Components of Comparison

Article from CRP

Article from Student

Title

Foreign Ownership and Investment: Evidence from Korea

Financial Markets Integration in India

Topic

The understanding and accessing financial market

The understanding and accessing financial market

Theory used by article

Modigliani and Miller (1958)

Firm’s investment solely on the profit opportunity.

Fleming (1962); Mundell (1963)

The openness of the financial system to know the structure of their economies and implement policies that will be effective in achieving their aims.

Hypothesis of research

Cash-flow sensitivity of investment to be lower in foreign owned firmsthan in domestically owned firms.

There is strong integration of the domestic call money market with the LIBOR.

Variables used in research

K_t = Capital at the beginning of period t

I_t = Capital expenditures during period t

Q_t = Average Q at the beginning of period t

TA_t = Total asset at the beginning of period t

B_t = Book value of debt at the beginning of period t

E_t = Market value of equity at the beginning period of t

CF_t = Cash flow during period t

High_i = 1 for firms with high foreign ownership, = 0 for firms with high foreign ownership

Low_i = 1 for firms with low foreign ownership, = 0 for firms with high foreign ownership

Before_t = 1 before 1998, = 0 after 1998

Aftert = 1 after 1998, =0 before 1998

-          91-day Treasury bill rates (TB-91)

-          Call Money Rates (CMR)

-          Indian Rupee/USdollar exchange rate (ER)

(as a measure of returns in the domestic financial markets)

-          London Inter-bank Offer Rate – LIBOR

(as the measure for the foreign interest rate)

Method of analysis

The ordinary least square (OLS) method

To result in biased estimates because of endogeneity and heterogeneity problems.

Generalized method of moments (GMM)

Is used for dynamic panel models and depends mainly on the adoption of appropriate instruments and the efficient elimination of unobserved firm effects.

Multiple co-integration approach

Result of the analysis

Table 2. The mean and standard deviation of each variable for 1992-2002 on 371 firms

Both investment ratio and cash-flow ratio are higher for firms with high foreign ownership. Investment-capital ratio, Q, sales ratio, and cash-flow ratio decreased after 1998.

Table 3. The basic GMM estimation results of investment function for the whole sample period

Sargan test results indicate that the instruments used are valid. Both m1 and m2 statistics are insignificant, indicate that little unobserved individual effects remain in the GMM estimation result. Wald test show that the model specification is satisfactory. For both the q model and the Euler model, it is found that firms are financially constrained since the coefficient in CF/K is statistically significant at the conventional level. It suggest that the availability of internal funds does affect investment level.

Table 4. Cash-flow sensitivity of investment varies across differing levels of foreign ownership

Both a q model and an Euler equation are estimated, adopting two classification methods to distinguish high foreign ownership from low foreign ownership. In both models, the cash flow sensitivity for firms with high foreign ownership is statistically insignificant. Cash flow has a significant impact on the investment of firms with low foreign ownership. It suggest that financial constraints faced by firms decrease as foreign ownership increases.

Table 5. Investment before and after 1998

The cash flow are lower after 1998. Before the stock market was opened,  the estimates were 0.815 and 0.214 while the estimates are 0.096 and 0.068 after 1998. The opening of the stock market is surely one of the factors in the mitigation of financial constraints. It is found that liquidity constraints are reduced mainly in firms with low foreign ownership. Cash-flow sensitivity in firms with high foreign ownership is statistically insignificant regardless of time periods.

Table 7. Nonlinearity test for foreign ownership and investment

No evidence is found for nonlinearity for foreign ownership and cash-flow effect. The coefficient in (CF/K) decrease monotonically with the level of foreign ownership. Liquidity constraints are not statistically significant in firms with high foreign ownership. Foreign ownership seems to have linear relationship to financial constraints.

Table 1. and Table 2.

All the four variables : CMR, TB-91, ER and LIBOR were found to be non-stationary in their levels while found to be stationary in their first differences. There is presence of long-run relationship only between CMR and LIBOR. The relationship between ER and LIBOR seems to be weak (at 10 per cent level of significance). There is no long-run relationship between TB-91 and LIBOR. It ndicates that while the short-term money market is more integrated with the international financial market, there is no so robust integration between the domestic foreign exchange market and the foreign market. This may be due to

the financial market reforms that are initiated in the money market. Also, the foreign exchange market in India is still a managed market with regular (both direct and indirect) intervention by the Reserve Bank of India in its day to day business.

Table 3.

Any changes in the LIBOR market, the speed of adjustment in the CMR is much higher than in ER. It only indicates that the Indian short-term money market, compared with any other segment of domestic financial markets, is more integrated and adjusts comparatively fast to the changes in the interinternational financial markets.

the changes in the international financial markets.