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Financial Globalization, Governance, and the Evolution of the Home Bias

Authors

  • BONG-CHAN KHO,

    1. Seoul National University
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  • RENÉ M. STULZ,

    1. Ohio State University, ECGI, and NBER
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  • FRANCIS E. WARNOCK

    1. University of Virginia, IIIS, FRB-Dallas, and NBER. We are grateful to Ji-Woong Chung, Jin-Woo Kim, Carrie Pan, and Francesca Silvestrini for research assistance. We thank Craig Doidge for providing us with crosslisting data. We are grateful for helpful comments and suggestions of an anonymous referee, Doug Skinner (the editor), Heitor Almeida, John Ammer, Menzie Chinn, Josh Coval, Craig Doidge, Wayne Ferson, Mary Margaret Frank, Andrew Karolyi, Philip Lane, Christian Leuz, Marc Lipson, Chris Lundblad, Gregory Miller, Jim Shapiro, José Viňals, Daniel Wolfenson, seminar participants at Boston College, Darden, Ente “Luigi Einaudi” Institute, Federal Reserve Bank of New York, IMF, and the Ohio State University, and participants at the BIS Annual Conference, ECB Conference on Financial Globalization, JAR Annual Conference, NBER IFM Meeting, WFA, and Wharton Impact Conference on International Governance. For generous support, Kho thanks the Institute of Management Research at Seoul National University and Warnock thanks the Federal Reserve Bank of Dallas and the Darden School Foundation.
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ABSTRACT

We merge portfolio theories of home bias with corporate finance theories of insider ownership to create the optimal corporate ownership theory of the home bias. The theory has two components: (1) foreign portfolio investors exhibit a large home bias against countries with poor governance because their investment is limited by high optimal ownership by insiders (the “direct effect” of poor governance) and domestic monitoring shareholders (the “indirect effect”) in response to the governance and (2) foreign direct investors from “good governance” countries have a comparative advantage as insider monitors in “poor governance” countries, so that the relative importance of foreign direct investment is negatively related to the quality of governance. Using both country-level data on U.S. investors' foreign investment allocations and Korean firm-level data, we find empirical evidence supporting our optimal corporate ownership theory of the home bias.

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