Effects of Foreign Institutional Ownership on Foreign Bank Lending: Some Evidence for Emerging Markets

• Author: Yi Zhu,Liangliang Jiang
• Published date: 01 June 2014
• DOI: http://doi.org/10.1111/irfi.12021
• Date: 01 June 2014

Effects of Foreign Institutional

Ownership on Foreign Bank

Lending: Some Evidence for

Emerging Markets*

LIANGLIANG JIANG†AND YIZHU‡

†Department of Economics, Lingnan University, Hong Kong and

‡Hong Kong Monetary Authority, Hong Kong

ABSTRACT

Despite the large literature on developed countries, little is known about the

interactions between corporate governance, foreign ownership, and foreign

bank lending in developing countries. Using data from five Latin American

countries from 2001 to 2008, we provide one of the first pieces of evidence of

how foreign ownership affects the loan cost of borrowers in emerging

markets. We find that in terms of foreign bank lending, the cost of debt

financing is significantly higher for firms whose largest shareholder is a

foreign institutional one. The results support the hypothesis that because of

potential agency conflicts between shareholders and creditors, having block

institutional shareholders tend to increase the borrowers’ debt burden. There

is further evidence supporting this agency conflict hypothesis as we find that

the effects of large institutional shareholders on borrowing costs become

larger (smaller) when the conflicts are aggravated (mitigated).

JEL Classification: G20, G32.

I. INTRODUCTION

Over the past few decades, issues on corporate governance, foreign ownership,

and international bank lending have interested both researchers and policy

makers. However, compared with the large literature focusing on firms in

industrialized countries, research on firms in developing countries remains

relatively scarce, largely due to shortage of high-quality data. Meanwhile, better

understanding of the interactions between corporate governance, foreign insti-

tutional ownership, and foreign bank lending and how they affect firm perfor-

mance in developing economies is badly needed for at least three reasons. First,

*We would like to thank an anonymous referee, the associate editor, Chen Lin, Yue Ma, and

seminar participants at the World Finance Conference 2013 for very helpful comments, and

Pennie Wong and Arbitor Ma for research assistance. Liangliang Jiang gratefully acknowledges

financial support from Lingnan University, Hong Kong.

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International Review of Finance, 14:2, 2014: pp. 263–293

DOI: 10.1111/irfi.12021

© 2014 International Review of Finance Ltd. 2014

following the market liberalization, foreign capital has recently become an

increasingly important source of finance for many emerging capital markets

(Bekaert et al. 2002). Among the increasing foreign investment, the share con-

tributed by institutional investors has grown rapidly (Stepanyan 2011), and

institutional investors now become major players not only in developed

countries but in emerging markets as well (Li et al. 2006; Ferreira and Matos

2008). Second, international-syndicated lending has also become an important

source of external finance in emerging markets and its size often exceeds that of

equity markets (Nini 2004). Third, most importantly, it is premature to gener-

alize the findings based on developed countries to developing ones because for

the latter, corporate governance may operate in many different ways because of

lack of necessary political and economic institutions for democracy and markets

to well function (Berglöf and Claessens 2006).1This paper fills in the gap in the

literature by providing one of the first pieces of evidence of how foreign

(institutional) ownership and foreign bank lending influence corporate finan-

cial outcomes in developing countries.

In particular, we use a newly collected data set on firms in five Latin American

countries (Argentina, Brazil, Chile, Colombia, and Peru) from 2001 to 2008 to

examine whether and to what extent concentrated institutional foreign own-

ership and foreign bank creditors affect firms’ costs of borrowing. Latin Ameri-

can firms are ideal for our research because both foreign institutional ownership

and foreign bank lending are highly prevalent in these countries. Based on our

own calculation, almost 80% of the Latin American firms in the FactSet data-

base have at least one of the firm’s 15 largest institutional investors from a

foreign country,2and nearly all of the syndicate loans of Latin American firms

in the DealScan database are made with at least one foreign lead bank.3This

echoes previous finding that Latin America is one of the regions with the

highest foreign bank participation (as measured by the percentage of assets held

by foreign banks) among all developing countries (Cull and Pería 2007).

It has been well documented that foreign institutional investors play an

important role in corporate governance and firm performance (Gillan and

Starks 2007; Ferreira and Matos 2008; Aggarwal et al. 2011; Stepanyan 2011),

1 For example, developing and emerging countries are constantly confronted with issues such

as the lack of property rights, the abuse of minority shareholders, contract violations, asset

stripping, and self-dealing. In addition, in sharp contrast with many developed countries

where the major corporate governance conflicts are between managers and scattered share-

holders, the dominant corporate governance conflicts in most developing economies lie

between controlling shareholders and minority shareholders.

2 There is (small) variation in the prevalence of foreign institutional ownership across the five

countries in our data. The shares of firms having at least one foreign institutional shareholder

are 88% in Argentina, 83% in Brazil, 86% in Chile, 77% in Colombia, and 66% in Peru. If we

look further at large foreign institutional shareholders (those with at least 5% of the total

shares, as studied in this paper), the proportions become somewhat lower, as shown in section

II.B.

3 We define a bank as a foreign creditor if its headquarter is located outside of the country where

the firm is located.

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