also for STAFF_COSTSt (= staff costs / sales) , AVG_STAFF_COSTSt (= log of the staff costs / employees), SG&At (=organizational capital by Eisfeldt & Papanikolau 2013)

11. 1. INTRODUCTION 2. DATA 3. RESULTS 4. CONCLUSIONS ► Data (Cont.): • Proxy 3 - Innovation Output: (source: USPTO) PATENTSt (t= year patent application is filed) Matching patent assignees in USPTO to Worldscope: [details] • step 1: standardize patent assignee names and firm names • step 2: multiple fuzzy string matching techniques results also for TRIADIC patents (USPTO, EPO and JPO), INDUSTRY-SCALED patents, CITE-WEGHTED patents

12. Ex: Apple’s patent on authentication to computers & mobile devices using fingerprints https://patents.google.com/patent/US8943580B2/en

13. Matching between USPTO and Worldscope

14. 1. INTRODUCTION 2. DATA 3. RESULTS 4. CONCLUSIONS ► Main Findings: Physical + Intangible Capital = CAPEX + R&D U.S. firms and non-U.S. firms have similar average CAPEX ratios at around 5%

15. 1. INTRODUCTION 2. DATA 3. RESULTS 4. CONCLUSIONS ► Main Findings: Physical + Intangible Capital= CAPEX + R&D US firms lead in R&D intensity, but Non-US exceed US firms in total R&D spending

16. 1. INTRODUCTION 2. DATA 3. RESULTS 4. CONCLUSIONS ► Main Findings: Innovation Output: = PATENTS U.S. firms more output, but >½ of USPTO patents granted to non-U.S. firms

19. 1. INTRODUCTION 2. DATA 3. RESULTS 4. CONCLUSIONS ► Data (Cont.): • FactSet/LionShares: institutional holdings data (Ferreira & Matos (2008)) Globally, institutional ownership is at 43% - US (75%), Non-US (23%) Foreign exceeds domestic ownership (except US, UK, CA, SE, DK) • IO_DOM = domestic institutional ownership • IO_FOR = foreign institutional ownership

20. Ind. Ind. Grey Grey A detailed view: largest firms in FR and SE by market-cap (Ferreira and Matos (2008)) • IO_DOMESTIC / IO_US_FOREIGN / IO_NONUS_FOREIGN • IO_INDEPENDENT / IO_GREY • Local shares / ADR receipts

21. http://wrds-web.wharton.upenn.edu/wrds/ds/factset/holdingsbyfirmmsci/index.cfmhttp://wrds-web.wharton.upenn.edu/wrds/ds/factset/holdingsbyfirmmsci/index.cfm

22. http://wrds-web.wharton.upenn.edu/wrds/ds/factset/holdingsbyfirmmsci/index.cfmhttp://wrds-web.wharton.upenn.edu/wrds/ds/factset/holdingsbyfirmmsci/index.cfm

23. 1. INTRODUCTION 2. DATA 3. RESULTS 4. CONCLUSIONS ► Endogeneity: IV using MSCI dummy as instrument The importance of the MSCI index … Jun/2015: Jun/2016:

24. 1. INTRODUCTION 2. DATA 3. RESULTS 4. CONCLUSIONS ► First Stage: (IO_FOR)t ► Instrument: MSCI ACWI membership ► Placebo: No effect on IO_DOM

25. 1. INTRODUCTION 2. DATA 3. RESULTS 4. CONCLUSIONS ► Second-Stage: (CAPEX+R&D)t ► Robustness: Table IA.6 . 2005-10 (IFRS) . (c,y,t) FEs .% of sales . R&D & CAPEX (separately)

26. 1. INTRODUCTION 2. DATA 3. RESULTS 4. CONCLUSIONS ► Second-Stage (2): log (EMPLOYMENTt) ► Robustness: Table 12 . STAFF_COST . AV_STAFF_COST . SG&A

27. 1. INTRODUCTION 2. DATA 3. RESULTS 4. CONCLUSIONS ► Second-Stage (3): log(1+PATENTSt) ► Robustness: Table IA.7 . >0 Patent firms . 2001-08 . (c,y,t) FEs . 3-yr patents . Industry-scaled . Patents/R&D . Cite-weighted . “Triadic” . Poisson

28. 1. INTRODUCTION 2. DATA 3. RESULTS 4. CONCLUSIONS ► Endogeneity (1): IV with bandwith (Appel, Gormley & Keim, 15) ►. +/- 10% of stocks in each country around the expected MSCI cut-off rank (85% cumulative sum of market capitalization in each country )

29. 1. INTRODUCTION 2. DATA 3. RESULTS 4. CONCLUSIONS ► Endogeneity (2): Diff-in-Diff around MSCI additions (574)

30. ► Endogeneity (2): Diff-in-Diff around MSCI additions (574)

31. 1. INTRODUCTION 2. DATA 3. RESULTS 4. CONCLUSIONS ► Monitoring vs. Career Concerns Channel: INV_TURNOVER = Investor horizon, i.e. weighted average churn rate of institutional investors (Gaspar, Massa & Matos, 2005) IO_FOR_LT = Holdings (end-of-year) by long-term foreign institutions, defined as those with weighted average portfolio turnover rate below the median, as a fraction of market capitalization (FactSet/LionShares).

32. 1. INTRODUCTION 2. DATA 3. RESULTS 4. CONCLUSIONS ► Monitoring vs. Career Concerns Channel (2): GOV41 = Governance index (Aggarwal, Erel, Ferreira & Matos (2011)) ANTI_SD = Anti-self-dealing index (Djankov, La Porta, Lopez-de-Silanes, Shleifer (2008)) COMPETITION = 1- Industry Lerner index (Aghion, Van Reenen, and Zingales (2013))

33. 1. INTRODUCTION 2. DATA 3. RESULTS 4. CONCLUSIONS ► Monitoring vs. Career Concerns Channel (3):

34. 1. INTRODUCTION 2. DATA 3. RESULTS 4. CONCLUSIONS ► Long-Term Effects: Productivity & Firm Value

35. 1. INTRODUCTION 2. DATA 3. RESULTS 4. CONCLUSIONS Conclusions - Globalization of the shareholder base of firms is a positive force - Higher Foreign IO associated with greater long-term investment in FIXED, INTELLECTUAL and HUMAN CAPITAL and leads to higher shareholder value - Our evidence suggests that “monitoring channel” of foreign portfolio investors is important in explaining these results - Results go against popular fears that label foreign investors as ‘locusts’