1 s2.0 S0261560613000405 Main - PDF 3f - Tid 3d 26acdnat 3d1400641827

Large foreign ownership and stock price
informativeness around the world

Wen He
a,
*
, Donghui Li
b,1
, Jianfeng Shen
b, 2
, Bohui Zhang
b, 3
a
The University of New South Wales, School of Accounting, Australian School of Business, Kensington,
Sydney, NSW 2052, Australia
b
The University of New South Wales, School of Banking and Finance, Australian School of Business,
Kensington, Sydney, NSW 2052, Australia
JEL classications:
G15
O16
Keywords:
International nancial market
Large foreign ownership (LFO)
Stock price informativeness
Probability of informed trading (PIN)
Price non-synchronicity (NONSYNC)
a b s t r a c t
This study investigates the relation between large foreign owner-
ship (LFO) and the informativeness of stock prices in 40 markets.
We show that LFO is positively related to price informativeness,
measured by probability of informed trading (PIN) and price non-
synchronicity (NONSYNC) which reects rm-specic variations in
stock returns. We also nd a stronger association between stock
returns and future earnings innovations for rms with higher LFO.
Further analysis reveals that the effect of LFO on price informa-
tiveness is stronger in developed economies and markets with
strong investor protection and a transparent information
environment.
2013 Elsevier Ltd. All rights reserved.
1. Introduction
Foreign investors have emerged as an important group of investors in many nancial markets. Take
our sample of 2002 as an example, foreigners on average owned 28% of shares in 3189 rms in 40
markets. Given the signicant presence of foreign investors in local markets, the specic roles played
by foreign investors in local markets have attracted considerable attention from both academics and
* Corresponding author. Tel.: 61 2 93855813; fax: 61 2 93865925.
E-mail addresses: wen.he@unsw.edu.au (W. He), donghui@unsw.edu.au (D. Li), jianfeng.shen@unsw.edu.au (J. Shen), bohui.
zhang@unsw.edu.au (B. Zhang).
1
Tel.: 61 2 93855873; fax: 61 2 93866347.
2
Tel.: 61 2 93854581; fax: 61 2 93866347.
3
Tel.: 61 2 93855834; fax: 61 2 93866347.
Contents lists available at SciVerse ScienceDirect
Journal of International Money
and Finance
j ournal homepage: www. el sevi er. com/ l ocat e/ j i mf
0261-5606/$ see front matter 2013 Elsevier Ltd. All rights reserved.
http://dx.doi.org/10.1016/j.jimonn.2013.04.002
Journal of International Money and Finance 36 (2013) 211230
policy makers. One stream of research has studied the effects of foreign equity investments on the real
side of invested rms and local economy, such as productivity, investment and growth (e.g., Henry,
2000a; Bekaert et al., 2005, 2009). Another stream of research examines properties of stock prices
including liquidity (Bekaert et al., 2007; Rhee and Wang, 2009), return volatility (Bae et al., 2004; Li
et al., 2011), and the cost of capital (Bekaert and Harvey, 2000; Henry, 2000b).
This study investigates whether foreign investors, particularly large foreign investors (LFO), affect
the extent to which stock prices incorporate value-relevant information and thus are informative about
a rms fundamental value. In an efcient market, stock prices incorporate all the available information
and reect a rms intrinsic value. However, prices could fail to reveal all the available information
because of various frictions such as information cost (Grossman and Stiglitz, 1980) and limits to
arbitrage (Shleifer and Vishny, 1997). Consequently, the degree of price informativeness varies across
rms and has important implications for both managers and investors. More informative stock prices
can help managers make better decisions in capital investment, resulting in higher efciency in capital
allocation and corporate investment (Wurgler, 2000; Durnev et al., 2004; Chen et al., 2007). Infor-
mative prices also reduce the risk for uninformed investors and thus lower the cost of capital for the
rm (Fernandes and Ferreira, 2009). Therefore, given foreign investors substantial share ownership, it
is important to understand the impact of foreign investors on a rms stock price informativeness.
The existing literature suggests two potential channels through which large foreign shareholders
could improve the informativeness of stock prices of the invested rm. First, large foreign shareholders
could improve the informativeness of stock prices through their informed trading. Compared with
small shareholders, large shareholders tend to have a stronger incentive and better capability to collect
and process value-relevant information.
4
Thus the information-based trading by large shareholders, for
example, selling their stakes upon negative information, facilitates the capitalization of fundamentals
into stock price (Edmans and Manso, 2011; Admati and Peiderer, 2009; Edmans, 2009).
5
Second, large foreign shareholders could enhance price informativeness by improving corporate
governance and disclosure quality of the invested rms.
6
Jin and Myers (2006) showthat poor investor
protection and opaque nancial disclosure reduces price informativeness. The reason is that managers
and controlling shareholders tend to engage in self-dealing activities to extract private benets at the
expense of other shareholders (e.g., Shleifer and Vishny, 1989; Morck, 1996). To camouage their self-
dealing activities, managers may withhold information or manipulate accounting disclosure, which
makes stock prices less informative about a rms fundamentals (Fan and Wong, 2002; Jin and Myers,
2006; Gul et al., 2010). Furthermore, agency problems could deter sophisticated investors from
engaging in costly and risky informed arbitrage, which also reduces the amount of relevant informa-
tion in stock prices (Morck et al., 2000). If large foreign shareholders, due to their signicant interest at
stake, closely monitor managers and constrain agency problems, we expect to nd more informative
stock prices.
However, it remains an empirical questionwhether large foreign investors can be effective monitors
of local managers and insiders. On the one hand, relative to domestic shareholders, foreign share-
holders may incur a higher cost to collect relevant information to effectively monitor insiders due to
the geographic and cultural distance (Kang and Kim, 2008, 2010). On the other hand, large foreign
shareholders would be less engaged with insiders compared with their domestic counterparties, which
could facilitate their monitoring role. Further, the differences in corporate governance practices
4
A number of studies document mixed evidence on whether foreign investors have better information than local investors
(Grinblatt and Keloharju, 2000; Hau, 2001; Seasholes, 2004; Choe et al., 2005; Dvorak, 2005). We note that foreign investors in
these studies are likely to be foreign mutual funds with relatively small ownership in local companies. In contrast, we focus on
large foreign investors that own at least 5% of shares of a rms stock. The substantial shareholding of large foreign investors
should allow them to be better informed than outside investors.
5
In their theoretical model, Edmans and Manso (2011) show that the monitoring role of large shareholders does not
necessarily rely on active trading by large shareholders. The mere threat of exit upon negative information could effectively
convey information about rm value and improve the informativeness of stock prices.
6
The vast majority of blockholder literature focuses on how blockholders add value through direct intervention or moni-
toring. See, Shleifer and Vishny (1986), Admati et al. (1994), Kahn and Winton (1998), Maug (1998), Aghion et al. (2004), among
others.
W. He et al. / Journal of International Money and Finance 36 (2013) 211230 212
between the home country and the host country could also make large foreign shareholders more
effective monitors of insiders compared with their domestic counterparties, especially for those large
foreign shareholders coming from good governance countries and investing in poor governance
countries (Kho et al., 2009).
We dene large foreign shareholders as those ultimate owners who own more than 5% of
outstanding shares of a rm and are domiciled outside the country of the invested rm.
7
LFO is
calculated as the percentage of shares outstanding owned by all large foreign shareholders. Following
the literature, we employ two measures of price informativeness: probability of informed trading (PIN)
and price non-synchronicity (NONSYNC). Developed by Easley et al. (1997), PIN is the ratio of informed
trading intensity to total trading intensity and thus measures the probability of trades placed by
informed traders. The market micro-structural model in Easley et al. (1997) indicates that the higher
the PIN, the greater the amount of information in stock prices.
8
Building on this insight, a few studies
have used PIN to measure price informativeness (e.g., Easley et al., 1996, 1998, 2002; Chen et al., 2007;
Brockman and Yan, 2009, Ferreira et al., 2011).
Our second proxy for price informativeness, NONSYNC, is based on rm-specic variations in stock
returns. Specically, we compute NONSYNC as a logistic transformation of the R-square from the
regression of stock returns on returns of the local market index and US market index. Roll (1988) is one
of the rst to suggest that rm-specic return variation might capture the rate of information incor-
poration into stock prices through trading.
9
Morck et al. (2000) propose the use of this variable to
measure the informativeness of stock prices. Recent empirical evidence supports the view that large
rm-specic return variation indicates more informative stock prices. For example, Durnev et al.
(2003) show that rm-specic return variation is positively related to the extent to which stock
returns reect future earnings information. NONSYNC is also found to be positively associated with the
efciency of capital allocation (Wurgler, 2000; Durnev et al., 2004; Chen et al., 2007). In the literature,
NONSYNC has been employed to measure price informativeness in a number of studies (see, for
example, DeFond and Hung, 2004; Piotroski and Roulstone, 2004; Chan and Hameed, 2006; Daouk
et al., 2006; Bris et al., 2007; Brockman and Yan, 2009).
Using a cross section of 3189 rms in 40 markets in 2002, we nd that LFO is positively related to
both proxies of stock price informativeness, PIN and NONSYNC. This positive relation is robust to the
control of lagged price informativeness, and a number of rmand country characteristics. To gauge the
economic signicance of the effect of LFO, we show that if LFO increases from the rst quartile (9%) to
the third quartile (45%) in the sample, PIN would increase by 1.52.3 percentage points. The effect of
LFO is stronger than that of any other rmcharacteristic included in the regressions except for rmsize
which is typically found to be the most signicant determinant of PIN (Aslan et al., 2011).
10
Analysis
based on NONSYNC gives similar inferences about the economic signicance of LFO. Overall, the results
suggest that LFO is an important determinant of price informativeness for our sample rms.
To shed further light on the effect of LFO on price informativeness, we examine whether companies
with high LFO have stock prices that contain more information about future operating performance
measured by earnings. Our results show that for rms with higher LFO, current stock returns are more
signicantly related with contemporaneous and future earnings innovations. This evidence suggests
that stock prices of high LFO rms are more informative about rms future earnings, which provides a
more direct support for the effect of LFO on price informativeness.
7
We trace upward along the chain of ownership to identify the ultimate owners. More details about large foreign ownership
data will be provided in section II.
8
Vega (2006) nds that stocks with higher PIN have smaller post-earnings-announcement drifts. Her result suggests that
stocks with higher PIN adjust to fundamentals more quickly, supporting PIN as a measure of price informativeness.
9
Roll (1988) nds that the R-squares of a market model or multi-factor model of individual stocks returns are very low on
average for U.S. stocks, indicating high rm-specic return variations. He further shows that excluding days with public rm-
specic news does not improve R-squares much, which suggests that high rm-specic return variations could be possibly due
to trading on private information.
10
In our sample, an inter-quartile increase in rm size is associated with about a 7% decrease in PIN. For all other major
determinants of PIN, such as bid-ask spread, share turnover and return volatility, an inter-quartile change is associated with a
less than 1% change in PIN.
We proceed to investigate whether the association between LFO and price informativeness varies
systematically with country-level corporate governance and information infrastructure. This investi-
gation helps understand whether local institutional infrastructures complement or substitute LFO in
improving price informativeness, and thus deepens our understanding of the mechanisms underlying
the informational role of large foreign shareholders. Prior literature offers two competing views. One
view is that large foreign shareholders may play a more important role in markets with weaker
governance and a poorer information environment. In these markets, monitoring by large foreign
shareholders serves as a substitute for weak institutional infrastructures, and the marginal benet of
improving rms governance and transparency could be higher. Further, due to the bonding of home-
country laws and the lack of engagement with insiders, foreign investors may serve as more effective
monitors of insiders in markets with poor governance (Kho et al., 2009). The other view suggests a
stronger informational role of large foreign shareholders in markets with better governance and infor-
mationenvironment, due to a complementary effect betweeninstitutional infrastructures andrm-level
governance, as suggested by Doidge et al. (2007). In these markets, the cost of collecting information and
monitoring insiders is lower, which could facilitate the informational role of large foreign shareholders.
Therefore, it is an empirical question as to whether large foreign shareholders play a larger or smaller
informational role in markets with stronger governance and better information infrastructures.
Using several measures of the strength of investor protection and information disclosure, we nd
that the association between LFO and measures of price informativeness is stronger in markets with
stronger investor protection and better information disclosure. Furthermore, the association between
stock returns and future earnings innovations increases with LFO more signicantly in these markets.
These results suggest that large foreign shareholders play a larger informational role in markets with
stronger investor protection and better information disclosure, which supports the view of comple-
mentarity between market-level and rm-level governance forces.
Our paper contributes to the literature on the role of foreign equity investment in local markets in
three ways. First, we document an important economic benet associated with foreign equity invest-
ment, i.e., improvedinformativeness of stockprices. Second, whilemost of theexistingstudies focus only
on the effect of foreign equity investment in emerging markets, we study the effect of LFOon stock price
informativeness in both emerging and developed markets. We also show that the role of foreign
shareholders could vary signicantlyacross markets. Third, we employa measure of actual large foreign
ownership to study the effect of foreign equity investment in local markets, while most existing studies
examine market liberalization events or use a stock investibility index to proxy for foreign equity in-
vestment.
11
While market openness and investibility are related to foreign investors ability to invest in
local markets, they dont necessarily correspond to the exact holdings of foreign investors.
Two recent studies are closely related to ours. Gul et al. (2010) examine the relationship between
foreign equity ownership and the rm-level information environment in China. They compare a
measure of stock price non-synchronicity between rms issuing only A-shares, which are invested
almost exclusively by domestic investors, and rms issuing A-shares along with B-shares or H-shares,
both of which are invested almost exclusively by foreign investors.
12
Bae et al. (2012) nd that, in 21
emerging markets, a stocks investibility by foreign investors is positively related to the timeliness of
incorporating global market information into stock prices.
Our paper also connects to a large stream of literature on block ownership. In particular, Brockman
and Yan (2009) nd evidence that aggregate block ownership is positively associated with the infor-
mativeness of stock prices in the US market. However it is unclear whether their evidence is applicable
to other markets, since there are signicant differences between large foreign shareholders and do-
mestic block shareholders in their monitoring role and information advantage. Furthermore, the in-
ternational setting allows us to examine whether the roles played by blockholders vary with country-
level governance and information infrastructures. Our results showthat strong investor protection and
11
The exception is Li et al. (2011) who use the same measure as ours.
12
Since 2002, some qualied foreign institutional investors (QFII) could also invest in A-shares, and some qualied domestic
institutional investors (QDII) could also invest in B and H shares and overseas markets. Please refer to Gul et al. (2010, page 11)
for more institutional details.
transparent information environment facilitates large foreign shareholders role in improving price
informativeness.
Finally, our paper adds to an emerging set of literature on the interaction between market-level and
rm-level governance forces. Bergman and Nicolaievsky (2007) model the choice of how much
investor protection and related mechanisms by rms depends on the legal and investor protection
regime of the market. Doidge et al. (2007) nd that observable rmcharacteristics explain much less of
the variance in governance ratings than country characteristics, and especially lack explanatory power
in less developed markets. Li et al. (2011) showthe stabilizing role of large foreign shareholders is more
profound in markets with better corporate governance. Our study provides further support on this
complementarity viewof market-level and rm-level governance forces by showing that large foreign
shareholders play a larger role in markets with stronger investor protection and better information
disclosure.
The paper proceeds as follows. In Section 2 we describe the construction of key variables and data.
In Section 3 we present and discuss our empirical results. And nally we conclude in Section 4.
2. Construction of variables, data and sample
2.1. Construction of variables
2.1.1. Large foreign ownership (LFO)
Following Li et al. (2006) and Li et al. (2011), LFO is calculated as the sum of foreign block share-
holdings with a block dened as a holding larger than or equal to 5% of a rms issued shares. According
to Li et al. (2011), A foreign shareholder is dened as a citizen of another country, a business entity
registered (or head-quartered) in another country, or an unlisted majority-owned subsidiary of a
foreign company (page 9). More details about the identication and construction of LFO could be
found in Li et al. (2006) and Li et al. (2011).
2.1.2. Probability of informed trading (PIN)
Everything else equal, the more intensively informed investors trade, the more information is
incorporated into the stock price. Thus we employ the probability of informed trading (PIN) developed
by Easley et al. (1997) as one of the proxies of price informativeness. In the market micro-structural
model of Easley et al. (1997), trades are executed by two groups of investors: informed investors
who trade on their private information and uninformed investors who trade on liquidity needs. At the
beginning of each trading day, a private information event occurs with the probability a, where the
probability that bad (good) news happens is d (1 d). Both informed trades and uninformed trades are
assumed to arrive in the market following independent Poisson processes. Informed trades arrive at
the rate of m only on the days with a private news event. Informed traders buy when the news is
positive and sell when the news is negative. The arrival rate of uninformed buy (sell) trades is
b
(
s
)
which is independent of the occurrence and sign of the private news event. Based on the estimated
parameters, the probability that an order is froman informed investor could be calculated as follows
13
:
PIN
am
am
b

s
(1)
The set of parameters, q (a, d,
b
,
s
), is estimated by maximizing the following likelihood function,
LqjB; S
Y
T
t 1
LqjB
t
; S
t
(2)
where T denotes the number of trading days in a year, and B
t
(S
t
) denotes the number of buy (sell)
orders on day t. For a specic day t, the likelihood function is
13
See Easley et al. (1997) and Easley et al. (2002) for a detailed discussion of the structural model and the estimation of PIN.
LqjB
t
; S
t
1 ae
S
t
s
S
t
!
e
B
t
b
B
t
!
ade
s
m
s
m
S
t
S
t
!
e
B
t
b
B
t
!
a1 de
S
t
s
S
t
!
e
b
m
b
m
B
t
B
t
!
(3)
Researchers can estimate PIN fromintra-day data. Recent empirical evidence supports the viewthat
PIN captures the amount of (private) information in stock prices. For example, Easley et al. (2002) nd
stocks with high PIN earn higher returns, consistent with stock prices reecting risk of private infor-
mation as captured by PIN. Vega (2006) nds that stocks with high PIN have smaller post-earnings-
announcement drifts, suggesting that prices of high PIN stocks adjust to earnings information in a
timelier manner. Chen et al. (2007) showthat corporate investment is more sensitive to prices for high
PIN stocks, consistent with these stocks having more informative prices. Other studies using PIN to
measure price informativeness include Brockman and Yan (2009), and Ferreira et al. (2011).
2.1.3. Price non-synchronicity (NONSYNC)
Another measure of price informativeness is price non-synchronicity (NONSYNC) which is based on
R
2
obtained from the market model of stock returns,
r
i; j; t
a
i
b
i
r
m; j; t
g
i
r
m; US; t
e
j; t

i; j; t
(4)
where r
i,j,t
is the return on rm is stock in market j at time t, r
m,j,t
and r
m,US,t
are the returns on the
market index of market j and the U.S. at time t respectively, and e
j,t
refers to a change in the exchange
rate per U.S. dollar for the currency of market j at time t. We estimate the above equation using weekly
data in a year. According to Morck et al. (2000), a higher value of 1 R
2
indicates that more rm-
specic information is capitalized into stock price and thus stock price is more informative.
Following Morck et al. (2000), we logistically transform 1 R
2
to obtain an appropriate distribution,
NONSYNC
1 R
2
R
2
(5)
The idea that price non-synchronicity, or rm-specic return variation, measures price informa-
tiveness is based on the observation of Roll (1988) that market returns and public news announce-
ments explain only a small portion of stock return variations. He indicates that private information
incorporated in prices could be one reason for the low R
2
of market models for stock returns. Based on
this idea and the pattern of market model R
2
across markets, Morck et al. (2000) propose to use price
non-synchronicity as a measure of price informativeness. Durnev et al. (2003) show that rms with
high price non-synchronicity have returns that are more informative about future earnings, which
supports the use of price non-synchronicity as a measure of price informativeness. Further supporting
evidence comes from studies showing that price non-synchronicity is associated with the efciency of
capital allocation and investment (Wurgler, 2000; Durnev et al., 2004; Chen et al., 2007). In the
literature, NONSYNC has been employed to measure price informativeness in a number of studies (see,
for example, DeFond and Hung, 2004; Piotroski and Roulstone, 2004; Chan and Hameed, 2006; Daouk
et al., 2006; Bris et al., 2007; Brockman and Yan, 2009).
2.2. Data and sample
We obtain data from following sources: a) ownership data from the OSIRIS database and Lexis/
Nexis; b) intraday prices, quotes, and trading data from Reuters Datascope Tick History (RDTH, pre-
viously known as TAQTIC); c) stock returns and exchange rate data from Datastream; d) rm-level
nancial data from Worldscope and Global COMPUSTAT; and e) market-level characteristics from
World Development Indicators, Global Competitiveness Report by the World Economic Forum, the
International Financial Corporation of the World Bank Group, and other resources.
Our sample covers 3189 rms with foreign block ownership data in 40 markets in 2002. The number
of rms differs across model specications due to the availability of various control variables. We
require sample rms to have non-missing LFO data to avoid potential errors associated with the
treatment of rms without LFO data. Leaving out rms with missing LFO also helps mitigate the po-
tential endogeneity issue about the investment decision by foreign investors. Data availability restricts
our sample to year 2002, but we expect our results to be applicable to other time periods since the
ownership of large shareholders tends to be stable and persistent.
LFO is measured at the end of 2002, while PIN and NONSYNC are calculated using the data of 2003
which is one-year ahead of the period to construct all independent variables. To control for the effect of
large domestic ownership, we include as a control variable the largest domestic ownership (LDO)
which is calculated as the percentage of shares outstanding held by the largest domestic shareholders
at the end of 2002. We also control various rm-level and market-level characteristics which are ex-
pected to relate to both proxies of price informativeness and the preference of foreign investors.
Following the previous literature (Easley et al., 2002; Chan and Hameed, 2006), we control the
following rm-level variables which are expected to relate to PINor NONSYNC: 1) rmsize, measured as
the log of market capitalization in US$ at the end of 2002 (LogMV); 2) liquidity, measured as the average
of quoted spread in 2002 (PQSPR); 3) trading activity, measured as the average monthly share turnover,
trading volume in shares divided by the number of shares outstanding, in 2002 (TURNOVER); and 4)
stock return volatility, measured as the standard deviation of monthly stock returns in 2002 (STDRET).
In addition to the above variables, we also control the following variables which could relate to
foreign investors investment preferences: 1) rm growth, measured as the log ratio of book equity at
the end of the scal year ending in 2002 to the market capitalization at the end of 2002 (LogBM); 2)
leverage ratio, measured as the ratio of long-term debt over the common equity at the end of the scal
year ending in 2002 (LEVERAGE); 3) dual-listing in the US via initiating an American Depositary Receipt
program, measured as a dummy variable taking value 1 if a rmhas an ADR and 0 otherwise (ADR); and
4) rm protability, measured as return on equity for the scal year ending in 2002 (ROE) and annual
stock return in 2002 (RET12).
The measures of price informativeness such as PIN and NONSYNC could differ systematically across
markets with different degrees of economic and nancial development which could be also related to
the foreign investors choice of invested markets. We include the following market-level variables to
control the degree of economic and nancial development: 1) the log of per capita GDP measured in
US$ in 2002 (LogGDPPC); 2) the annual GDP growth rate in 2002 (GDPGR); 3) the standard deviation of
annual GDP growth rates over the period 1998 to 2002 (STDGDPGR); 4) the ratio of stock market
capitalization at the end of 2002 to the annual GDP of 2002 (MVGDP); 5) the ratio of private credit to
GDP in 2002, where private credit refers to nancial resources available to private sectors through
loans, purchases of non-equity securities, trade credits and other accounts receivable (PCRGDP); and 6)
the standard deviation of monthly market returns in 2002 (STDMRET).
Table 1 presents the summary statistics of selected rmcharacteristics for rms in our sample. Panel
A shows that, on average, 28% of shares outstanding are held by large foreign shareholders. The level of
LFOdiffers signicantly across rms, with a standard deviation of 23%and an inter-quartile value of 34%.
Similarly, there exists signicant variation across rms in the two proxies of price informativeness, PIN
and NONSYNC. More interestingly, both variables seemto vary systematically with LFO. In Panel B, when
we divide the sample into three equally-sized groups based on the level of LFO, we nd both PIN and
NONSYNC to increase monotonically with LFO. Finally, in Panel C and D, we report the number of rms
and the average value of each variable market by market for developed and emerging markets sepa-
rately. The number of rms differs across markets, ranging from a minimum of 8 rms for Russia to a
maximumof 460 rms for the U.S. On average a developed market has about twice the number of rms
represented in our sample as that of an emerging market. Firms in emerging markets tend to have
slightly higher LFO. For price informativeness proxies, rms in emerging markets on average have a
lower NONSYNC, but about the same level of PIN, relative to those rms in developed markets.
3. Empirical results
3.1. Cross-sectional relationship between LFO and price informativeness
We estimate the cross-sectional relation between LFO and price informativeness fromthe following
regression,
Table 1
Summary statistics. This table presents the summary statistics for rms in our sample. In Panel A we report some summary
statistics of rm characteristics for all rms in our sample. In Panel C, we report the average value of rm characteristics within
three groups classied by the level of LFO. Finally, in Panels A and B we present the average value of rmcharacteristics market by
market for developed and emerging markets respectively. All variables are dened in the Appendix.
Statistics LFO PIN NONSYNC LDO LogMV LogBM PQSPR TURNOVER STDRET LEVERAGE ROE RET12 ADR
Panel A: Summary statistics of rm characteristics for the pool sample
Mean 0.28 0.27 1.95 0.14 5.53 0.23 0.03 0.06 0.14 0.49 0.04 0.00 0.14
Stdev 0.23 0.13 1.52 0.19 2.03 0.82 0.04 0.11 0.10 0.81 0.27 0.05 0.35
Q1 0.09 0.18 0.85 0.00 4.03 0.70 0.01 0.01 0.08 0.00 0.00 0.02 0.00
Median 0.19 0.25 1.78 0.00 5.44 0.22 0.01 0.03 0.11 0.21 0.08 0.00 0.00
Q3 0.43 0.33 2.86 0.23 6.87 0.24 0.03 0.07 0.17 0.60 0.16 0.02 0.00
LFO PIN NONSYNC LDO LogMV LogBM PQSPR TURNOVER STDRET LEVERAGE ROE RET12 ADR
Panel B: The average value of rm characteristics for groups of rms with different levels of LFO
Low 0.09 0.25 1.79 0.24 5.75 0.22 0.02 0.07 0.13 0.51 0.04 0.00 0.15
Medium 0.22 0.27 1.96 0.15 5.44 0.21 0.03 0.06 0.14 0.50 0.02 0.00 0.16
High 0.53 0.28 2.10 0.04 5.40 0.28 0.03 0.05 0.13 0.45 0.05 0.01 0.12
Market N LFO PIN NONSYNC LDO LogMV LogBM PQSPR TURNOVER STDRET LEVERAGE ROE RET12 ADR
Panel C: The average value of rm characteristics for each developed market
Australia 157 0.24 0.31 2.74 0.13 3.76 0.41 0.04 0.04 0.18 0.22 0.26 0.01 0.01
Austria 26 0.38 0.29 1.19 0.20 6.26 0.26 0.01 0.02 0.12 0.56 0.07 0.02 0.06
Belgium 50 0.38 0.40 2.85 0.13 5.06 0.21 0.03 0.01 0.10 0.52 0.06 0.01 0.02
Canada 146 0.27 0.24 2.08 0.09 5.55 0.43 0.02 0.05 0.18 0.44 0.01 0.05 0.32
Denmark 38 0.22 0.29 2.41 0.15 5.41 0.19 0.03 0.04 0.13 0.63 0.11 0.01 0.08
Finland 21 0.24 0.33 3.13 0.13 5.74 0.56 0.02 0.04 0.09 0.41 0.12 0.02 0.10
France 196 0.26 0.32 2.53 0.25 5.46 0.42 0.03 0.05 0.15 0.69 0.02 0.00 0.10
Germany 138 0.35 0.25 2.96 0.18 4.61 0.01 0.05 0.01 0.19 0.47 0.07 0.02 0.05
Hong Kong 110 0.36 0.30 2.00 0.17 5.22 0.12 0.03 0.05 0.13 0.25 0.02 0.01 0.05
Ireland 24 0.22 0.32 3.06 0.13 5.28 0.37 0.05 0.04 0.16 0.48 0.03 0.02 0.13
Italy 59 0.35 0.22 1.57 0.17 6.06 0.10 0.01 0.06 0.12 1.09 0.00 0.00 0.07
Japan 163 0.22 0.23 2.05 0.10 5.21 0.07 0.01 0.05 0.12 0.38 0.05 0.01 0.02
Netherlands 57 0.21 0.31 2.51 0.14 5.56 0.24 0.03 0.05 0.12 0.45 0.02 0.01 0.16
New Zealand 30 0.26 0.25 1.94 0.10 5.16 0.45 0.02 0.03 0.10 0.66 0.10 0.02 0.03
Norway 38 0.23 0.29 2.13 0.16 5.44 0.17 0.02 0.15 0.16 0.74 0.08 0.01 0.05
Singapore 61 0.37 0.32 1.95 0.13 4.75 0.16 0.03 0.06 0.12 0.26 0.07 0.01 0.00
Spain 65 0.22 0.19 2.14 0.19 6.97 0.63 0.01 0.05 0.10 0.79 0.08 0.01 0.07
Sweden 52 0.20 0.24 1.84 0.10 5.45 0.48 0.02 0.09 0.21 0.48 0.10 0.00 0.08
Switzerland 74 0.25 0.29 2.33 0.17 6.02 0.36 0.02 0.04 0.14 0.50 0.05 0.01 0.05
United Kingdom 256 0.19 0.23 2.82 0.09 5.35 0.50 0.05 0.08 0.14 0.43 0.01 0.00 0.09
United States 460 0.21 0.19 3.26 0.10 4.73 0.61 0.02 0.12 0.25 0.62 0.12 0.01 1.00
Average 106 0.27 0.28 2.36 0.14 5.38 0.30 0.03 0.05 0.14 0.53 0.01 0.00 0.12
Panel D: The average value of rm characteristics for each emerging market
Argentina 29 0.51 0.30 1.50 0.12 5.04 0.42 0.02 0.12 0.29 0.47 0.00 0.02 0.24
Brazil 44 0.57 0.32 0.84 0.10 5.10 0.18 0.07 0.02 0.19 0.68 0.12 0.02 0.16
Chile 50 0.39 0.42 1.48 0.17 5.44 0.06 0.06 0.01 0.09 0.43 0.10 0.01 0.27
China 36 0.21 0.20 2.07 0.25 5.14 0.91 0.00 0.07 0.10 0.15 0.03 0.02 0.00
Greece 38 0.29 0.19 0.50 0.22 5.26 0.35 0.01 0.04 0.12 0.41 0.09 0.03 0.03
India 108 0.40 0.25 1.51 0.07 4.86 0.51 0.01 0.03 0.13 0.46 0.20 0.02 0.04
Indonesia 83 0.36 0.40 1.96 0.18 3.62 0.03 0.06 0.04 0.25 0.67 0.07 0.07 0.02
Israel 33 0.25 0.32 1.92 0.13 5.13 0.57 0.04 0.05 0.17 0.43 0.02 0.03 0.39
Korea 88 0.22 0.19 0.57 0.11 4.70 0.40 0.01 0.24 0.20 0.57 0.06 0.01 0.02
Malaysia 93 0.30 0.32 1.58 0.14 4.49 0.06 0.02 0.02 0.09 0.24 0.05 0.00 0.00
Mexico 24 0.30 0.31 0.77 0.27 6.28 0.06 0.03 0.02 0.11 0.52 0.08 0.00 0.35
Philippines 54 0.39 0.40 2.28 0.11 3.26 0.43 0.10 0.04 0.16 0.44 0.01 0.01 0.00
Poland 39 0.53 0.24 1.32 0.10 5.15 0.22 0.03 0.02 0.14 0.54 0.03 0.00 0.00
Portugal 21 0.35 0.35 2.29 0.22 4.78 0.02 0.14 0.01 0.13 1.85 0.02 0.02 0.05
Russian 8 0.25 0.18 2.92 0.23 6.34 0.30 0.00 0.00 0.15 0.27 0.19 0.01 0.25
South Africa 54 0.32 0.34 1.54 0.15 5.13 0.06 0.04 0.03 0.14 0.47 0.10 0.05 0.07
Taiwan 38 0.21 0.29 0.83 0.10 6.23 0.19 0.01 0.20 0.17 0.21 0.11 0.02 0.05
Thailand 97 0.30 0.34 2.89 0.12 4.18 0.08 0.03 0.01 0.12 0.41 0.14 0.03 0.00
Turkey 31 0.54 0.19 0.19 0.10 4.32 0.06 0.01 0.25 0.23 0.22 0.13 0.00 0.00
Average 51 0.35 0.29 1.50 0.15 4.97 0.13 0.04 0.06 0.16 0.50 0.08 0.00 0.10
Price informativeness
m; i
a
0
a
1
LFO
m; i
a
2
LDO
m; i

X
j
b
j
Firm control
j
m; i
X
k
g
k
Market control
k
m

m; i
: (6)
Price informativeness is measured by either PIN or NONSYNC. To isolate the effect of LFO from its
domestic counterparty, we control for the effect of the holding of the largest domestic shareholder
(LDO). We also include the lagged value of price informativeness proxy to control for its persistence. We
further control various rm-level and market-level variables which are expected to relate to both the
proxies of price informativeness and the investment preference of large foreign shareholders, as dis-
cussed in the above section. To minimize the potential endogeneity issue, the dependent variable is
constructed based on data in 2003 which is one-year ahead of the period, 2002, used to construct all
independent variables.
Tables 2 and 3 present the regression results using PIN and NONSYNC as the dependent variable
respectively. We consider various model specications to test the relation between LFO and price
informativeness proxies: model (1) tests the bivariate relation without including control variables;
models (2)(4) sequentially control the holdings of the largest domestic shareholders, the lagged
value of price informativeness proxy, and other rm-specic variables; and nally model (5) con-
trols both rm-level and market-level variables. The sample size varies with the addition of control
variables. The t-statistics (reported in parentheses) are computed based on robust standard errors
clustered by market. Our discussion focuses on the results using PIN as the dependent variable
(Table 2), while the key results are qualitatively similar if NONSYNC is used as the dependent
variable.
The results in Table 2 show that the coefcient of LFO is positive and signicant across all model
specications. Along with country-xed effects, LFO explains about 20% of the cross-sectional variation
Table 2
Relation between LFO and PIN. This table presents the results of the regression specied in the following equation,
PIN
m; i
a
0
a
1
LFO
m; i
a
2
LDO
m; i
a
3
PIN L1
m; i
a
4
LOGMV
m; i
a
5
LOGBM
m; i
a
6
PQSPR
m; i
a
7
TURNOVER
m; i
a
8
STDRET
m; i
a
9
LEVERAGE
m; i
a
10
ROE
m; i
a
11
RET12
m; i
a
12
ADR
m; i
b
1
LOGGDPPC
m
b
2
MVGDP
m
b
3
PCRGDP
m
b
4
GDPGR
m
b
5
STDGDPGR
m
b
6
STDMRET
m

k; i
For each explanatory variable, we report its regression coefcient and the robust t-statistic (in parentheses) calculated from the
standard error with the market clustering. All variables are dened in the Appendix.
Variable (1) (2) (3) (4) (5)
INTERCEPT 0.184 (19.61) 0.374 (23.22) 0.363 (22.31) 0.279 (12.33) 0.447 (8.82)
LFO 0.066 (4.79) 0.044 (3.13) 0.068 (4.38) 0.058 (3.58) 0.045 (2.78)
LDO 0.056 (3.51) 0.043 (2.61) 0.047 (2.70)
PIN_L1 0.241 (5.94) 0.306 (7.72)
LOGMV 0.025 (11.70) 0.026 (11.77) 0.020 (8.64) 0.019 (8.31)
LOGBM 0.002 (0.43) 0.002 (0.44) 0.005 (1.42) 0.002 (0.53)
PQSPR 0.433 (2.79) 0.401 (2.60) 0.184 (1.25) 0.233 (1.69)
TURNOVER 0.018 (0.69) 0.029 (1.12) 0.024 (1.18) 0.008 (0.34)
STDRET 0.120 (3.49) 0.117 (3.39) 0.100 (2.84) 0.109 (3.12)
LEVERAGE 0.002 (0.51) 0.002 (0.61) 0.002 (0.78) 0.001 (0.33)
ROE 0.018 (1.75) 0.018 (1.68) 0.007 (0.74) 0.005 (0.59)
RET12 0.092 (1.35) 0.081 (1.22) 0.018 (0.28) 0.051 (0.79)
ADR 0.037 (4.37) 0.035 (4.14) 0.026 (3.10) 0.011 (1.62)
LOGGDPPC 0.007 (1.58)
MVGDP 0.005 (1.70)
PCRGDP 0.037 (4.97)
GDPGR 0.900 (4.42)
STDGDPGR 0.543 (3.17)
STDMRET 0.276 (5.44)
Country dummy Yes Yes Yes Yes No
Nobs 2170 1848 1848 1744 1744
Adj-Rsq 19.76% 38.92% 39.35% 44.27% 39.13%
in PIN. After controlling various rm-level determinants of PIN, the coefcient on LFO remains
signicantly positive. For example, the coefcient of LFO in model (4) is 0.043, which is statistically
signicant at 1% level. In model (5), we further replace the country-xed effects with country char-
acteristics and nd similar results.
The coefcient of LFOis also economically signicant given the sample distribution of LFO. When LFO
increases from its 25 percentile (9%) to 75 percentile (45%) values, everything else equal, PIN would
increase by 1.52.3 percentage points, depending on the model specication. This suggests that relative
torms with9%LFO, rms with45%LFOhave about 2%moreof all trades initiatedfrominformedtraders.
To put this effect in comparison, we do a similar calculation for all other rmcharacteristics included in
our regressions, based on the quartile values reported in Panel A, Table 1 and the estimated regression
coefcients in Table 2. For other rm characteristics except for rm size (LOGMV), an inter-quartile
change is typically associated with a marginal change in PIN around 1% or even less. This comparison
suggests that, althoughthe effect of LFOappears small, LFOis a keydeterminant of price informativeness.
Turning to control variables, PIN seems to vary signicantly with some rm characteristics. PIN is
very persistent, as indicated by the signicant coefcient on the lagged value of PIN. LDO is also
positively related to PIN, suggesting that large domestic shareholders also help improve price infor-
mativeness. Further, PIN is higher in stocks that are smaller in size, more illiquid, and less volatile in
returns, consistent with ndings in Aslan et al. (2011). Finally, PIN also varies systematically with some
market-level characteristics. PIN is lower in markets with a more developed private nancial system, a
higher GDP growth rate and more volatile stock market returns.
Table 3 reports regression results using NONSYNC as the dependent variable. The coefcient on LFO
is positive and statistically signicant across all model specications. After calculating the economic
signicance of the coefcients, we nd LFO has larger impact on NONSYNC than most rm charac-
teristics except for rm size. For control variables, NONSYNC is lower in rms with low LDO, a bigger
market capitalization, a higher book-to-market ratio, and higher bid-ask spreads. Further, the
Table 3
Relation between LFO and NONSYNC. This table presents the results of the regression specied in the following equation,
NONSYNC
m; i
a
0
a
1
LFO
m; i
a
2
LDO
m; i
a
3
NONSYNC L1
m; i
a
4
LOGMV
m; i
a
5
LOGBM
m; i
a
6
PQSPR
m; i
a
7
TURNOVER
m; i
a
8
STDRET
m; i
a
9
LEVERAGE
m; i
a
10
ROE
m; i
a
11
RET12
m; i
a
12
ADR
m; i
b
1
LOGGDPPC
m
b
2
MVGDP
m
b
3
PCRGDP
m
b
4
GDPGR
m
b
5
STDGDPGR
m
b
6
STDMRET
m

k; i
Variable (1) (2) (3) (4) (5)
INTERCEPT 3.047 (29.75) 4.467 (21.96) 4.364 (21.31) 3.434 (16.68) 1.484 (3.33)
LFO 0.520 (4.75) 0.340 (2.82) 0.547 (3.86) 0.426 (3.12) 0.323 (2.40)
LDO 0.480 (2.96) 0.295 (1.90) 0.342 (2.24)
NONSYNC_L1 0.256 (9.54) 0.309 (12.09)
LOGMV 0.357 (17.87) 0.358 (17.99) 0.281 (14.16) 0.260 (13.37)
LOGBM 0.089 (2.45) 0.088 (2.46) 0.087 (2.55) 0.134 (3.87)
PQSPR 3.618 (3.60) 3.340 (3.35) 1.866 (1.99) 2.500 (2.75)
TURNOVER 0.299 (1.07) 0.207 (0.74) 0.026 (0.12) 0.191 (0.78)
STDRET 0.133 (0.42) 0.105 (0.33) 0.171 (0.56) 0.035 (0.12)
LEVERAGE 0.026 (0.84) 0.023 (0.74) 0.036 (1.29) 0.025 (0.82)
ROE 0.212 (2.17) 0.204 (2.10) 0.165 (1.80) 0.175 (1.90)
RET12 1.179 (1.66) 1.088 (1.56) 0.195 (0.30) 0.290 (0.46)
ADR 0.075 (0.72) 0.059 (0.56) 0.065 (0.69) 0.023 (0.26)
LOGGDPPC 0.118 (2.83)
MVGDP 0.004 (0.13)
PCRGDP 0.291 (3.65)
GDPGR 2.820 (1.43)
STDGDPGR 10.140 (6.63)
STDMRET 0.267 (0.44)
Country dummy Yes Yes Yes Yes No
Nobs 3189 1849 1849 1849 1849
Adj-Rsq 19.90% 44.03% 44.28% 48.92% 44.85%
estimated coefcients on both ownership variables, 0.426 for LFO and 0.295 for LDO, are comparable in
the scale to that on the ownership variable reported in Fernandes and Ferreira (2008).
14
Overall, the results reveal a positive relationship between LFO and measures of price informative-
ness, consistent with our hypothesis that large foreign shareholders improve the informativeness of
stock prices. However, this relationship might be spurious if some rmcharacteristics are omitted from
in the regression but are related to both LFO and the degree of price informativeness. One possibly
omitted variable is earnings quality, because higher quality of earnings could be associated with both
larger shareholders and more informative prices. We use three measures of earnings quality as sug-
gested by Leuz et al. (2003): the magnitude of accruals (ACCRUAL), earnings smoothing (SMOOTH), and
earnings correlation (CORR). ACCRUAL is widely used in the accounting literature to measure the degree
of earnings management. SMOOTH measures the extent to which reported earnings are smoothed
across scal years to reduce the variability of earnings. And CORR measures the correlation between
changes in accruals and changes in operating cash ows, and thus the lower the correlation, the more
likely it is that accruals are manipulated to conceal economic shocks to a rms operating cash ows.
Thus earnings quality decreases in ACCRUAL and SMOOTH, and increases in CORR. The construction of
these variables is detailed in the Appendix. When we include these measures of earnings quality into
regressions, we nd that the coefcient of LFOremains almost unchanged and statistically signicant in
all model specications except one in which NONSYNC is used as the dependent variable and ACCRUAL
is used as the proxy for earnings quality. We conclude that the positive relation between LFO and price
informativeness is robust to the control of earnings quality.
3.2. LFO and the association between stock returns and earnings innovations
At this point our empirical analyses nd a positive relation between LFO and two proxies of price
informativeness: PIN and NONSYNC. Though both measures have been shown theoretically and
empirically in previous studies to capture the extent to which stock prices incorporate value-relevant
information, it is possible that they rely on some impractical assumptions and serve as very noisy
proxies of price informativeness. In this section, we employ a more direct, albeit more narrow, measure
of price informativeness the extent to which earnings information is reected in stock prices, and test
its relation to LFO. Prior studies have shown that stock prices contain information about future earnings
(Ayers and Freeman, 2003; Durnev et al., 2004). If LFO is positively related to the extent to which stock
prices incorporate relevant information, including earnings information, we would expect this alter-
native price informativeness measure to increase in LFO.
15
We run the following regression to test whether stock prices of rms with higher LFO contain more
information about contemporaneous and future earnings innovations,
R
i
a
0
a
1
DE
i
a
2
DE1
i
b
1
DE
i
LFO
i
b
2
DE1
i
LFO
i
a
3
LFO
i
a
4
DE
i
LDO
i
a
5
DE1
i
LDO
i
a
6
LDO
i
a
7
DE
i
LOGMV
i
a
8
DE1
i
LOGMV
i
a
9
LOGMV
i
X
m
g
m
Market dummy
m
i

i
;
(7) where R is the annual stock return in 2003, DE and DE1 are the annual changes in earnings in 2003 and
2004 scaled by the market capitalization at the beginning of each year respectively, and other variables
are dened in section II and measured in 2002. We expect the coefcients of DE and DE1 to be positive,
suggesting prices contain information about current and future earnings (Ayers and Freeman, 2003). If
LFO is positively associated with the pricing of earnings information, we would expect the coefcients
14
When regressing NONSYNC on OWNERSHIP, which is the percentage of closely held shares, Fernandes and Ferreira (2008)
found a coefcient of 0.007 for developed markets and 0.004 for emerging markets (columns (3) and (7) in their Table 7, page
235) based on a sample of international stocks. Please note that they measured OWNERSHIP in percentage.
15
As will be introduced shortly, empirically we measure the informativeness of stock prices about earnings by the association
between stock returns and earnings innovations. We also use the term pricing of earnings information in later discussions to
refer to this measure, in the sense that the association measures the extent to which earnings information is incorporated in
stock prices.
on the interaction terms of LFO and earnings changes to be signicantly positive. We control for the
effect of LDO and rm size, as well as country-xed effect.
Table 4 presents the regression results. Column 1 conrms that contemporaneous and future
earnings innovations are positively associated with stock returns, validating the use of the return-
earnings association to examine the informativeness of stock prices. More importantly, the result in
Column 2 shows a signicantly positive coefcient on the interaction terms of LFO and earnings
changes, suggesting that stock prices of rms with a higher LFO contain more information about
current and future earnings innovations. The adjusted R-square also increases from 9.1% to 9.8% by
adding the two interaction terms. In Columns 3 to 5, we progressively add controls for LDO and rm
size. The coefcients for the interaction term between LFO and earnings changes remain statistically
signicant. These results suggest that LFO is positively associated with the extent to which stock
returns reect earnings information. This evidence corroborates the ndings in the regressions with
PIN and NONSYNC as the proxies of price informativeness.
3.3. Does large foreign shareholders contribute to the informativeness of stock prices?
Our empirical analyses so far indicate a positive relation between LFO and the informativeness of
stock prices, after controlling for various rm-level and market-level variables. We interpret our
ndings as consistent with the view that large foreign shareholders contribute to the price discovery
and the informativeness of stock prices. However, we are aware of two potential issues with the above
interpretation.
The rst issue is the possible spurious relation between LFO and price informativeness. It could be
the case that both LFO and price informativeness are driven by unknown rmcharacteristics which are
not controlled in our analyses. We think it unlikely though we cannot totally rule out this possibility.
We measure price informativeness using data in 2003, one-year ahead of the period used to construct
LFO, and include the lagged value of the dependent variable as a regressor. If LFO in 2002 and price
informativeness measure in 2003 are correlated due to the unobserved rmnature and the persistence
in price informativeness measure, we would expect this relation to be trivial once the lagged price
informativeness measure is controlled. Our regression results indicate a signicant relation between
LFO in 2002 and price informativeness measures in 2003, even after controlling for the contempora-
neous relation between LFO and price informativeness.
The second concern with our interpretation is the potential reverse causality. The positive relation
between LFO and price informativeness could be due to large foreign shareholders preference for
Table 4
Relation between LFO and the association between stock returns and earnings innovations. This table presents the results of the
regression specied in the following equation,
R
i
a
0
a
1
DE
i
a
2
DE1
i
b
1
DE
i
LFO
i
b
2
DE1
i
LFO
i
a
3
LFO
i
a
4
DE
i
LDO
i
a
5
DE1
i
LDO
i
a
6
LDO
i
a
7
DE
i
LOGMV
i
a
8
DE1
i
LOGMV
i
a
9
LOGMV
i

X
m
g
m
Market dummy
m
i

i
Variable (1) (2) (3) (4) (5)
DE 0.720 (7.46) 0.361 (2.39) 0.308 (1.06) 0.205 (1.10) 0.092 (0.28)
DE1 0.541 (5.51) 0.303 (1.99) 0.111 (0.40) 0.264 (1.35) 0.204 (0.64)
DE*LFO 1.395 (3.09) 1.435 (3.17) 1.615 (3.38) 1.690 (3.51)
DE1*LFO 0.951 (2.05) 0.935 (2.02) 1.008 (2.02) 1.049 (2.09)
LFO 0.004 (0.07) 0.009 (0.15) 0.039 (0.57) 0.025 (0.36)
DE*LDO 0.876 (1.42) 0.982 (1.58)
DE1*LDO 0.183 (0.30) 0.346 (0.56)
LDO 0.108 (1.27) 0.082 (0.96)
DE*LOGMV 0.011 (0.23) 0.019 (0.39)
DE1*LOGMV 0.089 (1.85) 0.093 (1.92)
LOGMV 0.017 (2.45) 0.017 (2.43)
Country dummy Yes Yes Yes Yes Yes
Nobs 1609 1609 1609 1609 1609
Adj-Rsq 9.10% 9.80% 10.30% 10.15% 10.58%
stocks with more informative prices. While this reverse causality is quite possible, we believe it un-
likely to drive our results and thus invalidate our inferences, based on both empirical evidence and
theoretical arguments.
First, a common approach to inferring causality is to run a Granger causality test using the difference
of variables. Due to the availability of only one-year of LFO data, we are unable to run a formal Granger
causality test. However, as emphasized above, we run a predictive regression of the price informa-
tiveness measure in 2003 on LFO in 2002, controlling for the lagged dependent variable. To some
extent, it is similar to the spirit of a simple Granger causality test based on a vector auto-regression
including only one lag of the variables, i.e., VAR(1) model.
16
We nd a signicant coefcient on LFO
in our predictive regression after controlling the lag of dependent variable, which seems to be
consistent with LFO Granger-causing price informativeness.
Second, for the reverse causality to drive our results, it must be that large foreign shareholders base
their investment decision on their expectation of the future price informativeness which is not related
to the current price informativeness. Though conceptually possible, this reverse causality due to
forward-looking has not been established in any theoretical or empirical work according to the best of
our knowledge. Instead, our ndings seem to be consistent with a signicant body of literature on the
roles played by large shareholders and foreign investors in improving governance and price discovery,
as we discussed in Section 1.
Finally, in the cross-market analysis to be presented in Section 3.4, we nd that LFO is more
signicantly related to price informativeness in markets with a more developed economy, better
investor protection, and a more transparent information environment. If our results were driven by a
reverse causality from price informativeness to LFO, it would be difcult to explain why price infor-
mativeness is less attractive to foreign investors in markets with worse investor protection and a
poorer information environment. In these markets where information is lacking, stocks with infor-
mative prices should be more attractive to investors who base their investment decision on price
informativeness, compared to those markets where information is abundant. On the contrary, as we
will discuss in detail in Section 3.4, if large foreign shareholders indeed help improve price informa-
tiveness, better investor protection and a more transparent information environment at the market
level could facilitate this informational role of large foreign shareholders, which could explain the
cross-market differences in our ndings.
To summarize, we interpret our results as consistent with large foreign shareholders improving price
informativeness. Though a reverse causality is completely possible, it is less likely to drive our results
basedontheabove discussions. Nevertheless, duetotheempirical difcultyof establishinga causeeffect
relation, we are still open to alternative explanations and call for cautions in interpreting our results.
3.4. Macro governance forces and the relation between LFO and price informativeness
Based on a large cross-section of rms in 40 markets, we nd a positive relation between LFO and
price informativeness. Our results suggest that large foreign shareholders play an important information
role in local equity markets by improving the informativeness of stock prices. We now proceed to
examine whether this information role of large foreign shareholders vary across countries in a sys-
tematic way. Specically, we examine whether country-level economic development, investor protec-
tion and information quality affect the association between LFO and price informativeness. The results
from this analysis should sharpen our understanding of the informational role of foreign investors.
We rst investigate the effect of economic development on the relation between LFO and price
informativeness. According to the classication by the International Financial Corporation of the World
Bank Group, we divide our sample into developed-market and emerging-market sub-samples. There
16
The equation in a bivariate VAR(1) model, Dy
t1
c aDy
t
bDx
t

t1
, could be expressed as follows after re-arranging
variables: y
t1
c (a 1)y
t
ay
t1
bx
t
bx
t1

t1
. The two variables, y and x here, correspond to price informativeness
and LFO in our analyses respectively. Thus our regression model parallels VAR(1) model in a simple Granger causality test, in the
sense of an unrestricted model without including the 2nd lag of the dependent and the independent variables. We conrm that
including the 2nd lag of the dependent variable price informativeness measures in 2001 does not alter our results.
are signicant differences between these two sub-samples in terms of economic growth, development
and openness of nancial markets, and presence of foreign investors. We run the regression of price
informativeness on LFO, as specied in Equation (6), for both sub-samples and report the results in
Table 5. To save space, we only report the coefcients of LFO and LDO, although all the control variables
are included in regressions. The results show that LFO is more related to price informativeness mea-
sures in developed markets than in developing markets. For example, in the regression with PIN as the
dependent variable, the coefcient on LFO is 0.060 (t-statistic 2.90) in the developed-market sample,
while the same coefcient becomes 0.028 and insignicant (t-statistic 1.01) in the emerging-market
sample.
17
When NONSYNC is used as the dependent variable, the coefcient on LFO is also larger in the
developed-market sample, though the difference between the two samples is smaller.
We next investigate the effect of country-level governance forces such as investor protection and
information transparency. We consider two measures of the market-level investor protection regime:
the legal origin and the anti-self-dealing index. There is evidence that markets with common law
provide better protection for investor rights (La Porta et al., 1998). The anti-self-dealing index is
developed by Djankov et al. (2008) and focuses on a markets litigation governing self-dealing trans-
actions. The higher the value of the anti-self-dealing index, the better the protection of shareholders
interests. Two sub-samples are formed based on whether a markets legal system is common civil law
origins and whether its anti-self-dealing index is above the medium value of the index across all
markets in the sample. We run the same regression as specied in Equation (6) for both sub-samples
and report the coefcients of LFO and LDO in Table 6. The results show that LFO is more related to both
proxies of price informativeness in markets with the common law legal origin compared to markets
with the civil lawlegal origin. When we measure investor protection by the anti-self-dealing index, we
nd LFO is more related with PIN in high-index markets than in low-index markets.
Turning to information quality, we consider two market-level proxies: the disclosure score and the
nancial transparency index. The disclosure score is based on survey results about the level and
availability of nancial disclosures and is reported in the annual Global Competitiveness Report issued
by the World Economic Forum. Following Gelos and Wei (2005), we average the disclosure scores of
1999 and 2000 and then divide the average score by 10 to obtain a range from 0 to 1. The nancial
transparency index is developed by Bushman et al. (2004) and measures the intensity and timeliness of
nancial disclosures by rms. For both the disclosure score and the nancial transparency index, a
higher value means better disclosure and a more transparent information environment. We then
divide markets into two groups based on the median value of either the disclosure score or the nancial
Table 5
Relation between LFO and price informativeness: Developed versus emerging markets. This table presents the results of the
m;i
a
0
a
1
LFO
m; i
a
2
LDO
m; i
a
3
Price informativeness L1
m; i
a
4
LOGMV
m; i
a
5
LOGBM
m; i
a
6
PQSPR
m; i
a
7
TURNOVER
m; i
a
8
STDRET
m; i
a
9
LEVERAGE
m; i
a
10
ROE
m; i
a
11
RET12
m; i
a
12
ADR
m; i
b
1
LOGGDPPC
m
b
2
MVGDP
m
b
3
PCRGDP
m
b
4
GDPGR
m
b
5
STDGDPGR
m
b
6
STDMRET
m

k; i
The price informativeness is measured as either PIN or NONSYNC. The regression is run separately for developed-market and
emerging-market sub-samples. For the main variables of interests, we report their regression coefcients and the robust t-
statistics (in parentheses) calculated from the standard errors with the market clustering. All variables are dened in the
Appendix.
Variable Dep. Var. PIN Dep. Var. NONSYNC
(1) Developed markets (2) Emerging markets (3) Developed markets (4) Emerging markets
LFO 0.060 (2.90) 0.028 (1.01) 0.462 (2.72) 0.424 (1.93)
LDO 0.042 (2.26) 0.069 (1.67) 0.307 (1.68) 0.454 (1.58)
Nobs 1219 525 1303 546
Adj-Rsq 42.66% 34.76% 42.94% 39.16%
17
We test the signicance of the difference by running a pool regression in which interaction terms between developed
market dummy and rm characteristics are added. The coefcient on the interaction between LFO and developed market
dummy is positive and signicant.
transparency index, and run the same regression in Equation (6) for each sub-sample. Table 7 reports
the coefcients of LFO and LDO. Results show that the relation between LFO and price informativeness
is stronger in markets with a high disclosure score or a high nancial transparency index, regardless of
whether PIN or NONSYNC is used to proxy for price informativeness.
Finally, to corroborate the above ndings in our cross-market analyses, we study how the effect of
LFO on the earningsreturns relation varies systematically across markets with different macro
Table 6
Market-level investor protection and the relation between LFO and price informativeness. This table presents the results of the
m; i
a
0
a
1
LFO
m; i
a
2
LDO
m; i
a
3
m; i
a
4
LOGMV
m; i
a
5
LOGBM
m; i
a
6
PQSPR
m; i
a
7
TURNOVER
m; i
a
8
STDRET
m; i
a
9
LEVERAGE
m; i
a
10
ROE
m; i
a
11
RET12
m; i
a
12
ADR
m; i
b
1
LOGGDPPC
m
b
2
MVGDP
m
b
3
PCRGDP
m
b
4
GDPGR
m
b
5
STDGDPGR
m
b
6
STDMRET
m

k; i
The price informativeness is measured as either PIN or NONSYNC. The sample is split into two sub-samples based on whether a
markets legal system originates from common law or civil law and whether its anti-self-dealing index is above the medium
value of the index across all markets in the sample. The regression is run separately for two sub-samples. For the main variables
of interests, we report their regression coefcients and the robust t-statistics (in parentheses) calculated fromthe standard errors
with the market clustering. All variables are dened in the Appendix.
Variable Legal origin Anti-self-dealing index
Common law Civil law High Low
Panel A: Dependent variable PIN
LFO 0.064 (2.48) 0.044 (2.52) 0.069 (3.94) 0.036 (1.18)
LDO 0.045 (1.79) 0.063 (2.77) 0.080 (3.33) 0.022 (0.87)
Nobs 894 850 1120 624
Adj-Rsq 35.71% 49.02% 47.91% 32.11%
Panel B: Dependent variable NONSYNC
LFO 0.517 (2.93) 0.140 (0.64) 0.274 (1.57) 0.395 (1.83)
LDO 0.393 (1.95) 0.300 (1.23) 0.421 (2.01) 0.157 (0.65)
Nobs 978 871 1159 690
Adj-Rsq 47.30% 43.34% 44.28% 47.75%
Table 7
Market-level information transparency and the relation between LFO and price informativeness. This table presents the results of
the regression specied in the following equation,
m; i
a
0
a
1
LFO
m; i
a
2
LDO
m; i
a
3
m; i
a
4
LOGMV
m; i
a
5
LOGBM
m; i
a
6
PQSPR
m; i
a
7
TURNOVER
m; i
a
8
STDRET
m; i
a
9
LEVERAGE
m; i
a
10
ROE
m; i
a
11
RET12
m; i
a
12
ADR
m; i
b
1
LOGGDPPC
m
b
2
MVGDP
m
b
3
PCRGDP
m
b
4
GDPGR
m
b
5
STDGDPGR
m
b
6
STDMRET
m

k; i
The price informativeness is measured as either PIN or NONSYNC. The sample is split into two sub-samples based on whether a
markets disclosure score or nancial transparency index is above the medium value of the variable across all markets in the
sample. The regression is run separately for two sub-samples. For the main variables of interests, we report their regression
coefcients and the robust t-statistics (in parentheses) calculated from the standard errors with the market clustering. All
variables are dened in the Appendix.
Variable Disclosure score Financial transparency
High Low High Low
Panel A: Dependent variable PIN
LFO 0.082 (3.65) 0.004 (0.18) 0.052 (2.43) 0.047 (1.85)
LDO 0.064 (2.94) 0.018 (0.69) 0.033 (1.70) 0.085 (2.28)
Nobs 1118 626 1161 583
Adj-Rsq 42.77% 38.01% 42.96% 34.63%
Panel B: Dependent variable NONSYNC
LFO 0.513 (2.95) 0.358 (1.76) 0.423 (2.42) 0.363 (1.78)
LDO 0.379 (2.00) 0.402 (1.59) 0.271 (1.45) 0.304 (1.16)
Nobs 1197 652 1244 605
Adj-Rsq 43.68% 39.66% 43.45% 37.14%
governance regimes. We classify markets into two groups along the same dimensions as above, and
estimate separately for each sub-sample the regression of stock returns on earnings innovations and
their interactions with rm characteristics, including LFO, as specied in Equation (7). Table 8 reports
the coefcients of the interaction terms between LFO and current and future earnings changes. The
results indicate that stock prices of rms with a higher LFO are more informative about contempo-
raneous and future earnings innovations in developed markets and markets with the common law
legal origin, a high anti-self-dealing index, a high disclosure score and a high nancial transparency
index. The coefcients on the interactions between LFO and earnings innovations are consistently
positive and statistically signicant in almost all these markets. In contrast, none of the interaction
terms is signicant in emerging markets and markets with a civil law legal origin, a low anti-self-
dealing index, a low disclosure score and a low nancial transparency index.
To summarize, we nd the association between LFO and price informativeness is stronger in
markets with better investor protection and a more transparent informational environment. The re-
sults suggest that large foreign shareholders play a more important informational role in markets with
better investor protection and a more transparent information environment. Our ndings highlight the
importance of macro governance forces in facilitating the information role of large foreign share-
holders. This is consistent with the nding in Doidge et al. (2007) that observable rm characteristics
explain much less of the variation in rms governance ratings than market characteristics, and have
little explanatory power in less developed markets. They suggest that market-level and rm-level
governance mechanisms could be complementary in shaping a rms governance outcome. Viewing
the informational role of large foreign shareholders via monitoring and informed trading as a specic
rm-level governance force, we argue that its potential effect on the informativeness of stock prices
also depends on the macro governance forces such as investor protection and transparency, and nd
evidence consistent with this argument.
4. Conclusion
With the increase in cross-border equity investments due to nancial globalization, the economic
roles played by foreign equity investors attract signicant attention from both regulators and aca-
demics. In terms of asset pricing implications, most existing studies focus on the benets of risk-
sharing among investors across borders and the reduction in cost of capital associated with the lift-
ing of the cross-border investment barriers. In this study, we investigate another potential economic
benet of foreign equity investment, the improved informativeness of asset prices, which has not been
Table 8
Market-level governance forces and the relation between LFO and the pricing of earnings information. This table presents the
results of the regression specied in the following equation,
R
i
a
0
a
1
DE
i
a
2
DE1
i
b
1
DE
i
LFO
i
b
2
DE1
i
LFO
i
a
3
LFO
i
a
4
DE
i
LDO
i
a
5
DE1
i
LDO
i
a
6
LDO
i
a
7
DE
i
LOGMV
i
a
8
DE1
i
LOGMV
i
a
9
LOGMV
i

X
m
g
m
Market dummy
m
i

i
The sample is split into two sub-samples according to the following market-level variables: The developed market dummy, the
common law market dummy, the anti-self-dealing index, the disclosure score, and the nancial transparency index. Then the
regression is run separately for two sub-samples. For the main variables of interests, we report their regression coefcients and
the robust t-statistics (in parentheses) calculated fromthe standard errors with the market clustering. All variables are dened in
the Appendix.
Variable Market development Legal origin Anti-self-dealing
index
Disclosure score Financial
transparency
DVP EMG Common
law
Civil law High Low High Low High Low
DE*LFO 1.820
(3.33)
0.735 (0.63) 2.105
(3.39)
0.322
(0.42)
1.820
(3.33)
0.735 (0.63) 2.046
(3.56)
0.164
(0.16)
1.922
(3.43)
0.393
(0.42)
DE1*LFO 1.118
(1.98)
0.023
(0.02)
1.059
(1.59)
1.097
(1.45)
1.118
(1.98)
0.023
(0.02)
1.078
(1.86)
0.264 (0.24) 1.331
(2.18)
0.624
(0.71)
Nobs 1253 356 1029 579 1253 356 1118 491 1283 326
Adj-Rsq 7.26% 24.68% 9.35% 17.71% 7.26% 24.68% 6.78% 21.72% 11.10% 12.41%
sufciently studied in existing literature. Specically, we study the informational role of large foreign
shareholders who are expected to matter most among foreign equity investors.
Using a cross section of 3189 rms from 40 markets in 2002, we nd evidence that rms with a
higher LFO tend to have more informative stock prices, measured by the probability of informed
trading and price non-synchronicity. Further, stock prices of these rms also tend to be more infor-
mative about contemporaneous and future earnings innovations. These results suggest that large
foreign shareholders contribute to the informativeness of stock prices. Using several measures of the
strength of macro governance infrastructure, we nd that LFO seems to matter more in markets with
stronger macro governance forces, such as those with a more developed economy, better investor
protection, and a more transparent information environment. These ndings are consistent with macro
governance forces facilitating the effect of LFO on price informativeness, and echo recent evidence of
the complementarity between market-level and rm-level governance forces in Doidge et al. (2007).
Overall, our ndings shedsome light ontheroles of foreigninvestors inlocal markets andtheeffects of
capital market opening. Wendevidenceconsistent withthepositiveroleof large foreignshareholders in
improving the informativeness of stock prices in local markets. Further, macro governance infrastructure
seems to affect the extent to which large foreign shareholders could play this informational role.
Our study is subject to several limitations. First, price informativeness is unobservable and we have
to make inferences based on some empirical proxies. Both proxies of price informativeness, the prob-
ability of informed trading (PIN) and price non-synchronicity (NONSYNC), have been shown to capture
the information content of prices theoretically and empirically in the previous literature (e.g., Easley
et al., 1997; Morck et al., 2000). We also substantiate the ndings with further evidence based on a
more direct and intuitive measure of price informativeness the extent to which stock returns reect
earnings news. However, we are aware that the validity of inferences that we draw from our results
depends on whether our measures of price informativeness adequately capture the extent to which
information is incorporated into stock prices. We caution readers of this important assumption when
interpreting our results. Second, our inferences are based on the cross-sectional regression results,
which reveal correlations rather than causality. We address the endogeneity issue partially by running
regressions of price informativeness measures in year 2003 on LFO and control variables in year 2002.
Further, our ndings from cross-market analyses are difcult to be explained by the reverse causality.
However, due to data limitations, we are unable to conduct more sophisticated analyses such as Granger
causality test and (semi) natural experiment, to infer the causality more directly. Given these limitations,
we are unable to completely exclude alternative explanations, and we again caution readers of this issue.
Acknowledgments
We acknowledge nancial support from the University of New South Wales. We thank Fariborz
Moshirian, Peter Pham, and Jason Zein for sharing their data. All errors are ours.
Appendix. Variable Denitions
Ownership variables:
LFO: large foreign ownership in 2002, calculated as the sum of foreign block shareholdings, where a
block is dened as a holding larger than or equal to 5% of a rms issued shares.
LDO: the largest domestic ownership in 2002, calculated as the largest shareholdings by domestic
shareholders.
Price informativeness measures:
PIN: the probability of informed trading in 2003, estimated based on the structural model in Easley
et al. (1997).
NONSYNC: the degree of price non-synchronicity in 2003, calculated as the logistic transformation of
(1 R
2
) obtained from the market model of stock returns.
Firm-level earnings quality measures:
ACCRUAL: accruals in 2002 scaled by last years total assets.
SMOOTH: smoothness of reported earnings, calculated as the ratio of the standard deviation of oper-
ating income to the standard deviation of cash ows over the 5-year window from 1998 to 2002.
CORR: correlation coefcient between accruals and operating cash ows over the 5-year window from
1998 to 2002.
Other rm-level variables:
LogMV: the log of the market capitalization measured in US$ at the end of 2002.
LogBM: the log of the ratio of book equity at the end of scal year ending in 2002 to the market
capitalization at the end of 2002.
PQSPR: the average of quoted spreads in 2002.
TURNOVER: the average monthly trading volume in shares divided by the number of shares
outstanding in 2002.
STDRET: the standard deviation of monthly stock returns in 2002/
LEVERAGE: the ratio of long-term debt over the common equity at the end of scal year ending in
2002.
ROE: the return on equity for the scal year ending in 2002.
RET12: the annual stock return in 2002.
ADR: the dummy variable taking value 1 if a rm has an ADR and 0 otherwise at the end of 2002.
R: the annual stock return in 2003.
DE: the changes in earnings from 2002 to 2003, scaled by the market capitalization at the beginning of
2003.
DE1: the changes in earnings from2003 to 2004, scaled by the market capitalization at the beginning of
2004.
Market-level governance measures:
DVP and EMG: dummy variables for developed and emerging markets respectively according to the
classication by the International Financial corporation of the World Bank Group.
Common Law and Civil Law: dummy variables for markets with a common law legal origin and those
with a civil law legal origin.
Anti-self-dealing index: the index measuring a markets litigation governing self-dealing transactions
and developed by Djankov et al. (2008).
Disclosure score: the score measuring the level and availability of nancial disclosures based on survey
results reported in the annual Global Competitiveness Report issued by the World Economic Forum.
Following Gelos and Wei (2005), we average the disclosure scores of 1999 and 2000 and then divide
the average score by 10 to obtain a range from 0 to 1.
Financial transparency index: the index measuring the intensity and timeliness of nancial disclosures
by rms and developed by Bushman et al. (2004).
Other market-level variables:
LogGDPPC: the log of per capita GDP measured in US$ in 2002.
MVGDP: the ratio of stock market capitalization at the end of 2002 to the annual GDP of 2002.
PCRGDP: the ratio of private credit to GDP in 2002 where private credit refers to nancial resources
available to the private sector through loans, purchases of non-equity securities, trade credits and other
accounts receivables.
GDPGR: the annual GDP growth rate in 2002.
STDGDPGR: the standard deviation of annual GDP growth rates over the period 1998 to 2002.
STDMRET: the standard deviation of monthly market returns in 2002.
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