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Informed trading by foreign institutional investors as a constraint on tunneling: evidence from China

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posted on 2023-06-09, 05:33 authored by Xiaoxiang ZhangXiaoxiang Zhang, Xiaotong Yang, Roger StrangeRoger Strange, Qiyu Zhang
Research Question/Issue: This paper investigates how the trading activities of foreign institutional investors (FIIs) affect the tunneling activities of controlling shareholders in an emerging economy (China). Research Findings/Insights: We use an unbalanced panel dataset of 167 FIIs with investments in Chinese real estate firms during the period 2003 to 2011, which gives us 1006 firm-year observations in total. We find strong support for our hypothesis of an inverted U shaped relationship between FII trading turnover and the extent of tunneling by controlling shareholders. Theoretical/Academic Implications: In many emerging economies, the institutional environments for investor protection are weak. Powerful controlling shareholders may take the opportunity to extract private benefits via tunneling activities to the detriment of minority shareholders, and informed minority investors may also take advantage of less well-informed investors. There are thus multiple principal-principal agency conflicts. FIIs are a particularly important group of informed investors. On the one hand, large-scale aggressive trading by FIIs should drive stock prices to fundamentals, provide market discipline to management, and thus limit tunneling. On the other hand, FIIs may opt to exploit their private knowledge to gain trading profits at the expense of uninformed investors, and implicitly support tunneling. We highlight these potential effects, and demonstrate empirically an inverted U-shaped relationship between FII trading turnover and the extent of tunneling. Practitioner/Policy Implications: Tunneling is a serious issue, particularly in emerging economies where the institutional arrangements for minority investor protection are often weak. FII involvement may enhance market discipline, but may also exacerbate the problem so policy-makers need to guard against potential adverse effects. An ownership cap on FII shareholdings is unlikely to be effective, but policy-makers might strengthen QFII license revocation policies and issue more licenses to promote competition among FIIs

History

Publication status

  • Published

File Version

  • Accepted version

Journal

Corporate Governance: An International Review

ISSN

0964-8410

Publisher

Wiley

Issue

4

Volume

25

Page range

222-235

Department affiliated with

  • Business and Management Publications

Full text available

  • Yes

Peer reviewed?

  • Yes

Legacy Posted Date

2017-03-27

First Open Access (FOA) Date

2019-05-13

First Compliant Deposit (FCD) Date

2017-03-27

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