Foreign Investors' Reaction to Lower Profitability – The Role of Information Asymmetry^*

Abstract

Owners of firms in trouble are more exposed to moral hazard problems than owners of successful firms. Foreign owners who face higher costs to monitor the firm should be more vulnerable to these problems than domestic ones. Consequently, a downward revision in a firm's expected future earnings should push foreign investors to sell their shares to a larger extent than domestic investors. We test this hypothesis on profit warnings issued at the Helsinki Stock Exchange. Our results reveal that in the wake of profit warnings foreign investors will predominantly sell, while domestic investors pick up the net sales by foreigners. Differences in the scale of the foreign investor sell-out reaction are explained by a number of variables. The most significant one is our proxy for the magnitude of surprise in the warning. The reaction also increases with the degree of perceived information asymmetry for the firm that issued the warning, while foreign members on the firm's board have a moderating impact. By contrast, a number of general corporate governance-related variables have no statistically significant impact on the reaction.

The Relationship between Information Asymmetry and the Quality of Audit: An Empirical Study in Istanbul Stock Exchange

“…One of the requirements of corporate governance is a high quality management. A high quality management decreases information asymmetry, too (Berglund & Westerholm, 2010). The number of independent members in top management is important in terms of the measurement of the quality of management.…”

“…Increasing number of voluntary disclosures by management depending on corporate governance (Karamanou & Vafeas, 2005), the existence and the independence of audit committee (Krishnan & Visvanathan, 2008), and high quality of management (Berglund & Westerholm, 2010) are among the factors reducing information asymmetry. These factors stand as non-financial variables that can be used for measuring information asymmetry.…”

Does stock market liberalisation restrain corporate financialisation?

“…These advantages enable them to dig out reliable firm-specific information (Bae et al, 2012) and make more reasonable anticipation about future corporate earnings. Berglund and Westerholm (2010) conclude that foreign investors are more likely to sell their shares in response to their expected profitability than domestic investors. Similarly, Chen et al (2009) suggest that foreign investors earn higher abnormal returns even holding the same access to public information and foreseen strategies.…”

Does governance transparency lead to more supportive foreign investment?

“…They cannot evaluate information about the markets and the firms in the markets (Yang et al, 2012) because of institutional difference. Even though foreign investors possess previous investment experience, they remain in a disadvantageous or vulnerable position in terms of information to evaluate the invested firms due to agency issues (Berglund & Westerholm, 2010). Furthermore, Mitton (2002) argued that firms adhering to better governance and more information T&D in emerging economies would suffer less from financial crises.…”