FINANCIAL INSTITUTIONAL INVESTORFIRM SPECIFIC FACTORS & INVESTMENT PREFERENCES IN INDIA

PROJECT REPORT SUBMITTED TO UNIVERSITY OF DELHI IN PARTIAL FULFILMENT OF REQUIREMENT FOR THE AWARD OF DEGREE OF BACHELOR OF BUSINESS STUDIES
BY:

NITESH GOYAL
BBS-3F (B) - 4735 || UNIVERSITY ROLL NO: 70062 UNDER THE GUIDANCE OF:

DR. ROHINI SINGH (MENTOR) SHAHEED SUKHDEV COLLEGE OF BUSINESS STUDIES (UNIVERSITY OF DELHI) NEW DELHI 110092 || APRIL, 2010

E XECUTIVE

S UMMARY

Foreign institutional investors have gained a significant role in Indian capital markets. The Asian Crisis marked a regime shift in the determinants of FII flows to India with some factors occupying a prominent position since the crisis. The flows are correlated with economic variables at both Global and the Country level. However, the effect of various other factors in attracting foreign flows and their intensity is the aspect not studies in literature. It is an attempt to showcase that the availability of foreign capital depends on many other factors other than the countrys economic development alone. The broad objective of the present paper is to gain a better understanding of the nature and determinants of FII flows. The paper analyses the FII investment flows data to bring out the key features of these flows: Firm-level characteristics Shareholding pattern and Company variables that influence Financial Institutional Investors (FII) investment allocations. Steps can be taken at firm-level to create an environment conducive to foreign institutional investment. The results in the paper suggest that the availability of foreign capital depends on factors, particularly the Firm specific factors, other than the countrys economic development alone. After controlling for the country effect, firms with better ownership status, accounting quality, financial records and corporate governance attract more foreign capital. In conclusion the paper suggests that steps can be taken at the firm level to create an environment conducive to foreign portfolio investment. It is observed that foreign investors invested in companies duly considering some important Shareholding and company variables. The Indian Promoters (Government) holdings and the foreign investments are inversely related. Foreign investors tend not to avoid investing in companies where family shareholding of promoters is substantial. It is also observed that Public Shareholding is seen as a positive attraction and FIIs invest in companies with a higher volume of shares owned by the general public. Among the Company Variables (financial performance) the Earning per Share and Debt to Equity are significant factors influencing their investment decision.

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A CKNOWLEDGEMENT
Specialization project demands all the time and mettle of the students and gives an opportunity to get in-depth knowledge in their area of interest. No amount of words written can be sufficient and adequate to acknowledge all the people who have provided me with the inspiration, guidance and help during the preparation of the report. It is a great pleasure to have the opportunity to extend my heart-felt thanks to everybody who helped me in the successful completion of this project. I would like to sincerely acknowledge the guidance and unflinching support provided by Dr. Rohini Singh, my Project Mentor. Throughout the course of project, she has provided very useful insights and given her full cooperation, relentless support and encouragement. A special mention to the Computer and its staff members for providing access to CapitaLine database, SPSS software and a vast variety of journals, books and magazines. Without this repository of knowledge, the project wouldnt have been so close to reality. I am also grateful to Satyam Arora for all the help and support. Last but not the least; I extend a vote of thanks to all others who gave me their invaluable encouragement, support and guidance at various phases of the project. The errors and shortcomings are my sole responsibility.

Nitesh Goyal Roll No. 4735 || University Roll No. 70062 S. S. College of Business Studies

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C ERTIFICATE

OF AUTHENTICITY

I hereby declare that this research paper titled Financial Institutional Investors: Firm Specific Factors & Investment Preference in India prepared under the guidance of Dr. Rohini Singh is an original piece of work. It has not been copied from any source what so ever and has not been submitted earlier to any other institution. All efforts made in this endeavour have been personally made by me and any similarity to any past or present work is purely coincidental.

Place: New Delhi || Date: April, 2010

Nitesh Goyal Shaheed Sukhdev College of Business Studies BBS-3 F B College Roll No. 4735 Examination Roll No. 70062 Contact No. +91-9999 699 917 e-mail: nitesh.nyk@gmail.com

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T ABLE

OF

C ONTENTS
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1. I ntrod uction.................................................................................................................. 2. Literat ure Review........................................................................................................ 3. Theory....................................................................................................................... .....

3. 1. 3. 2. 3. 3. 3. 4.

11 What we know about Int er nat i onal P or tfoli o F lows ? .................................................... 11 F or ei gn Ins t it ut ional Inves t ment in Indi a: An Over vi ew ............................................... 11 2009: F II I nves t ment is incr eas i ng in India..................................................................... 12 D es cr ipt ion of Var iabl es......................................................................................................... 15

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4. Res earch Objectives......................... ............................................................................ 5. Res earch Method ology................................................................................................ .

16 5. 1. S har ehol di ng Patt er n.............................................................................................................. 16 5. 2. Company Var iables .................................................................................................................. 16 5. 3. S el ect ion Of Sa mpl e And S our ces Of Data ...................................................................... 17 5. 4. Ti me S er ies R egr es s ion............................................................................................................. 17 5. 5. Cros s S ect ional Regr es s ion....................................................................................................... 17 5. 6. Panel Dat a Regr es s i on.............................................................................................................. 18 5. 7. Fixed Effect s M odel ................................................................................................................... 5. 8. T est T o D eci de Us e Of Dummy Var iabl es . .............................................................................. 19 5. 9. T est of Mult icolli near it y........................................................................................................... 19 5. 10. Regr es s i on Models ................................................................................................................... 20

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6. Li mit ations of the S tudy...........................................................................................

21 6. 1. Sampl e Dat a .............................................................................................................................. 21 6. 2. Fixed Effect s M odel.................................................................................................................. 21 20 7. 1. S har ehol di ng P att er n Regr es s ion......................................................................................... 7. 2. Company Var iabl es R egr es s ion............................................................................................ 7. 3. S har ehol di ng P att er n Ti me-S er ies Regr ess ion....................................................................
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7. Obs ervations / Key Findi ngs & Analys i s.....................................................................

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7. 4. 7. 5. 7.6. 7. 7. 7. 8. 7.9. 7.10.

Company Var iabl es T i me-S er ies Regr es s ion....................................................................... S har ehol di ng P att er n Cr os s-S ect ional Regr es s ion.............................................................. Company Var iabl es Cr os s-S ect ional Regr es s i on................................................................ S har ehol di ng P att er n Combi ned R egr es s ion........................................................................ Company Var iabl es Combi ned Regr es s i on........................................................................... S har ehol di ng P att er n: Stat ist ical T est ...................................................................................... Company Var iabl es : Stat ist ical T est ......................................................................................... 33 35 36

27 27 28 29 30 30 31

8. Concl us ion....................................................................................................................... 9. One Step Ahead (S cope For Furt her Analys is )......................................................
References.................................................................................................... ....................

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L IST

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T ABLES
20 20 22 23 25 27 27 28 29 30 30 31 32

1. Table 1: Pears on Correl ation (EPS, P/E, Yield)........................................................... 2. Table 2: Regres s ion Models .......................................................................................... 3. Table 3: Des criptive S tatis tics of I ndependent Vari ables ......................................... 4. Table 4: S hareholdi ng Pattern: Regres s i on ................................................................ 5. Table 5: Comp any Vari ab les : Regres s ion .................................................................... 6. Table 6: S hareholdi ng Pattern: Ti me -s eries Regres s ion........................................... 7. Table 7: Comp any Vari ab les : Ti me -s eri es Regres s ion............................................... 8. Table 8: S hareholdi ng Pattern: Cros s -s ectional Regres s ion.................................... 9. Table 9: Comp any Vari ab les : Cros s -s ect ional Regres s ion........................................ 10. Table 10: S hareholdi ng Pattern: Combi ned Regres s ion .......................................... 11. Table 11: Comp any Vari ables : Combi ned Regres s ion .............................................. 12. Table 12: S hareholdi ng Pattern: S tatis tical Tes t..................................................... 13. Table 13: Comp any Vari ables S tatis tical Tes t..........................................................

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1. I NTRODUCTION
Portfolio investment flows from industrial countries have become increasingly important for developing countries in recent ye ars. Countries with higher levels of economic development tend to have more developed capital markets and are believed to have greater ability to obtain foreign capital. Since the beginning of liberalization FII flows to India have steadily grown in importance. Today, India is the second fastest growing economy after China. It has recently seen positive foreign institutional investor (FII) inflows driven by the sound fundamentals and growth opportunities. Countries and firms are interested in attracting foreign capital because it helps to create liquidity for both the firms stock and the stock market in general. This leads to lower cost of capital for the firm and allows firm to compete more effectively in the global market place. This directly benefits the economy and the country. Availability of foreign capital depends on many firm specific factors other than economic development of the country. Contemporary research has investigated only the portfolio preferences of FIIs from the viewpoint of fund management companies. This paper attempts to examine some specific characteristics of the firms included in sensitivity index (Sensex) of Bombay Stock Exchange and their influence in attracting more foreign institutional investment. Positive fundamentals combined with fast growing markets have made India an attractive destination for foreign institutional investors (FIIs). According to analysts, the upward revision of economic growth from 5.8 per cent to 6.1 per cent, better-than-expected performance of companies in the quarter ended-June 30, the proposed new direct taxes code that might lead to savings in the tax payers money, and the trade policy with an ambitious target of US$ 200 billion exports for 2010-11 have all revived the confidence of FIIs investing in India. FIIs have made net investments of US$ 10 billion in the first six months (April to September) of 2009-10. A major portion of these investments have come through the primary market, than through buying via secondary markets. (Source: India Brand Equity Foundation)

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FII i l s i t Indian e ities ha e been steady e e since the ma ets we e opened up to FIIs in 1993. With the e ception of FY99 and FY09, net flows ha e been positi e. FIIs own a dominant 16% of Indian e uities (worth US$147bn) and account for 10 -15% of the e uity volumes. (Source: CLSA Asia-Pacific Markets). Although FIIs pulled out US$ 9.77 billion of the Indian e uity markets during FY09, they have been quick to return in FY10 and within just the first four months they have nearly made up for the e it, reinvesting US$ 8.50 billion or 87% of the amount that they had pulled out in FY09. (Source: CLSA Asia -Pacific Markets)

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2.

L ITERATURE

R EVIEW

The investment and future prospects by Financial Institutional Investors has become a matter of great concern as the Indian equity market is growing. A recent research survey by Japan Bank for international operation (JBIC), shows that in the next 3 years, India will be the third most favoured investment destination for Japanese investors. A Smith Barney (a CITI group Division) study says estimated market value of foreign institutional investment in the top 200 companies in India (including ADRs and GRDs) at current market prices is US$43 billion. This is 18% of the market capitalization of BSE 200. ` Studies show that management run by family group have distinctive role play. Moreover, block shareholders influence the firm performance (Cho & Padmanabhan, 2001). Governance of listed companies plays an important role in foreign intuitional investment decisions. When governments become block share shareholder their objective will be quite different from those of private investors. Agawam, Clapper and Winsock (2005) observed that foreign investors preferred the companies with better corporate governance. Investor protection is poor in case of firms with controlling shareholders who have ability to expropriate assets. The block shareholders affect the value of the firm and influence the private benefits they receive from the firm. Companies with such shareholders will find it expensive to raise external funds. It is also found that when company have management which is dominated by or affiliated to controlling family, investor protection will be relatively weak and it is difficult to determine the degree of separation of management from ownership. Also the firm value is negatively related to board affiliation in family controlled firms. Dahlquist et al. (2003) analysed foreign ownership and firm characteristics for the Swedish market. They found that foreigners have greater presence in large firms, firms paying low dividends and in firms with large cash holdings. They explained that firm size is driven by liquidity. They measured international presence by foreign listings and export sales. They reiterated that foreigners tend to underweight the firms with a dominant owner. Moreover, foreign fund managers have less information about the domestic stocks than the domestic fund managers. Li and Jing-Bon (2004) found that foreign investors tend to avoid stocks with high cross- corporate holdings. They suggested that FII are likely to be efficient processors of public information and are attracted to Japanese firms with low information asymmetry. Morin (2000) explored the influence of French model of shareholding and management on FII. They commented that France has undergone rapid change from a financial network economy to a financial market economy. The new pattern has broken the traditional system of cross holding and facilitated the arrival of FII who bring with them new techniques and demands efficient corporate management. What could be firm level factors that influence foreign capital from an economic standpoint is the question yet to be answered. Efforts have been made by Parana, P.K. to develop a module using random effects to check the effect of various variables on FII flows for year 2002-06. This paper uses a different methodology and data for year 2005-09 to explore deeper into Firm specific variables and the FII flows.

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Outside investors will lower the price they pay if they fear consumption of private benefits of control family. Chloe, Cho, Stutz (2005) found that US (United States) investors do indeed hold fewer shares in firms with ownership structures that are more conducive to expropria tion by controlling insiders. In companies where insiders are dominating information access and availability to the shareholders will be limited. With less information, foreign investors face an adverse selection problem. So they under invest in such stocks. Leas, Nanda and Winsock (2003) further asserted that the information problems cause foreigners to hold fewer assets in firms. Firm level characteristics can be expected to contribute to the information asymmetry problems. Concentrated family control makes it more likely that information is communicated via private channels. Informative Insiders have incentives to hide the benefits from outside investors by providing opaque financial statements and managing earnings. Haw, Hub, Hwang and Wu, (2004) also found that firm level factors cause information asymmetry problems to FII. Their paper found evidence that US investment is lower in firms where managers do not have effective control. Foreign investment in firms that appear to engage in more earnings management is lower in countries with poor information framework. There is a growing literature on the determinants of global investment flows and allocations. Prior research focused on international portfolio flows and examined the relationship between portfolio flows and stock returns. Most of these studies have analysed global and country level factors that influence investment allocations. This paper investigated empirically the firm specific variables, which influence the investment decision of foreign investors.

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3.

T HEORY

3. 1. W HAT WE KNOW ABOUT I NTERNATIONAL P ORTFOL IO F LO WS ? International portfolio flows are, as opposed to foreign direct investment, liquid in nature and are motivated by international portfolio diversification benefits for individual and institutional investors in industrial countries. They are usually undertaken by institutional investors like pension funds and mutual funds. Such flows are, therefore, largely determined by the performance of the stock markets of the host countries relative to world markets. With the opening of stock markets in various emerging economies to foreign investors, investors in industrial countries have increasingly sought to realize the potential for portfolio diversification that these markets present. While the Mexican crisis of 1994, the subsequent Tequila effect, and the widespread Asian crisis have had temporary dampening effects on international portfolio flows, they have failed to counter the long-term momentum of these flows. Indeed, several researchers5 have found evidence of persistent home bias in the portfolios of investors in industrial countries in the 90s. However, as more and more countries particularly the emerging markets open up their markets for foreign investment, investors in developed countries will have a greater opportunity to hold foreign assets. 3. 2. F ORE IGN I NST ITUTIONAL I NVESTMENT IN I ND IA : A N O VERV IEW India opened its stock markets to foreign investors in September 1992 and has, since 1993, received considerable amount of portfolio investment from foreigners in the form of Foreign Institutional Investors (FII) investment in equities. This has become one of the main channels of international portfolio investment in India for foreigners13. In order to trade in Indian equity markets, foreign corporations need to register with the SEBI as Foreign Institutional Investors (FII). SEBIs definition of FIIs presently includes foreign pension funds, mutual funds, charitable/endowment/university funds etc. as well as asset management companies and other money managers operating on their behalf.

The sources of these FII flows are varied. The FIIs registered with SEBI come from as many as 28 countries (including money management companies operating in India on behalf of foreign investors). US-based institutions accounted for slightly over 41%, those from the UK constitute about 20% with other Western European countries hosting another 17% of the FIIs. It is, however, instructive to bear in mind that these national affiliations do not necessarily mean that the actual investor funds come from these particular countries. Given the significant financial flows among the industrial countries, national affiliations are very rough indicators of the home of the FII investments. In particular institutions operating from Luxembourg, Cayman Islands or Channel Islands, or even those based at Singapore or Hong Kong are likely to be investing funds largely on behalf of residents in other countries. Nevertheless, the regional breakdown of the FIIs does provide an idea of the relative importance of different regions of the world in the FII flows.

3. 3. 2009: FII I NVESTMENT IS INCREASING I N I ND IA

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Nearly half of the Rs 70,000 crore offshore investments that have come into Indian bourses this fiscal, till October 2009, are from alleged tax havens such as Mauritius, Hong Kong and Luxembourgthe three together contributing almost Rs 25,000 crore of the net inflow from foreign institutional investors (FIIs). Significant omissions from this list are FIIs of Singapore and Switzerland, the two countries that had figured among the top five with the highest investments in Indian equities during the economic slowdown of 2008. FIIs from the two countries had put in over Rs 15,000 crore last year. The government has said there is no cause of concern on the strong FII flow into stock markets with finance minister Pranab Mukherjee stating that regulators were keeping a close watch on the money flow and would act if it was alarming. Till October 2009, FII held equities totalled more than $160 billion. According to a finance ministry statement, the highest investments have come from US-based FIIs, to the tune of Rs 21,344 crore till November 10. Second on the list is Luxembourg with Rs 12,275 crore. France, Mauritius, the UK, UAE, Hong Kong, Australia, Norway and Canada are the other countries in the top 10, in that order. Investments from Mauritian FIIs have been Rs 9,400 crore, ahead of the UK (Rs 4,900 crore), UAE (Rs 4,800 crore) and Hong Kong (Rs 3,438 crore). 3. 4. D ESCR IPT ION O F V AR IABLES The paper analyses Firm specific factors- Shareholding pattern & Company variables. The relationship between these attributes and Financial Institutional Investors has been analyzed. 3. 4. 1. S hareholdi ng Pattern A firms shareholding pattern influences its performance for several reasons. Differences in identity & concentration among shareholders determine their relative power, incentives and ability to monitor managers. Shareholders such as family groups, financial institutions, government, and individuals have their own divergent goals. It is examined whether the ownership has any influence on the investment decision of foreign institutional investors. 3. 4. 2. Corporat e Perfor mance It is important to understand the factors that can cause investors to stay away from providing capital to foreign firms. Prior research observed that more foreign funds were invested in firms with largest market capitalization, higher dividend yield and higher leverage. The measures of performance considered in the previous research studies have guided the selection of the ratios. 3. 4. 3. S hare Ret urns It has been observed that foreign portfolio investors are more interested in investment returns than in long-term relationships. Also contribution and influence of foreign funds was weak in closely-knit companies with close ties to domestic financial institutions and corporate groups. Stock market

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performance indicates the investors perceptions about the company. Market prices reflect not only the performance but also investors expectations about the future performance. 3.4.4. Price Earni ngs rati o The investors will assess the performance of the company and one significant indicator of financial performance often used is earning per share. Price earning ratio indicates the growth of market price in relation to the earnings of the company. It establishes the relationship between the earnings and the market price. In the year 2005 the price earning ratio was high at 23.1 in BSE Sensex, which could attract more foreign Investments. The research analysts reported that in the year 2006, the ratio was trailing at around 19%. 3. 4. 5. Price to book val ue Over 80% of the reporting parameters used to manage the company are designed to gauge returns to shareholders. Most management decisions are therefore biased towards delivering short-term value to them. An income statement or balance sheet does not reveal the companys ability to create value for customers, employees or shareholders. According to the OECD, most companies are well aware that the facts and figures contained in the financial reports fail to capture fully the essence of their operations. This fact is particularity evident in the case of companies whose book value is markedly different from the market value. The book value of the equity measures approximately the capital contributed by the shareholders, where as market price of the equity reflects how productively the firm has employed the capital contributed by the shareholders as assessed by stock market. The ratio of price to book value gauges whether the market valuation of the company is relative its worth or not.

3. 4. 6. Yield Yield has been computed to measure the shareholders returns. It is computed based on dividends and share price appreciation to reflect the overall return to the shareholders. All these ratios are computed quarterly.

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4.

R ESEARCH

O BJECTIVES

The question that whether capital flow in a country primarily is a result of changes in global factors and the events and indicators in the recipient countries like its credit rating and domestic stock market return alone or the Firm specific factors too have an impact. The paper is an attempt to answer this. Undoubtedly the global and country-specific factors seem to matter, but the Firm Specific factors also play a molar role in attracting FII. This paper uses data from the CapitaLine database and with the help of SPSS software empirically proves the importance of Firm specific factors. Thus, the broad objective of the present paper is to gain a better understanding of the nature and determinants of FII flows. The paper analyses the FII investment flows data to bring out the key features of these flows: Firm-level characteristics Shareholding pattern and Company variables that influence Financial Institutional Investors (FII) investment allocations. Steps can be taken at firm-level to create an environment conducive to foreign institutional investment.

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5.

R ESEARCH

M ETHODOLOGY

5. 1. S HAREHOLDING P ATTERN A firms shareholding pattern influences its performance in several ways. Differences in identity & concentration among shareholders/owners determine their relative power, incentives and ability to monitor managers. Shareholders such as family groups, financial institutions, government, and individuals have their own divergent goals. The objective of the paper is to examine whether the ownership has any influence on the investment decision of foreign institutional investors. Variables considered under Shareholding Pattern are: Corporate Bodies, Foreign Investors (other than FII), Government (Indian Promoter), Institutions (Financial & others), and General Public. The share holding of the respective groups is taken in percentage form to control the firm size. The data
on all these variables is collected for each quarter for five years (20 quarters) from 2 0 0 5 to 2 0 0 9 .

5. 2. C OMPANY V AR IABLES It is important to understand the factors that can cause investors to stay away from providing capital to foreign firms. Prior research observed that more foreign funds were invested in firms with largest market capitalization, higher dividend yield and higher leverage. The measu of performance res considered in the previous research studies have guided the selection of the Company Variables.
The paper considers five firm specific variables Company Variables. The data is collected on quarterly basis for a period of five years. Variables considered under Companies Variables are: Earning per Share (EPS), Price Equity Ratio (P/E ratio), Book to Market Price (P/B ratio), Dividend Yield percentage, Market Capitalization, Debt to Equity. The data on all these variables is collected for each quarter for five years (20 quarters) from 2 0 0 5 to 2 0 0 9 .

5. 3. S ELECTION O F S AMPLE A ND S OURCES O F D ATA BSE Sensex or Bombay Stock Exchange Sensitive Index is a value-weighted index composed of 30 stocks that started January 1, 1986. The Sensex is regarded as the pulse of the domestic stock markets. It consists of the 30 largest and most actively traded stocks, representative of 19 sectors, on the Bombay Stock Exchange. These companies account for around fifty per cent of the market capitalization of the BSE. The index is scientifically designed based on globally accepted construction and review methodology. It is widely reported and accepted both in the Indian and international markets. Hence the paper considers all thirty Sensex scripts as a sample for the period of five years - 2005 to. The information about Shareholding pattern (ownership structure), financial performance and the stock returns of the sample companies is collected from CapitaLine
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Database.

5. 4. T IME S ERIES R EGRESS ION Also known as longitudinal data, Time series is a data set containing observations on a single phenomenon observed over multiple time periods. In time series data, both the values and the ordering of the data points have meaning. Time series analysis comprises methods for analyzing time series data in order to extract meaningful statistics and other characteristics of the data. In our sample, the time series consists of all variables over a period of five years i.e. 20 quarters.

5. 5. C ROSS S ECT IONAL R EGRESS ION

A data set containing observations on multiple phenomena observed at a single point in time is calledcross-sectional. In cross-sectional data sets, the values of the data points have meaning, but the ordering of the data points does not. It is an one-dimensional data.

5. 6. P ANEL D ATA R EGRESS ION A data set containing observations on multiple phenomena observed over multiple time periods is called panel data. Panel Data aggregates all the individuals, and analyzes them in a period of time. Alternatively, the second dimension of data may be some entity other than time. The process of combining cross sectional and time series data to form a panel is called pooling. Whereas time series and cross-sectional data are both onedimensional, panel data sets are two-dimensional. Typically, cross sectional parameters may shift over time in a manner that is not reflected in the choice of time series explanatory variables, or individuals may vary in important ways within the cross section in a manner that is not reflected in the choice of cross section variables. As a result, the use of panel data adds a new dimension of difficulty to the problem of model specification.

5. 7. F IXED E FFECTS M ODEL

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Fixed effects model is a statistical model that represents the observed quantities in terms of explanatory variables that are all treated as if those quantities were non-random. Fixed effect model introduces dummy variables that allow the intercept term to vary over time and over cross section units. This is to overcome the difficulty with the least-squares pooling procedure wherein the assumption of constant intercept and slope may be unreasonable. In Fixed Effect Model, if the slope varies as well, each separate cross section regression would involve a distinct model and pooling would be inappropriate. Dummy Variables: N is the number of cross section units and T is the number of time periods. The model adds N-1 and T-1 dummy variables. The two variables are omitted since their addition would result in perfect collinearity among the explanatory variables. In order to obtain unbiased and consistent estimates of all parameters (including the slope beta), we can make use of Ordinary Least Squares. A total of NT-N-T, degrees of freedom would be involved. The dummy variable coefficients would measure the change in the cross-section and time-series intercepts (with respect to the first individual in the first period of time).

5. 8. T EST T O D EC IDE U SE O F D UMMY V AR IABLES The decision to add dummy variables is made on the basis of statistical testing. The test involves a comparison of the error sum of squares associated with the two estimation techniques. Since the ordinary least-squares model includes more parameter restrictions than does the Fixed-effects model (the intercepts are restricted to be equal over time and over individuals), we would expect the error sum of squares to be higher for the ordinary least squares model. If the increase in the error sum of squares is not significant when the restrictions are added, we conclude that the restrictions are proper, and ordinary least squares can be applied. If the error sum of squares changes substantially, we opt for the Fixed-effects model. F= (ESS1-ESS2) / (N+T-2) (ESS2) / (NT-N-T) *ESS1 = Error sum of squares using the ordinary least squares model *ESS2 = Error sum of squares using the Fixed-effects model * N - No. Of Cross-sectional units || * T - No. Of Time periods

5. 9. T EST OF M ULTICOLLINEAR ITY

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Multicollinearity is a statistical phenomenon in which two or more predictor variables in a multiple regression model are highly correlated. In this situation the coefficient estimates may change erratically in response to small changes in the model or the data. In order to check this phenomenon, the correlation between three Company Variables (EPS, PE, Yield) was calculated using SPSS. TABLE 1: PEARSON CORRELATION EPS P/E Yield EPS P/E Yield 1 -.139 .174 -.139 1 -.159 .174 -.159 1

** Correlation is significant at the 0.01 level (2-tailed) It was observed that the variables (EPS, PE, Yield) are not significantly correlated. Thus, we could include all the three variables in the regression models.

TABLE 2: REGRESSION MODELS Dependent Variable 1. 2. 3. 4. 5. 6. 7. Financial Institutional Investors Financial Institutional Investors Financial Institutional Investors Financial Institutional Investors Financial Institutional Investors Financial Institutional Investors Financial Institutional Investors Independent Variable Shareholding Pattern Company Variables Dummy C + Shareholding Pattern Dummy C + Company Variables Dummy Q + Shareholding Pattern Dummy Q + Company Variables Dummy C + Shareholding Pattern + Dummy Q Regression Regression Time-Series Regression Time-Series Regression Cross Sectional Regression Cross Sectional Regression Panel-data Regression Regression

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8.

Financial Institutional Investors

Dummy C + Company Variables + Dummy Q

Panel Data Regression

6.

L IMITATIONS

OF THE

S TUDY

6. 1. S AMPLE D ATA These findings could not be taken for making generalizations because:  Sample is small and consists of only thirty companies  The study is based on Sensex sample. The Sensex companies have an external image that they are the best performers in the country. If the sample companies consist of probably a heterogeneous group then the results may give better insight into relationship of the specific variables.

6. 2. F IXED E FFECTS M ODEL  The use of dummies does not directly identify what causes the regression line to shift over time and over individuals.  The dummy variable technique uses up a substantial number of degrees of freedom (N+T-2).

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7.

O BSERVATIONS

&

A NALYSIS

7. 1. E MPIR ICAL R ESULTS Among the thirty Sensex companies there were eighteen companies in which promoters are from family groups and four companies had the government as the promoter. Two companies had foreign promoters and three companies did not have any promoter holdings. The percentage share holding of these individual groups is taken as a variable for the purpose of the analysis. In this paper the summary statistics as given in Table 3 . explain that on an average around 17.80 % of the capital comes from foreign institutional investors on an average among Sensex companies. The promoters contribute around 34 % , the financial institutions provide 1 3 .5 0 % and public share is 11 % and the remaining from other sources. TABLE 3: DESCRIPTIVE STATISTICS OF INDEPENDENT VARIABLES Variables FII Corporate Bodies Total Foreign FII Government (Indian Promoters) Institutions (Financial & others) Public & others EPS P/E Ratio P/B Ratio Div Yield % Log of Market Capitalization Debt to Equity 7. 2. S HAREHOLDING P ATTERN R EGRESSION TABLE 4(A): MODEL SUMMARY Minimum (%) 0 0 0 0 0.33 1.40 0 5.10 0.90 0.15 4.1 0 Maximum (%) 64.50 58 69.70 89.5 37.60 37.30 152.20 53.30 23.65 8.34 5.24 8.50 Mean (%) 17.80 16.02 10.30 17.95 13.50 10.73 38.57 19.42 4.62 2.19 4.57 0.73

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Model R R Square Adjusted R Square Std. Error of the Estimate a .463 .215 .208 10.59655 dimension0 1 Predictors: (Constant), I_Public, I_Foreign, I_CorporateBodies, I_Institution, I_IndianPromoter TABLE 4(B): ANOVAB Model Sum of Squares df Mean Square Regression 18227.923 5 3645.585 32.467 Residual 66698.366 594 112.287 Total 84926.289 599 Predictors: (Constant), I_Public, I_Foreign, I_CorporateBodies, I_Institution, I_IndianPromoter Dependent Variable: D_FII TABLE 4(C): COEFFICIENTSA Unstandardized Coefficients B (Constant) I_CorporateBodies I_Foreign I_IndianPromoter I_Institution I_Public Dependent Variable: D_FII MODEL SUMMARY Adjusted R Square .208 .000 28.640 -.186 -.199 -.225 -.348 .291 ANOVA Significance Constant Corporate Bodies Foreign -.336 -.279 Std. Error 1.543 .025 .030 .022 .056 .073 -.336 -.279 -.523 -.300 .189 COEFFICIENTS Beta .000 .000 Sig. F Sig. .000a

Model

Standardized Coefficients Beta t 18.558 -7.360 -6.662 -10.144 -6.183 3.988 Sig. .000 .000 .000 .000 .000 .000

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Indian Promoter Institution Public *Dependent Variable: Financial Institutional Investment

-.523 -.300 .189

.000 .000 .000

 The adjusted R Square is relatively low and the significance level very high, which shows that 20.8% of the dependent variable i.e. Financial Institution Investment is explained by the Shareholding Pattern in companies.  Analysing the Coefficients, we observe that the Indian Promoter (Government Shareholding) have a high negative beta with a high significance level. This is followed by Corporate Bodies (Promoters) and Institutions (Financial and others) with moderately high negative beta and high significance. This shows that any increase in shareholding by these variables might cause a decrease in the shareholding of FIIs.  Among all variables in the Shareholding Pattern, Public Shareholding has a positive beta. Thus the FIIs prefer shareholding by general Public.

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7. 3. C OMPANY V AR IABLES R EGRESS ION TABLE 5(A): MODEL SUMMARY Model Adjusted R R R Square Sq 1 .779a .607 .602 dimension0 Predictors: (Constant), I_DebtToEquity, I_Yield, I_log.MarketCap, I_EPS, I_PB, I_PE

Std. Error of the Estimate 7.57346

Model

TABLE 5(B): ANOVAb Sum of Squares df

Mean Square

Sig. 6 .000a 557 8207.312 57.357 563

Regression 49243.873 6 8207.312 Residual 31947.986 557 57.357 Total 81191.859 563 143.091 Predictors: (Constant), I_DebtToEquity, I_Yield, I_log.MarketCap, I_EPS, I_PB, I_PE Dependent Variable: D_FII

Model

TABLE 5(C): COEFFICIENTSA Unstandardized Coefficients B Std. Error

Standardized Coefficients Beta

Sig.

(Constant) I_EPS I_PE I_PB

25.298 .091 .003 .677

3.855 .009 .039 .127

.277 .003 .177

6.563 9.876 .083 5.343

IN

.000 .000 .934 .000

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I_Yield I_log.MarketCap I_DebtToEquity Dependent Variable: D_FII TABLE 5 MODEL SUMMARY Adjusted R Square .602 .000

-.191 -3.579 4.869

.100 .817 .204

-.055 -.119 .648

-1.907 -4.381 23.815

.057 .000 .000

ANOVA Significance EPS P/E P/B Yield Constant

COEFFICIENTS Beta .277 .003 .177 -.055 -.119 .648 .000 .934 .000 .057 .000 .000 Sig.

log. Market Capitalization Debt to Equity *Dependent Variable: Financial Institutional Investment

 The adjusted R Square is relatively high with high significance level, which shows that 60.2% of the dependent variable i.e. Financial Institution Investment is explained by the Company Variables as a whole.  Analysing the Coefficients, we observe that the Debt to has a high positive beta with a high significance level. Clearly this is one of the most significant variable (based on analysis) that the FIIs consider while investing in a company.  EPS and P/B ratio being other variables that seem to hold importance in investment decision by FIIs.

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7. 4. S HAREHOLDING P ATTERN : T IME -S ER IES R EGRESS ION TABLE 6 MODEL SUMMARY Adjusted R Square .939 .000 ANOVA Significance Constant Corporate Bodies Foreign Indian Promoter Institution Public 7. 5. C OMPANY V AR IABLES : T IME -S ER IES R EG RESSION TABLE 7 MODEL SUMMARY Adjusted R Square .945 .000 ANOVA Significance EPS P/E P/B Yield log. Market Capitalization Debt to Equity
y

COEFFICIENTS Beta .008 -.300 -.005 -.201 -.067 .709 .000 .892 .000 .230 Sig.

COEFFICIENTS Constant .009 .087 -.019 .029 -.027 .100 Beta .738 .000 .523 .059 .339 .048 Sig.

The suitability use of dummy variables is cross checked with the help of a Stastical test (refer: 7.10, 7.11): The test analysis recommends that the observations of the Time-series regression should be avoided for the overall analysis. 7. 6. S HAREHOLDING P ATTERN : C ROSS -S ECT IO NAL R EGRESSION TABLE 8 MODEL SUMMARY ANOVA COEFFICIENTS

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Adjusted R Square .185

Significance .000

Constant Corporate Bodies Foreign Indian Promoter -.336 -.279 -.521 -.298 .190

Beta .000 .000 .000 .000 .000

Sig.

Institution Public *Dependent Variable: Financial Institutional Investment

 The most important aspect of the analysis of Cross-section regression of shareholding pattern is in comparison with the regression of Shareholding pattern without dummies (Model summary 1). We observe that the beta values and significance are highly similar in values. Thus, it further emphasizes the previous analysis of Shareholding Pattern.  Analysing the Coefficients, we observe that the Indian Promoter (Government Shareholding) have a high negative beta with a high significance level. This is followed by Corporate Bodies (Promoters) and Institutions (Financial and others) with moderately high negative beta and high significance. This shows that any increase in shareholding by these variables might cause a decrease in the shareholding of FIIs.  Among all variables in the Shareholding Pattern, Public Shareholding has a positive beta. Thus the FIIs prefer shareholding by general Public.

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7. 7. C OMPANY V AR IABLES : C ROS S -S ECT IONAL R EGRESS ION TABLE 9 MODEL SUMMARY Adjusted R Square .596 .000 ANOVA Significance EPS P/E P/B Yield log. Market Capitalization Debt to Equity *Dependent Variable: Financial Institutional Investment Constant .292 .019 .169 -.068 -.100 .643 COEFFICIENTS Beta .000 .615 .000 .027 .001 .000 Sig.

 The analysis of Cross-section regression of Company Variables in comparison with the regression of Company Variables without dummies (Model summary 2), we observe that the beta values and significance are very close in values. Thus, it further emphasizes the previous analysis of Company Variables.  The adjusted R Square is relatively high with high significance level, which shows that 59.6% of the dependent variable i.e. Financial Institution Investment is explained by the Company Variables as a whole.  Similar to the Company Variables regression, in Cross-sectional regression of Company Variables, we observe that the Debt to Equity has a high positive beta with a high significance level. Thus the observation further strengthens the conclusion that Debt to Equity is one of the most significant variables that the FIIs consider while investing in a company.  EPS and P/B ratio being other variables that seems to hold importance in investment decision by FIIs. 7. 8. S HAREHOLDING P ATTERN : P ANEL D ATA R EGRESSION TABLE 10 MODEL SUMMARY Adjusted R Square .946 .000 ANOVA Significance Constant Corporate Bodies .073 COEFFICIENTS Beta .003 Sig.

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Foreign Indian Promoter Institution Public

-.012 -.012 -.181 -.069

.837 .713 .000 .215

7. 9. C OMPANY V AR IABLES : P ANEL D ATA R EG RESSION TABLE 11 MODEL SUMMARY Adjusted R Square .953 .000 ANOVA Significance EPS P/E P/B Yield log. Market Capitalization Debt to Equity
y

COEFFICIENTS Constant .050 .128 -.145 -.003 .120 .123 Beta .057 .000 .000 .849 .001 .011 Sig.

The suitability use of dummy variables is cross checked with the help of a Stastical test (refer: 7.10, 7.11): The test analysis recommends that the observations of the Time-series regression (and thus Combine/Panel data) should be avoided for the overall analysis.

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F=

(ESS1-ESS2) / (N+T-2) (ESS2) / (NT-N-T)

7. 10. S HAREHOLDING P ATTERN : S TATIST ICAL TEST The decision to add dummy variables is made on the basis of statistical testing. The test involves a comparison of the error sum of squares associated with the two estimation techniques. Since the ordinary least-squares model includes more parameter restrictions than does the Fixed-effects model (the intercepts are restricted to be equal over time and over individuals), we would expect the error sum of squares to be higher for the ordinary least squares model. In case of Shareholding Pattern, we observe that the test for cross sectional is significant (234.64) and thus the restrictions added are justified. However, in Time-series regression, we observe that the test shows an insignificant value (0.07). Thus we exclude or avoid the use of dummy variables used in time series regression. Together, the combined data contains both Dummy C and Dummy T. Thus we also avoid the observations from the panel data to arrive at an overall analysis.

* ESS1 Error sum of squares using the ordinary least squares model * ESS2 - Error sum of squares using the Fixed-effects model * N No. Of Cross-sectional units || * T - No. Of Time periods TABLE 12. SHAREHOLDING PATTERN STATISTICAL TEST 1 Dummy C + Shareholding Pattern ESS1 66698.366 ESS2 4853.476 N 600 T 20 F 234.6414436 2 Dummy T + Shareholding Pattern ESS1 66698.366 ESS2 66446.232 N 600 T 20 F 0.069873877 3 Dummy C + Shareholding Pattern + Dummy T ESS1 66698.366 ESS2 4193.79 N 600 T 50 F 675.0535623

F=

(ESS1-ESS2) / (N+T-2) (ESS2) / (NT-N-T)

7.11. C OMPANY V AR IABLES : S TATIST ICAL TEST The decision to add dummy variables is made on the basis of statistical testing. The test involves a comparison of the error sum of squares associated with the two estimation techniques. Since the ordinary least-squares model includes more parameter restrictions than does the Fixed-effects model (the intercepts are restricted to be equal over time and over individuals), we would expect the error sum of squares to be higher for the ordinary least squares model. If the increase in the error sum of squares is not significant when the restrictions are added, we conclude that the restrictions are proper, and ordinary least squares can be applied. If the error sum of squares changes substantially, we opt for the Fixed-effects model. In case of Company Variables, we observe the same as Shareholding Pattern; the test for cross sectional is significant (183.23) and thus the restrictions added are justified. However, in Time-series regression, we observe that the test shows an insignificant value (0.54). Thus we exclude or avoid the use of dummy variables used in time series regression. Together, the combined data contains both Dummy C and Dummy T. Thus we also avoid the observations from the panel data to arrive at an overall analysis.

* ESS1 Error sum of squares using the ordinary least squares model * ESS2 - Error sum of squares using the Fixed-effects model * N - No. Of Cross-sectional units || * T - No. Of Time periods TABLE 13. COMPANY VARIABLES - STATISTICAL TEST 1 Dummy C + Shareholding Pattern ESS1 31947.986 ESS2 4190.05 N 600 T 30 F 183.2348763 2 Dummy T + Company Variable ESS1 31947.986 ESS2 31339.867 N 600 T 30 F 0.536700004 3 Dummy C + Company Variable + Dummy T ESS1 31947.986 ESS2 3461.741 N 600 T 50 F 372.7123067

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8.

C ONCLUSION

Domestic sources of outside finance are limited in many countries, particularly those with emerging markets. Through capital market liberalization, foreign capital has become increasingly significant source of finance. In developing countries like India foreign capital helps in increasing the productivity of labour and to build up foreign exchange reserves to meet the current account deficit. Foreign Investment provides a channel through which country can have access to foreign capital. However, the question remained that whether capital flow in a country primarily is a result of changes in global factors and the events and indicators in the recipient countries like its credit rating and domestic stock market return alone or the Firm specific factors too have an impact. The answer is mixed undoubtedly the global and country-specific factors seem to matter, but the Firm Specific factors play a molar role in attracting FII. This paper empirically proves this and also suggests that steps can be taken at firm-level to create an environment conducive to foreign institutional investment. Analysing the Shareholding pattern and its implications, it is observed that the foreign investment is more in companies with higher volume of publicly held shares. One major factor which proves to be conducive to FII flows is the promoters. This means that there is inverse relationship between the promoter share holding and foreign institutional Investment. This is in conformity with the theoretical construct that the foreign investors do not prefer t he companies w her e family shareholders dominate. Also the analysis proves that there is no significant influence of foreign promoters or that of financial institutions on foreign institutional investors. This infers that higher the publicly traded shares in a firm high will be the foreign investment. Among the Company Variables (financial performance variables) the share returns and Earning per share are more influencing variables on their investment decision. This provides a pointer for furt her research that market performance is the strong basis for attracting more foreign investment for the individual companies. The foreign institutional investors with draw their money when the stock market performance starts sliding down. The results also confirm that price earnings ratio too hares have significant influence on FII. Thus the broad objective of the present paper that was to gain a better understanding of the nature and determinants of FII flows is duly achieved. The analysis with the help of regression models and other statistical has brought out the key features of these flows: Firm-level characteristics Shareholding pattern and Company variables that influence Financial Institutional Investors (FII) investment allocations. The results in the paper suggest that the availability of foreign capital depends on factors, particularly the Firm specific factors, other than the countrys economic development alone. After controlling for the country effect, firms with better ownership status, accounting quality, financial records and FI I S : F IRM S PEC IFIC F ACTORS & I NVESTMENT P REFERENCE || 31

corporate governance attract more foreign capital. In conclusion the paper suggests that steps can be taken at the firm level to create an environment conducive to foreign portfolio investment.

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9.

O NE

S TEP A HEAD (S COPE FOR FURTHER A NALYSIS )

In the paper, we have analyzed Firm level characteristics: Shareholding pattern and Company variables that influence FII investment allocations. To increase the scope of study and to go one step ahead of the already established literature we can explore several related areas. FII flows and stock returns: Determining the Cause and Effect The sentiments in the Dalal street and particularly among common man has been that FII control the market and the market returns dance to the tunes of FII moods. Is such a sentiment of the common man trading in the Indian equity markets justified? If yes then it must also be true that FII flows are not only the result but also contribute to the performance of a Companys stock. Thus, apart from the impact they create on the market, their holdings will influence firm performance. For instance, when foreign institutional investors reduced their holdings in Dr. Reddys Lab by 7% to less than 18%, the company dropped from a high of around US$30 to the current level of below US$15. This 50% drop is apparently because of concerns about shrinking profit margins and financial performance. These instances made analysts to generally claim that foreign portfolio investment has a short term investment horizon. Growth is the only inclination for their investment. Their strategy is Why take risk when you are not in profit-exit. According to the industry experts, hedge funds played a very active role in Indian stock market since 2003 by entering both Indian cash and derivative market. The upward trend in the domestic market is due to hedge funds and not due to regular long-term FIIs. Thus the foreign portfolio investments are found to be very volatile in nature. FII flows and contemporaneous stock returns are strongly correlated in India. The correlation coefficients between different measures of FII flows and market returns on the Bombay Stock Exchange during different sample periods can be studied Douma, Pallathiatta and Kabir (2006) investigated the impact of foreign institutional investment on the performance of emerging market firms and found that there is positive effect of foreign ownership on firm performance. They also found impact of foreign investment on the business group affiliation of firms.

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R EFERENCES
1. R OBERT S. P INDYCK (E CONOMETR IC M OD ELS AND E CONOMIC F OREC ASTS P G . 250-253) U SE O F P AN EL D ATA , E STIM ATION WITH P ANEL D ATA & F IXED E FFECT M ODELS 2. P RASANNA , P. K. (J OAAG, V O L 3, N O . 2.) FII INVESTMENT PREFER ENC E I ND IA 2008 3. S APAN S HAH (T ULANE U N IVERSITY ) & D H WAN I M EHTA (IES M AN AGEMENT C O LLEGE ) - A S TUDY : F II FLO WS IN I ND IA 4. R AJ ESH C HAKRABARTI (D U PREE C O LLEGE O F M AN AGEMENT , G EORGIA I N STITUTE O F T ECHNOLOGY ) F II FLO WS TO I ND IA N ATURE & C AU SES 5. R EENA A GARWAL , L EORA K LAPPER , P ETER D. W YSOCK I (W OR LD B AN K P O LICY R ESEARCH W ORKING P AP ER 3101, J U LY 2003) - P ORTFO LIO P REFER ENCES O F F OREIGN I N STITUTION AL I NVESTORS 6. K R ISHNA R EDDY C H ITTEDI (D OCTOR AL S CHOLAR , C ENTER FOR D EV ELOPMEN T S TUDIES , T RIV ANDRUM , K ER AL A . ) V O LATILITY O F I ND IAN S TOCK M AR KET & FII FLO WS

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