The International Conference on Accounting, Finance, Economics and Management
A Sustainability Development Perspective
August 25th - 26th, 2023
Nha Trang City, Vietnam
Foreign versus local institutional ownership and stock price
co-movement: Evidence from an emerging market
Thi Bao Ngoc Nguyen a*, Dun-Yao Keb, Kai-Chien Chenc, Pi-Yun Yang d
a
Faculty of Accounting and Finance, Nha Trang University, 02 Nguyen Dinh Chieu Street, Vinh Tho District, Nha Trang City, Khanh Hoa
Province, Vietnam
b
Department of Finance, National Sun Yat-sen University, No.70 Lien-hai Road, Kaohsiung City,Taiwan
c
Department of Statistics, National Cheng Kung University, No.1, University Road, Tainan City 70101, Taiwan
d
College of Management, National Kaohsiung University of Science and Technology, No.1, University Rd., Yanchao Dist., Kaohsiung City
82445, Taiwan
Nhà đầu tư tổ chức là một thực thể gom tiền để mua chứng khoán, tài sản bất động sản và các tài sản đầu tư
khác hoặc tạo ra các khoản vay.
* Corresponding author. Tel.: +84 358776818.
E-mail address: ngocntb@ntu.edu.vn
ABSTRACT
Limited scholarly exploration has been dedicated to investigating the influence of foreign
and local institutional ownership on stock price co-movement. In this study, we aim to
contribute to the understanding of this phenomenon by leveraging the agency-linked
external monitoring theory. By analyzing a sample of firms in Taiwan spanning from 2004
to 2020, we present compelling evidence suggesting that foreign institutional ownership
exerts a more pronounced negative impact on stock price co-movement compared to local
institutional ownership, particularly for firms exhibiting a high degree of agency problems.
Our findings support the exterior monitoring hypothesis, indicating that foreign institutional
investors possess the ability to effectively capture firm-specific information flow,
consequently mitigating the co-movement of stock prices. Thus, our study offers a
resolution to the ongoing debate regarding whether foreign or local institutional investors
are more proficient in gathering and processing firm-specific information.
Keywords: Stock Price co-movement, Foreign Institutional Ownership, Local Institutional
Ownership, Exterior Monitoring
1. Introduction
In the realm of institutional investor studies, considerable attention has been given to the
monitoring incentives exhibited by institutional investors, with emphasis on the influence of
trader typology. Diverse forms of institutional ownership are known to exert varying impacts
on price formation and return co-volatility. While existing literature has offered ample
evidence regarding the stability, control, and size-related aspects of institutional holdings and
their monitoring effects on return co-movement, the examination of how institutional
ownership heterogeneity, viewed from the perspective of domicile, affects the informativeness
of stock returns has been comparatively limited.
An illustrative example of this phenomenon can be found in the research conducted by An
and Zhang (2013), who observed a negative relationship between stock price co-movement
and dedicated institutional investors, characterized by their substantial stake holdings and
extended investment horizons, as opposed to the group of transient institutions. Similarly, the
work of Borochin and Yang (2017) suggested that dedicated institutional investors possess the
potential to mitigate future firm mis-valuation in both magnitude and direction when
compared to transient traders. Additionally, previous research by Boubaker, Mansali, and
Rjiba (2014) confirmed the continuous reduction of firm's stock price co-variation when
controlling shareholders maintain a significant percentage of cash flow rights. Nevertheless,
despite these findings, there remains an unexplored aspect concerning the perceptions
originating from the geographical proximity perspective. Further investigation in this area is
warranted.
The Taiwanese stock market displays characteristics commonly associated with an active
stock market. Prior studies have demonstrated that emerging economies tend to exhibit higher
stock price synchronization when compared to established markets. In the case of Taiwan, it
stands among the most synchronized nations, with over 70% of stock price co-movement.
Researchers have attributed this higher synchronicity to weak property rights enforcement
(Morck, Yeung, & Yu, 2000). This finding serves as a motivation for us to delve deeper into
the impact of foreign and domestic institutional ownership on stock price co-movement in
Taiwan. Furthermore, in the context of Taiwan's emerging financial market, various types of
ownership structures in investment equity exert distinct effects on the information
environment. Taking a performance-based approach to explain the crucial monitoring role of
2
foreign ownership in Taiwan, studies conducted by Chuang, Lin, and Weng (2019); Hsu and
Wang (2014); R. D. Huang and Shiu (2009); Liang, Lin, and Chin (2012) affirm that overseas
institutional holdings, equipped with knowledge, experience, and resources, contribute to
enhancing the corporate information environment. They achieve this by addressing individual
investor-related agency problems, stimulating firm innovation, improving firm performance,
and encouraging voluntary disclosure. On the other hand, an opposing viewpoint presented by
Lee, Liu, Roll, and Subrahmanyam (2004) suggests that significant domestic institutional
investors in Taiwan execute trades based on superior information and serve as liquidity traders
on the stock exchange. Supporting this perspective, Shu and Chiang (2020) note that domestic
institutional ownership plays a critical monitoring role, influencing the informational nature of
firms by enhancing monitoring effectiveness and, consequently, promoting higher levels of
corporate social responsibility performance. Given the aforementioned contextual
background, the significant divergence in the monitoring impact between foreign and local
institutional ownership investors in Taiwan presents an appropriate and compelling research
context to examine the information content of their respective shareholdings. This study
setting offers the opportunity to investigate how the ownership structure of these investors
potentially influences the informativeness of stock prices in the market.
The debate surrounding the monitoring impact of foreign and local institutional investors
has become increasingly prominent, yet conclusive arguments remain elusive. In response, our
study aims to contribute by developing both the exterior and interior monitoring hypotheses to
assess the monitoring effectiveness of each ownership category on stock price co-movement
within the Taiwan market.
Utilizing an extensive sample of Taiwanese public firms covering the period from 2004 to
2020, we present compelling evidence that both foreign and local institutional ownerships
exhibit a negative correlation with stock price co-movement. Moreover, our regression
analysis accounts for a range of relevant variables that could influence price co-movement.
Notably, the results of our study demonstrate that, when compared to domestic ownerships,
foreign equity ownerships exhibit superior monitoring effectiveness, leading to a more
pronounced impact on improving firm-specific information incorporation into stock prices. As
a consequence, this phenomenon contributes to a reduction in stock price co-movement. This
empirical finding strongly supports our exterior monitoring hypothesis, suggesting that foreign
institutional ownerships actively partake in monitoring activities that bolster the dissemination
of firm-level information into the market. Consequently, this involvement helps to minimize
synchronous stock price movements, indicating a higher level of market efficiency and
reduced informational asymmetry. Overall, our study provides valuable insights into the
monitoring roles of foreign and local institutional investors in the Taiwan market, shedding
light on their distinct impacts on stock price co-movement.
Based on the agency-linked external monitoring theory, our study examines the impact of
non-local institutional investors on firm informativeness, particularly focusing on firms with
varying degrees of agency problems. We employ two measures to assess the agency problem
effect: the deviation between controlling rights and cash flow rights (referred to as DEV) and
the proportion of independent directors (referred to as BIND). Our findings reveal that the
informativeness-accelerating effect of non-local institutional investors is more pronounced in
firms facing significant agency problems. Specifically, we observe that compared to local
equity holdings, the co-movement-reducing effect of foreign institutional holdings is even
more negative for firms with a high level of agency problem (indicated by higher DEV or
lower BIND). These results provide further confirmation for our exterior monitoring
proposition, which suggests that non-Taiwanese-domiciled institutional funds possess a
remarkable capacity for effective monitoring among firms grappling with severe agency
problems. Their involvement is seen to mitigate the impact of agency issues and enhance the
dissemination of firm-specific information, thereby contributing to a reduction in stock price
co-movement. In conclusion, our study contributes valuable insights into the role of non-local
institutional investors in firms with agency problems, reinforcing the significance of external
monitoring in addressing agency-related challenges in the context of the Taiwan market.
3
Our study makes valuable contributions to the existing literature in two significant ways.
Firstly, it advances the understanding of the monitoring role of foreign institutional ownership
in influencing stock price co-movement and provides a comparison with the similar role of
local institutional ownership, particularly in the context of an emerging market like Taiwan.
By exploring institutional investor-related factors in relation to information content in the
security market, our study extends the analysis beyond the impact of monitoring effectiveness
on stock price co-movement. While previous studies have investigated how various aspects of
institutional investor monitoring affect stock price co-movement, such as managers' access to
the firm's cash flows (An & Zhang, 2013), future firm mis-valuation, and governance
characteristics (Borochin & Yang, 2017), as well as corporate transparency (Tee, 2017), the
impact of institutional ownership on the information function in the stock market has
remained unclear. This study bridges this knowledge gap by identifying and comparing
foreign institutional capital flows' fund-holding percentage with domestic equity holdings as a
novel determinant of synchronous stock price movements. This determinant plays a crucial
role in gathering and processing firm-level information and significantly influences stock
price efficiency. By shedding light on how foreign institutional investors outperform local
peers in creating various effects on the amount of firm-specific information reflected in stock
prices, this study addresses an important and previously untouched question. Secondly, our
study's evidence contributes to corporate governance theory, particularly in the realm of
external monitoring structure. It demonstrates that the negative influence between foreign
institutional ownership and stock price co-movement is more significant for firms with weaker
internal monitoring mechanisms, indicated by a higher degree of agency problems. This
finding highlights the foreign ownership-driven external monitoring channel as an effective
means of assisting such firms in enhancing corporate information quality and acting as a
substitute for those with inadequate monitoring systems. Overall, our study's findings offer
valuable insights into the role of foreign and local institutional investors in affecting stock
price co-movement, while also providing important implications for corporate governance
practices and the understanding of external monitoring structures in firms with varying levels
of agency problems.
The remainder of this paper is organized as follows. Section 2 reviews the related literature
and develops the hypotheses. Section 3 describes the sample construction and the variables
used in the study. Section 4 presents the research design, discusses the main empirical
findings, and includes additional tests conducted to support the results. Section 5 contains the
conclusion, summarizing the research outcomes, discussing their significance, and proposing
potential directions for future research.
2. Literature review and Hypothesis development
Previous research has extensively investigated the institutional monitoring-side hypothesis
rooted in market efficiency theory. This hypothesis posits that institutional oversight restricts
managers' access to the company's cash flows, leading to a reduction in the amount of firmspecific risk they undertake. As a result, the synchronization of stock prices is diminished,
indicating an improvement in the quality of firm-level stock price-impounded information (An
& Zhang, 2013; Tee, 2017), in which an individual firm's stock price reflects market-level,
industry-level, and firm-specific information. These research stream attribute that under the
monitoring power from institutional investors, firms are more likely to enhance internal
control effectiveness, which encourages firms to release more valuable informativeness to
debt holders and capital providers (Lin, Wu, Fang, & Wun, 2014; Shen, Liu, Xiong, Hou, &
Tang, 2021). The higher shareholdings of institutional investors, the lower stock price comovement becomes due to the increment in the information-assessing efficiency of the share
market and resource distribution, which institutional transactions hasten the integration of the
firm‐specific constituent of potential dividend yields news into prices alone (Hasan, Song, &
Wachtel, 2014; Piotroski & Roulstone, 2004). As a result, the firm's information environment
becomes more transparent and informative (Kun, Yu, & Hu, 2018).
Prior research has presented two competing perspectives on how foreign and local
institutional ownership influence a firm's information environment. On one hand, a substantial
4
body of literature supports the exterior monitoring hypothesis, which posits that foreign
institutional ownerships play a significant monitoring role by providing incremental firmspecific information compared to their domestic counterparts. For instance, firms with a
higher proportion of foreign institutional shareholders tend to enhance their corporate
governance systems through monitoring the investment policies of controlling shareholders
(Jeon & Ryoo, 2013; Park, Chae, & Cho, 2016). Additionally, the presence of foreign
investors improves the financial reporting quality of domestic firms by curbing management
conservatism, reducing information asymmetry, and enhancing accrual quality (Gu, An, Chen,
& Li, 2023; J.-B. Kim, Li, Luo, & Wang, 2020). This is attributed to foreign equity
ownerships possessing greater independence, resources, and expertise in collecting and
analyzing investment information. Their extensive experience in monitoring international
investment portfolios also aids in narrowing the information gap between foreign and
domestic entities through advanced monitoring technologies (I. Kim et al., 2016). In contrast,
Bena, Ferreira, Matos, and Pires (2017) highlight that foreign institutional investors tend to
adopt a more independent stance compared to their domestic peers. They are less likely to
engage in direct interactions with regional investee firms, operate based on globally accepted
business standards, and display less tolerance towards local government intervention.
Nonetheless, these non-domestic ownerships indirectly promote information transparency by
encouraging the following of financial analysts or accounting standard boards, and their
investments lead to enhanced corporate voluntary disclosure (Kacperczyk, Sundaresan, &
Wang, 2020). Such foreign ownership's impact is particularly notable in improving voluntary
disclosure and contributing more significantly to the price discovery process of listed firms
compared to domestic investors (Lien & Hung, 2023; Tsang, Xie, & Xin, 2019). In sum, the
exterior monitoring hypothesis suggests that foreign institutional ownership is likely to have a
more pronounced negative effect on stock price co-movement in comparison to domestic
institutional ownership.
Conversely, existing empirical evidence acknowledges the crucial monitoring role of local
institutional ownership and supports the interior monitoring hypothesis, which posits that
domestic institutional ownership positively impacts the flow of firm-specific information due
to their effective monitoring compared to foreign peers. For instance, I. Kim et al. (2016),
utilizing a large sample from 29 countries, propose the hometown hypothesis, which suggests
that domestic equity holdings are more effective at curbing earnings management, particularly
when they invest in smaller investee firms with fewer financial analysts and higher levels of
out-of-control insider trading. Similarly, Ferreira et al. (2017) provide empirical evidence
related to the quality of a firm's information environment, demonstrating that a higher fraction
of domestic portfolio flows can lead to an information advantage in countries with more
opacity, challenging market conditions, significant information asymmetry, and more
liquidity-related issues with specific stocks. Supporting this viewpoint, the involvement of
local equity ownerships, with their proximity advantages, plays a vital role in shaping the
corporate governance system in emerging markets. They achieve this by mitigating firmspecific information asymmetry, reducing information gathering and communication costs,
influencing the selection of independent board members, and impacting the ability of top
managers to capture the firm's cash flow or absorb firm-specific risk (Chung et al., 2022; Tee,
2017). Local institutional shareholdings may possess a greater information advantage in
controlling their investment portfolios and deterring opportunistic financial reporting.
Moreover, they establish better connections with related parties, including corporate insiders,
affiliated or subsidiary firms, substantial shareholders, main creditors, major customers, and
input suppliers (Liu, Chung, Sul, & Wang, 2018). In summary, the interior monitoring
hypothesis suggests that domestic institutional ownership exerts a more positive effect on
firm-specific information and a more negative effect on stock price co-movement compared to
foreign institutional ownership.
5
3. Sample and Descriptive Statistics
3.1 Sample Construction
We collected data on all common stocks listed on the Taiwan Stock Exchange (TWSE) and
the Taipei Exchange (TPEx) spanning the period from 2004 to 2020. Our sample comprises
22,610 firm-year observations. The data includes information on daily dollar volume, daily
stock return, earliest stages market capitalization, and yearly-based institutional ownership.
We obtained this empirical data from the Taiwan Economic Journal (TEJ) database. To ensure
the integrity of the sample, we excluded financial institutions, utilities, and observations with
non-positive total assets. All relevant variables used in this study were compiled from the TEJ.
3.2 Variable Definitions
3.2.1 Measuring stock price co-movement
In this study, we utilize stock market synchrony as an indicator of the extent to which market
and industry characteristics are reflected in equity returns. A higher R-squared value for a firm
indicates a stronger correlation between its stock price movements and market and industry
signals. To measure stock market synchrony, we adopt the widely used market-model Rsquare, first introduced by Morck et al. (2000). This proxy has been extensively employed in
the literature and has garnered substantial empirical support for its informative interpretation
(Dang, Dang, Hoang, Nguyen, & Phan, 2020; Gul, Kim, & Qiu, 2010; Xing & Anderson,
2011). Following the approach of An and Zhang (2013), we employ the following linear
regression in Equation (1) to compute the R-square value for each stock year:
(1)
where
is stock i’s weekly returns in week t over the year.
and
are the Taiwan
TAIEX value-weighted weekly market returns in week t and t−1 over the year, respectively.
and
are the value-weighted weekly industry j’s returns in week t and t−1 over the
year, respectively. and are estimated parameters.
To achieve a nearly normally distributed variable of co-movement (𝑅²) for firm 𝑖 in year 𝑡,
we take the logarithm of R-square. The co-movement proxy (
) is defined in Equation
(2) as follows:
A high R-square denotes a high degree of stock return moving together more, and a low
R-square denotes a low degree of stock return movement for a given stock for a specific
period.
3.2.2 Classification of institutional investors
In order to conduct our primary analysis, we collect firm-year data on institutional
ownership. The categorization of institutional investors is based on the geographical location
of the securities holding institution's country. Institutional holdings are classified as "foreign"
when the institution's country of origin is different from Taiwan, and they are labeled as
"local" when they are domiciled in Taiwan. For each firm-specific sample at the end of each
year, we calculate the total average ownership held by qualified foreign institutional investors
(FIO) and local institutional investors (LIO), which includes mutual funds and securities
dealers, in both the TWSE and the TPEx market. Subsequently, various analyses are
conducted to assess the impact of foreign and local institutional investors' ownership ratios on
stock price co-movement. This enables us to determine how the presence of foreign and local
institutional ownership influences the synchronicity of stock price movements.
6
3.2.3 Measuring relevant variables
In addition to firm-year observations on stock price and institutional ownership, we include
other relevant yearly-based firm and board characteristics measures in the final dataset. These
measures consist of market capitalization (CAP), market-to-book ratio (MB), the ratio of
earnings after taxes (ROE), the ratio of a firm's total debt to its total assets (DEBT), volatility
of firm-specific weekly returns (SIGMA), skewness coefficients of firm-specific weekly
returns (SKEW), kurtosis coefficients of firm-specific weekly returns (KURT), number of
board members (BSIZE), total fraction of shares of the stock owned by the board of directors
(BOR), percentage of directors who also occupy top managerial positions (BDUAL), and the
total fraction of shares of the stock owned by the top 10 largest shareholders (BLOCK). To
assess the influence of agency theory on the relation between foreign institutional ownership
(FIO) and local institutional ownership (LIO) with stock price synchronism, we incorporate
two agency problem proxies, namely, the deviation of control rights to cash flow rights (DEV)
and the proportion of independent directors (BIND), into the analysis.
Table 1 provides detailed definitions of these variables capturing firm and board
characteristics, as well as the agency problem proxies. These variables will be essential in
evaluating the relationship between foreign and local institutional ownership and stock price
co-movement in the subsequent analysis.
3.3 Descriptive Statistics
Table 2 presents a comprehensive summary of the univariate descriptive statistics
pertaining to the variables utilized in this research paper. The sample comprises firms
encompassing a total of 22,610 time-series observations spanning the years from 2004 to
2020.
<<Insert Table 2 Here>>
Panel A presents a comprehensive overview of the summary statistics concerning the
proportion of stocks exhibiting synchronous movement. Specifically, the mean and median
values for the dependent variable "Synch" are reported as -0.677 and -0.6, respectively.
Notably, these values surpass the corresponding figures documented by J.-B. Kim and Yi
(2015) for the Korean emerging market and Utz (2017) for the Japanese emerging market.
This suggests that Taiwanese firms display a greater inclination to incorporate industry and
market-specific information into stock prices, as opposed to firm-level information, in
comparison to their Korean and Japanese counterparts. Furthermore, the standard deviation of
"Synch" is indicated as 1.02, indicating the presence of cross-sectional variation in stock price
co-movement, which warrants further investigation in the subsequent analysis.
Moving on to Panel B, the statistics pertain to foreign and local institutional investors
holding substantial positions in the sample firms. Throughout the analysis period, the average
aggregate ownership by foreign and local institutional investors in the Taiwan Stock
Exchange (TWSE) stands at 10.087% and 1.002%, respectively. Notably, foreign institutional
holdings demonstrate a larger share of TWSE shares relative to mutual funds or securities
dealers, signifying their significant role within the Taiwan stock market, as discussed in prior
studies by C.-L. Chen et al. (2018), H.-G. Huang, Tsai, Weng, & Wu (2021), and Liang et al.
(2012).
Proceeding to Panel C, the focus is on other control variables that are likely to influence the
influx of individual firm-specific information into stock markets. On average, TWSE-listed
stocks exhibit the following characteristics: NT$ 18.315 billion capitalization (CAP), 1.801
MB market-to-book ratio (MB), 4.821% return on equity (ROE), 42.686% debt ratio (DEBT),
5.280% volatility (SIGMA), 0.526% skewness (SKEW), 2.974% kurtosis (KURT), 9.347%
blockholder ownership (BSIZE), 23.562% board size (BOR), 23.115% board duality
(BDUAL), and 21.554% block holder dual holdings (BLOCK).
Furthermore, the average values for agency index-related statistics, DEV and BIND, are
recorded as 3.281 and 0.204, respectively. This finding aligns with the conclusions drawn by
Chiu, Chung, and Hung (2021) and indicates the presence of significant agency conflicts
7
between controlling and minority shareholders in the Taiwanese market, primarily attributed
to the substantial discrepancy between controlling and cash flow rights over the entire period.
4. Main Results: Foreign versus Local Institutional Ownership and Stock Price comovement
4.1 Regression Analysis
In this section, our primary focus lies in examining the cross-sectional relationship between
foreign and local institutional ownership, serving as the key independent variable, and stock
price co-movement, which serves as the primary dependent variable. To achieve this, we
conduct a series of panel regressions, wherein we incorporate a comprehensive set of relevant
variables that are known to potentially influence stock price co-movements. By including
these relevant factors, we aim to account for their effects and isolate the impact of foreign
versus local institutional ownership on stock price co-movement (e.g., (Boubaker et al., 2014;
Chan & Hameed, 2006; Chiu et al., 2021; J.-B. Kim & Yi, 2015). The baseline specification is
in Equation (3):
(3)
where
is stock i’s stock price synchronicity in year y.
(
) is stock i’s
ownership by foreign (local) institutional investors at the end of year y.
are a set of
control variables for stock i in year y. are industry-fixed effect.
are year-fixed effect. The
outcomes of our primary regression in Equation (3) are presented in Table 2. All reported tvalues for the estimated coefficients throughout the paper are based on heteroscedasticityrobust standard errors clustered by years.
<<Insert Table 3 Here>>
As demonstrated in Table 3, our analysis reveals a statistically significant and negative
relationship between foreign institutional ownership (FIO) and local institutional ownership
(LIO) coefficients concerning stock price synchronicity (Synch). After meticulously
controlling for a comprehensive set of relevant cross-sectional factors, industry-fixed effects,
and year-fixed effects, we observe consistent results across the models. For instance, in Model
(1), the coefficient on FIO is estimated to be -0.0558, exhibiting a high t-value of -8.61 at the
1% significance level. Similarly, in Model (2), the coefficient on LIO is estimated to be 0.0134, with a t-value of -2.19 at the 5% significance level. An intriguing finding is that both
the absolute coefficient and t-statistic for FIO are greater than those for LIO, indicating that
the impact of overseas institutional investors supersedes that of domestic institutional
investors in influencing stock price synchronicity. This suggests that foreign institutional
ownership plays a more dominant role in shaping the co-movement of stock prices compared
to its domestic counterpart.
In Model (3), we proceed to estimate the combined effect of the two institutional investor
variables, FIO and LIO, in a multiple regression framework to determine which type of
institutional ownership exerts a more dominant influence on stock price co-movement. The
results reveal a similar pattern to the previous models, with both FIO and LIO coefficients
being statistically significant at the 1% and 5% levels, respectively, and exhibiting a negative
relationship with stock price co-movement (Synch). Interestingly, we observe that the impact
of TWSE foreign investors on stock price movement is stronger (more negative) than that of
domestic investors. For instance, the absolute value of the coefficient on FIO (0.0576) is
larger than that on LIO (0.0152). To further validate this finding, we conduct an F-test, which
confirms the statistically significant difference between the coefficients of FIO and LIO at the
1% level, with a coefficient value of -0.0425.
Overall, these results substantiate the negative association between foreign institutional
holdings and stock price synchronicity, in line with our initial hypothesis of the exterior
monitoring hypothesis. This suggests that foreign institutional ownership, being a more
8
influential driver of stock co-movement, enhances the assimilation of firm-specific
information into stock prices, consequently mitigating the co-volatility of share prices.
4.2 Considering various agency problem effects
In line with the findings from related studies by Gu, An, Chen, and Li (2022), Lel (2019),
and Lou, Lu, and Shiu (2020), it is established that foreign institutional ownership tends to be
more effective in monitoring managerial actions related to information transparency, reducing
real earnings management, and enhancing managerial decision-making quality. This, in turn,
leads to an improvement in the quality of firm-specific information. Building upon these
insights, we extend our investigation to examine whether the degree of agency problems
within a firm impacts the relationship between FIO and LIO and stock price co-movement.
For this purpose, we employ two widely recognized proxies for firm agency problems: the
deviation of controlling rights to cash flow rights (DEV), as developed by R La Porta, Lopezde-Silanes, Shleifer, and Vishny (1999) and later refined by Rafael La Porta, Lopez-DeSilanes, Shleifer, and Vishny (2002), and the proportion of independent directors (BIND)
within each sample firm during a given year. By re-estimating Model (3) from Table 3, we
categorize the sample into two subsamples based on the median values of each managerial
agency problem measure. This approach allows us to examine whether the relationship
between FIO, LIO, and stock price co-movement varies depending on the level of agency
problems experienced by the firm. Analyzing these subsamples will provide insights into the
interplay between foreign and local institutional ownership and the firm's agency issues
concerning stock price synchronicity.
<<Insert Table 4 Here>>
The analysis in Table 4 is centered around two agency proxies, DEV and BIND, and
explores how the relationship between foreign institutional ownership (FIO) and local
institutional ownership (LIO) and stock price co-movement varies across firms facing
different levels of agency problems.
Panel A of Table 4 presents the results for the DEV proxy. The sample is divided into two
subgroups based on the level of DEV, namely high DEV and low DEV, using the median of
DEV as the threshold. The findings reveal that qualified foreign institutional shareholders
exhibit a strong negative association with DEV across both high and low DEV subgroups. On
the other hand, local fund-sorted institutional shareholders show a significant negative
association with DEV only in the higher DEV subgroup. For instance, in the foreign fundsorted model, the estimated coefficient for higher DEV is -0.1072, and for lower DEV is 0.0275, both significant at the 1% level. In contrast, the estimated coefficient for local funds is
significant only in the higher DEV subgroup (coefficient = -0.0216, t = -2.51). The F-test
confirms that the difference in coefficients between FIO and LIO is significantly larger for the
higher DEV subgroup (difference in coefficient = -0.0856, p-value < 0.01).
Moving to Panel B, the results are based on the BIND proxy. The sample is divided into
two subgroups with high BIND and low BIND, using the median of BIND as the cutoff point.
The analysis reveals that the coefficient-related comparison between FIO and LIO is
significantly stronger in the lower BIND subgroup than in the higher BIND subgroup, in terms
of both magnitude and significance level, as determined by the F-test (difference in coefficient
= -0.0596, p-value < 0.01).
Overall, the findings in Table 4 indicate that the impact of FIO on stock price co-movement
is more pronounced in firms facing high severity of agency problems. This underscores the
importance of FIO-driven monitoring function in reducing the co-movement of stock prices,
particularly in firms with significant agency challenges.
9
5. Conclusions
This study's primary objective is to investigate the extent to which foreign and local
institutional ownership reflects firm-specific information by examining its impact on stock
price co-movement. The discussion revolves around two competing perspectives on how
institutional ownership affects stock price co-movement through the information content
impounded into stock prices. According to the exterior monitoring hypothesis, there is a
negative relationship between foreign institutional ownership and stock price co-movement.
This perspective suggests that foreign institutional investors play an effective monitoring role,
which results in a higher quality of information being incorporated into stock prices. Foreign
institutional investors are more likely to scrutinize managerial actions, enhance information
transparency, and curb earnings management. As a consequence, their presence leads to a
reduction in stock price co-movement since firm-specific information is more accurately
reflected in the stock prices. Thus, foreign ownership is expected to have a more significant
negative impact on stock price co-movement compared to domestic ownership. Conversely,
the interior monitoring hypothesis proposes a negative relationship between local institutional
ownership and stock price co-movement. This view posits that firms held by a higher fraction
of domestic institutional investors are better monitored. These local investors are more
familiar with the domestic market, regulations, and the business environment, enabling them
to effectively oversee managerial decisions. As a result, stock prices are more likely to reflect
firm-specific information accurately, leading to lower co-movement. In this scenario, local
institutional ownership is expected to have a more pronounced negative impact on stock price
co-movement compared to foreign ownership.
These two competing views present different perspectives on how institutional ownership
influences the information environment and stock price co-movement. The study aims to
empirically assess these hypotheses and shed light on the extent to which foreign versus local
institutional ownership impacts the incorporation of firm-specific information into stock
prices, ultimately affecting stock price co-movement. By examining the empirical evidence,
the study seeks to contribute to the existing literature on institutional ownership and its
implications for stock market efficiency and information dissemination.
Our study's examination of a unique sample of firms listed on the Taiwan Stock Exchange
from 2004 to 2020 yields empirical evidence consistent with the exterior monitoring
hypothesis. The findings support the notion that foreign institutional ownership reflects
greater firm-specific information into stock prices through effective monitoring.
Firstly, after controlling for relevant factors, the study reveals that firms with higher
ownership by both overseas and local institutional investors experience significantly lower
stock price co-movement. Remarkably, foreign institutional ownership emerges as the
dominant factor in explaining stock price co-movement, as confirmed by conducting an Ftest, which shows that the negative relationship between foreign ownership and stock price
co-movement is more substantial than that of local ownership.
Secondly, the study further investigates whether the exterior monitoring hypothesis holds
true in firms with weak governance systems. By using two proxies to measure the level of
firm agency problems (deviation of controlling rights to cash flow rights and proportion of
independent directors), the findings demonstrate that foreign institutional investors have a
stronger negative impact on stock price co-movement in firms facing higher severity of
agency problems compared to local institutional investors. This suggests that non-local equity
flows, i.e., foreign institutional investors, serve as a significant substitute monitoring channel
for firms with weak governance mechanisms. As a result, they contribute to incorporating
more firm-level information into their stock returns.
Our study's insights contribute to advance the understanding of how differences in
investment ownership influence corporate information flows and, consequently, impact stock
price synchronicity. This fresh perspective highlights that the participation of foreign
institutional capital is more informative for investors than local capital in gathering valuable
news related to price policy for future investment strategies. Furthermore, this study's
implications for policymakers emphasize the importance of considering the ideal proportion
of equity ownership to enhance the transparency of the national securities market.
10
While the study provides valuable insights, it acknowledges its limitations in not
encompassing the entire market participant spectrum. Consequently, it opens the door for
further research to explore the significance of market components and their diverse influences
on stock price efficiency. This avenue could lead to a more comprehensive understanding of
the interactions between different types of institutional ownership and their impact on
information dissemination in financial markets.
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13
Table 1. Variable Definition
This table lists the variable definitions used in this paper. The sample contains stocks listed on the Taiwan Stock
Exchange (TWSE) and the Taipei Exchange (TPEx) during the period 2004–2020. All data are collected from
the TEJ.
Panel A: Stock Price Synchronicity
Stock price synchronicity,
, where
is stock i’s R-square in year y estimated based on
the calendar-year regressions for each firm:
, where
is stock i’s weekly returns in
week t over the year.
and
are the Taiwan TAIEX value-weighted weekly market returns
in week t and t−1 over the year, respectively.
and
are the value-weighted weekly industry
j’s returns in week t and t−1 over the year, respectively.
Panel B: Institutional Ownership
Ownership held by qualified foreign institutional investors in the TWSE and the TPEx for each
FIO
sample firm at the end of each year.
Ownership held by local institutional investors (i.e., mutual funds and securities dealers) in the
LIO
TWSE and the TPEx for each sample firm at the end of each year.
Panel C: Other Controls
Synch
CAP
Market capitalization for each sample firm at the end of the year.
MB
Market-to-book ratio for each sample firm in a given year.
ROE
Ratio of earnings after taxes to the book value of equity for each sample firm in a given year.
Ratio of a firm’s total debt to its total assets for each sample firm in a given year.
Volatility of firm-specific weekly returns for each sample firm in a given year, measured as the
SIGMA
standard deviation of firm-specific weekly returns residuals estimated from Eq. (1).
Skewness coefficients of firm-specific weekly returns for each sample firm in a given year,
SKEW
measured as the standard deviation of firm-specific weekly returns residuals estimated from Eq.
(1).
Kurtosis coefficients of firm-specific weekly returns for each sample firm in a given year,
KURT
measured as the standard deviation of firm-specific weekly returns residuals estimated from Eq.
(1).
BSIZE
Number of board members for each sample firm in a given year
total fraction of shares of the stock owned by the board of director for each sample firm in a given
BOR
year.
Percentage of directors who also occupies the top manager positions for each sample firm in a
BDUAL
given year.
Total fraction of shares of the stock owned by the top 10 largest shareholders for each sample firm
BLOCK
in a given year.
Panel D: Agency Problem Proxies
Deviation of control rights to cash flow rights in a given firm-year, as measured in La Porta, LopezDEV
de-Silanes, Shleifer, and Vishny (1999, 2002).
BIND
Proportion of independent directors for each sample firm in a given year.
DEBT
14
Table 2. Descriptive Statistics
This table reports the descriptive statistics for the variables used in this paper. Definitions of variables are
detailed in Table 1. The sample contains stocks listed on the Taiwan Stock Exchange (TWSE) and the Taipei
Exchange (TPEx) during the period 2004–2020. N represents number of firm-year observations. All data are
collected from the TEJ.
N
Mean
STD
Q1
Median
Q3
Panel A: Stock Price Synchronicity
Synch
22,610
−0.677
1.020
−1.296
−0.600
0.031
Panel B: Institutional Ownership
FIO (%)
22,610
10.087
15.068
0.574
3.769
12.373
LIO (%)
22,610
1.002
2.383
0.001
0.056
0.819
Panel C: Other Controls
CAP (NT$ b)
22,610
18.315
120.801
1.278
2.996
8.206
MB
22,610
1.801
2.678
0.910
1.330
2.040
ROE (%)
22,610
4.821
22.870
0.240
6.600
13.680
DEBT (%)
22,610
42.686
19.352
28.090
42.300
55.340
SIGMA (%)
22,610
5.280
2.661
3.434
4.928
6.632
SKEW (%)
22,610
0.526
0.959
−0.078
0.430
1.026
KURT (%)
22,610
2.974
3.801
0.751
1.859
3.773
BSIZE
22,610
9.347
2.405
8.000
9.000
10.000
BOR (%)
22,610
23.562
14.748
12.690
20.035
30.648
BDUAL (%)
22,610
23.115
15.637
14.290
20.000
30.950
BLOCK (%)
22,610
21.554
11.959
13.137
19.366
27.499
Panel D: Agency Problem Proxies
DEV
22,610
3.281
34.845
1.010
1.079
1.403
BIND
22,610
0.204
0.151
0.000
0.222
0.306
15
Table 3. Regression Analysis of Synch on Foreign versus Local Institutional Ownership
This table reports the results of the panel regression analysis of Synch on foreign versus local institutional
ownership by estimating the following model:
where
is stock i’s stock price synchronicity in year y.
(
) is stock i’s ownership by foreign
(local) institutional investors at the end of year y.
are k control variables for stock i in year y. are
industry-fixed effects.
are year-fixed effects. For brevity, the constants, the industry-, and the year-fixed
effects are unreported. For comparison, we report the standardized coefficients. The t-statistics based on
heteroscedasticity-robust standard errors clustered by years are reported in parentheses. F-test is adopted to
compare the coefficients on
and
in the regression model. *, **, and *** indicate significance at the
10%, 5%, and 1% levels, respectively. The sample consists of stocks listed on the Taiwan Stock Exchange
(TWSE) and the Taipei Exchange (TPEx) during the period 2004–2020. All data are collected from the TEJ.
(1)
FIO
MB
ROE
DEBT
SIGMA
SKEW
KURT
BSIZE
BOR
16
(3)
−0.0558
−0.0576
(−8.61)***
(−8.85)***
−0.0134
−0.0152
(−2.19)**
(−2.48)**
0.2649
0.2433
0.2674
(26.84)***
(25.49)***
(26.98)***
−0.0697
−0.0667
−0.0673
(−12.28)***
(−11.62)***
(−11.74)***
0.0588
0.0671
0.0636
(9.72)***
(10.89)***
(10.31)***
−0.0240
−0.0237
−0.0233
(−3.99)***
(−3.92)***
(−3.86)***
0.0843
0.0865
0.0889
(12.40)***
(12.60)***
(12.96)***
−0.0060
−0.0063
−0.0073
(−0.79)
(−0.82)
(−0.95)
−0.0344
−0.0319
−0.0328
(−4.73)***
(−4.39)***
(−4.52)***
−0.0383
−0.0361
−0.0386
(−6.36)***
(−5.96)***
(−6.37)***
−0.1217
−0.1271
−0.1217
(−21.15)***
(−22.06)***
(−21.05)***
LIO
lnCAP
(2)
BDUAL
BLOCK
DEV
BIND
0.0013
0.0002
0.0020
(0.23)
(0.03)
(0.35)
−0.1725
−0.1817
−0.1725
(−29.25)***
(−31.14)***
(−29.14)***
−0.0137
−0.0132
−0.0140
(−2.59)**
(−2.47)**
(−2.64)**
0.0107
0.0069
0.0119
(1.61)
(1.04)
(1.79)*
Difference between FIO and LIO
−0.0425
F-value
26.74***
industry-fixed effect
Y
Y
Y
year-fixed effect
Y
Y
Y
N
22,610
22,610
22,610
Adj R2
0.4142
0.4112
0.4134
17
Table 4. Regression analysis of Synch on foreign versus local institutional ownership for subsamples sorted
by the degree of agency problems
This table reports the results of the panel regression analysis of Synch on foreign versus local institutional
ownership (
and
) by estimating Model (3) of Table 3, separately for subsamples sorted by the degree
of agency problems. In Panel A (B), two subsamples are sorted by DEV (BIND) based on its median in a given
year. For brevity, only the coefficients on
and
are reported. For comparison, we report the
standardized coefficients. The t-statistics based on heteroscedasticity-robust standard errors clustered by years
are reported in parentheses. F-test is adopted to compare the coefficients on
and
in the regression
model. *, **, and *** indicate significance at the 10%, 5%, and 1% levels, respectively. The sample consists of
stocks listed on the Taiwan Stock Exchange (TWSE) and the Taipei Exchange (TPEx) during the period 2004–
2020. All data are collected from the TEJ.
Panel A: Agency problem proxy by DEV
Higher DEV
Lower DEV
(DEV>median)
(DEV median)
FIO
−0.1072
−0.0275
(−10.73)***
(−2.99)***
LIO
−0.0216
−0.0101
(−2.51)**
(−1.15)
Difference between FIO and LIO −0.0856
−0.0174
F-value
49.13***
2.27
controls
Y
Y
industry-fixed effect
Y
Y
year-fixed effect
Y
Y
N
11,378
11,232
Adj R2
0.4254
0.4011
Panel B: Agency problem proxy by BIND
Higher BIND
Lower BIND
(BIND>median)
(BIND median)
FIO
−0.0323
−0.0798
(−3.60)***
(−8.65)***
LIO
−0.0064
−0.0202
(−0.73)
(−2.36)**
Difference between FIO and LIO −0.0259
−0.0596
F-value
5.58***
23.93***
controls
Y
Y
industry-fixed effect
Y
Y
year-fixed effect
Y
Y
N
11,215
11,395
Adj R2
0.4076
0.4260
18