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Control versus firm value: the impact of restrictions on foreign share ownership.

Various developed economies such as Switzerland, Finland, Sweden, and Norway have imposed foreign-ownership restrictions on the stocks of companies based there. The developing Asian economies such as Singapore, Malaysia, Thailand, Indonesia, Philippines, Taiwan, South Korea, and China have imposed similar restrictions on their stocks. While some of these restrictions are statutory, many are self-imposed through the company's articles of incorporation. Most of these companies in the Asian economies claim that their businesses involve strategic and national interests. Therefore, there is a need to maintain both operational and strategic control to prevent a take-over or a buyout. Fund managers and institutional investors who look for international diversification consider these restrictions explicit barriers to international investments.

The purpose of this study is to reconsider the case for such restrictions. My findings suggest that they may involve a significant loss of shareholder value. If management strives to maximize shareholder value, it may be advantageous to set in place alternative restrictions that prevent a loss of corporate control by the local shareholders.

I pose the question: does foreign ownership add value to the firm? If foreign ownership does in fact add value to the firm, then is there a case for lifting the foreign ownership limits? A unique event occurred on the Stock Exchange of Singapore (SES) that allows me to partially address this question. Following the delisting of Malaysian stocks on the SES on January 2, 1990, the Monetary Authority of Singapore announced on June 26, 1990, that the foreign ownership limit for local banks would be raised from 20% to 40%. This represents a relaxation of the restriction on foreign ownership. On the other hand, The Development Bank of Singapore (DBS) had until then been exempted from complying with any restriction on foreign ownership. It therefore was an event that effectively reduced the foreign ownership limit from 100% to 40% for DBS, while it grew from 20% to 40% for all other Singapore-incorporated banks. This event study investigates the effect of imposing (relaxing) such restrictions on firm value.

The redefinition of "foreigners" follows this relaxation of the restriction on foreign ownership. Malaysians, who were previously classified by the local banks as local shareholders, became foreign shareholders. As of June 26, 1990, there were two local banks that had separate listings: Overseas Chinese Banking Corporation (OCBC) and United Overseas Bank (UOB). Under the new definition, these banks would have breached the 20% foreign ownership limit. The DBS, on the other hand, which previously had no restriction on foreign ownership, had to comply with the 40% limit after the announcement. It announced that it would be freezing its prevailing foreign shareholdings at 44.1% for the time being. Its shares were suspended from trading on June 27, 1990. Separate listings of DBS Local and DBS Foreign started on June 29, 1990.

My preliminary evidence suggests that foreign ownership does enhance shareholder value for the larger companies on the Stock Exchange of Singapore (SES). While Stulz and Wasserfallen (1995) show that it may be optimal to restrict foreign ownership, this study suggests quite the opposite: shareholder value may increase through the relaxation, or better still, the lifting of such restrictions on foreign ownership. The corollary of my finding is that shareholder value may be decreased by the imposition or tightening of such restrictions.

This study also investigates the phenomenon of positive premia on foreign shares arising from restrictions on foreign ownership on the SES. The study identifies some of the explanatory factors for the cross-sectional variation of the premium. Preliminary findings suggest that firm size is an efficient signal for information availability for foreign investors. The firm-size effect subsumes liquidity and volatility effects on the SES. These findings have implications for governments, government-linked companies, and private corporations that have or are considering self-imposed restrictions on foreign ownership on their stocks.

The paper is structured as follows. In Section I, I discuss the restrictions on foreign ownership on the SES and the developments that led to separate listings. Section II discusses the relevant literature. The announcement effects of a change in the restrictions on foreign ownership of banks that are listed on the SES are analyzed in Section III. Section IV describes the data, the analyses, and the empirical findings. Section V concludes this study.

I. Restrictions of Foreign Ownership in Singapore

The statutory restriction on foreign ownership on the SES is confined to three industries: press, banking, and securities. Non-legislated limits on foreign ownership are self-imposed by the national carrier (Singapore Airlines), the national shipping line (Neptune Orient Lines), bus operator (Singapore Bus Services), petroleum company (Singapore Petroleum Company), and various privatized companies of the defense industry in Singapore.

A foreigner is most strictly defined as an individual who is not a citizen or permanent resident of Singapore; or a corporation, wherever incorporated, in which citizens or permanent residents of Singapore or any corporate body constituted by any statute of Singapore do not have an interest, in the aggregate, in at least 50% of the issued share capital of such corporation; or any legal entity (other than an individual or a corporation) which is not owned or controlled by the Government of Singapore or any authority thereof and is considered by the directors to be a foreign person.

Separate listings of local and foreign shares first started with Singapore Airlines (SIA) and Singapore Press Holdings (SPH) on May 3, 1988. Prior to that date, foreign investors who bought shares that were legally registered in the name of local investors were required to queue for registration of their shares when foreign-ownership restrictions became binding. Only when some other foreign investors had sold their shares to local investors and these were being re-registered in local investors' names could foreigners in the queue have the shares registered in their own name. While waiting for registration, these foreign investors risked losing out on dividend income, rights, and bonus issues. As a consequence, some foreign investors were willing to pay a premium for shares that were already legally registered in the name of another foreigner, rather than wait indefinitely for their turn to register shares that were bought from local investors. The persistent excess demand from foreign investors for SIA and SPH shares led to the development of over-the-counter markets for foreign shares in London, New York, and Tokyo. This in turn led to the separate listings of these shares on the SES on May 3, 1988.

The system of monitoring such restrictions on foreign ownership, whereby the nature of the share followed the identity of the registered holder, continued until October 1990. Under this system, local investors traded in local shares, and foreigners traded in foreign shares once the limits on foreign ownership became binding. In a sense, both local and foreign shares were then "restricted" shares. If local (foreign) investors want to hold foreign (local) shares without these shares losing their status, it had to be done through proxies. Of course, it was possible for a local (foreign) investor to hold unregistered foreign (local) shares illegally, if he was prepared to forego any dividends or rights or bonus issues.

This system of monitoring changed with the setting up of the Central Depository in October of 1990. Under this new system, ownership could be established at the point of purchase. The SES announced that all investors would be allowed to buy foreign shares that were traded under the scripless system. Such shares would maintain their foreign status and their premia no matter who holds them. This effectively legalized local investors holding foreign shares. Foreigners would remain restricted from holding local shares. Local shares would remain restricted to local investors while foreign shares became unrestricted shares.

By June 30, 1995, there were a total of 35 companies on the SES that carried restrictions on foreign ownership. When the limit on foreign ownership is about to be reached, the company would apply for - and SES would offer - separate listings of local and foreign shares under the scripless system. Table 1 shows that out of these 35 companies, 17 have arranged separate listings as of June 30, 1995.

II. Review of Relevant Literature

Stulz and Wasserfallen (1995) (hereafter S and w) propose a theory of foreign equity investment restrictions to explain why such restrictions exist in the first place. They show that under certain conditions, such restrictions maximize firm value. This may occur because the demand function for domestic shares differs between local and foreign investors due to deadweight costs in holding these securities. When foreign investors face greater deadweight costs in holding securities in their own countries, there would be capital flight to the domestic country. S and W model a condition in which the demand from foreign investors is less price elastic than from domestic investors. In this instance, firms can increase their value by imposing restrictions on foreign investors so that the foreign shares would trade at a premium to the local shares.

Both Loderer and Jacobs (1995) and S and W document an event study revolving around Nestle's November 17, 1988 announcement that it would allow foreign investors to buy registered shares with a limit of 3% for any one foreign investor. This announcement more than doubled the number of Nestle shares with voting rights available to foreign investors. Before the announcement, foreign investors could hold claims to slightly more than one-third of the total dividend payout of Nestle. After the announcement, foreign investors, in the aggregate, could hold claims to all of it, although each investor could own no more than 3%.

Both Loderer and Jacobs (1995) and S and W document that the unrestricted shares fell by SFr.2,079, from SFr.8,688 to SFr.6,609. At the same time, the price of the restricted shares increased from SFr.4,245 to SFr.5,782. As a result, the price ratio of the unrestricted to restricted shares fell from 2.05 before the announcement to 1.14 after the announcement.

Loderer and Jacobs (1995) offer four possible explanations for the Nestle crash: agency cost, tax evasion and wealth concealment, signaling, and price pressure. They analyze how various empirical findings taken together are inconsistent with the implications of each of the first three explanations but are consistent with those of the price-pressure hypothesis. The evidence supports the argument that both local and foreign investors have downward-sloping demand curves, rather than perfectly elastic demand curves that are implied in most international asset pricing models.

S and W argue that the price-corrections finding is consistent with the assumption of their model that there are deadweight costs that limit access to the domestic market. However, the finding that Nestle's value increased when the limit on foreign ownership was removed appears inconsistent with the predictions of their model. The model predicts that it would be optimal (value maximizing) for domestic firms to impose restrictions on foreign ownership when foreign investors face relatively greater deadweight costs in their home countries. The corollary is that it would be non-optimal for such finns to lift restrictions on foreign ownership. Yet, Nestle created value when the limit on foreign ownership was removed.

S and W's thesis is that it is optimal for firms to restrict foreign ownership when the demand by foreign investors is more inelastic than that of local investors. This condition results in segmented markets for local and foreign shares. Lam and Pak (1993) show that when the foreign-ownership limits become binding, such restrictions result in a localized form of segmentation in the markets for local and foreign shares on the SES. This means that the foreign shares that carry identical voting rights and rights to dividends, cash flows, and assets as the local shares of the same company would trade at different prices and offer different risk-return profiles under imperfect arbitrage conditions. Hietala (1989) and Bailey and Jagtiani (1994) observe the same phenomenon in Finland and Thailand, respectively, where foreign shares would trade at a positive premium to the local shares.

We have further evidence of market segmentation between the local and foreign shares on the SES. Lain, Koh, and Chia (1990) document that SIA Foreign offers an average excess return over SIA Local, even though it is persistently priced at a premium over SIA Local. Moreover, SIA Foreign appears to exhibit greater price volatility than SIA Local. SIA Foreign is found to offer [TABULAR DATA FOR TABLE 1 OMITTED] a higher average return than SIA Local while having a significantly lower beta with respect to the local market index. It is also observed that the dollar premium of SIA Foreign appears to increase over time after separate listing. It therefore appears that local investors would find it more attractive to invest in foreign shares rather than local shares.

In a separate study of 11 companies on the SES that have separate listings, Tse and Oh (1993) found that eight out of the 11 companies have foreign shares whose reward-to-variability ratio and reward-to-volatility ratio are superior to those of the local shares. These results are consistent with the earlier findings of Lam, Koh, and Chia (1990) that foreign shares appear to offer local investors higher risk-adjusted returns than the local shares of SIA when the foreign ownership limit has been reached.

In their study of the Thai capital market, Bailey and Jagtiani (1994) investigate the phenomenon of the positive premium on foreign shares on the Stock Exchange of Thailand (SET). Considering the hypothesis of differential required rates of returns on the local and foreign shares in a multi-factor asset pricing model framework, they suggest that foreign investors are prepared to pay a premium for liquid foreign stocks. They use two measures of liquidity to explain the cross-sectional variation of the premium on foreign shares.

Bailey and Jagtiani (1994) also offer an information-availability hypothesis for the premium on foreign shares. Firms that are large (small) tend to be better (less) known by foreign investors, and there is also more (less) information being produced for such firms. They also find evidence that the restriction in the supply of foreign shares is inversely correlated with the premium on foreign shares. Bailey and Jagtiani (1994) conclude that "high trading activity, good information flow, and privatization of large, well-known companies will attract foreign investors." These factors become more critical in developing financial economies, as information production and dissemination may be handicapped by the lack of concrete standards of professionalism in the financial services industry.

III. Event Study: The Announcement of the Revision of Foreign Ownership Limits for Banks on the Stock Exchange of Singapore

This event is unique because the restriction on foreign ownership tightened for the DBS while it was relaxed for the OCBC and the UOB with the announcement on June 26, 1990. Recall that the prices of Singapore bank stocks fell sharply in the London and US markets when they opened on June 26, 1990. When the market subsequently opened on June 27, 1990, in Singapore, OCBC foreign and UOB Foreign tumbled while their local shares shot up instantly, resulting in a significant fall in the premium on their foreign shares. As for DBS, a positive premium on its foreign shares emerged immediately after separate listing (see [ILLUSTRATION FOR FIGURES 1-3 OMITTED] for the price charts of the local and foreign shares of OCBC, UOB, and DBS respectively over the 30-day window around the announcement day).

Since the restrictions remained binding, the premia on these foreign shares increased over time. The premium on OCBC Foreign recovered to reach 30% again within a year. For UOB, it took three years for the premium on its foreign shares to hit 40% again.

What does this change in the restriction on foreign share ownership mean for firm value? Figure 4 illustrates how the value of DBS, OCBC, and UOB changed around the announcement day. At the stroke of the pen, the market capitalizations of OCBC and UOB increased by 4% and 9%, respectively. I surmise that the market capitalization of OCBC increased less than that of UOB because after the redefinition of "foreigners," OCBC already had 34.4% foreign shareholdings while UOB had only 26.7% foreign shareholdings. The restriction on foreign share ownership was therefore relaxed to a greater extent for UOB than for OCBC. If I extrapolate this to a complete lifting of all restrictions, it is reasonable to expect that the firm values of these local banks would have increased even more.

The opposite effect is evident for DBS in Figure 4. The market capitalization of DBS fell by 5% after the announcement and separate listing. The market was anticipating that new shares would have to be issued to local shareholders to bring the existing limit of 44.1% down to 40%.

IV. Data, Analyses, and Empirical Results

This section develops and tests a model that explains the stock market reaction evident in Figure 4.

A. Data

I identified 14 companies that had separate listings as of June 30, 1994. The foreign ownership limits range from 15% to 49%. Table 1 lists these 14 companies along with the dates of the separate listings and the respective foreign ownership limits. The data sources include the National University of Singapore Financial Database, the Stock Exchange of Singapore Journal, the Monthly Digest of Statistics, the Straits Times, and the Business Times. The data have been verified with a second source whenever available. The latest additions such as Hong Leong Finance, Overseas Union Trust, and Sing Investments are omitted in this study because of the relatively few data points available at the time of the analysis. The stock prices are adjusted for rights and bonus issues. The test period extends over three years from July 1991 through June 1994.

B. Definition of Variables

For each stock, five time series are constructed. I employed the daily percentage premium series, daily market capitalization series, daily liquidity series (two measures), and daily volatility series. Daily percentage premium is calculated as follows:

[P.sub.t] = ([P.sub.Ft] - [P.sub.Lt] / [P.sub.Lt]) 100 (1)

where

[P.sub.t] = percentage premium for day t

[P.sub.Ft]([P.sub.Lt]) = foreign (local) share closing price on day t

Total market capitalization is comprised of the combined market capitalizations of the local and foreign tranches. That is,

[S.sub.t] = [S.sub.Ft] + [S.sub.Lt]

= [P.sub.Ft] [N.sub.Ft] + [P.sub.Lt] [N.sub.Lt] (2)

where

[S.sub.t] = total market capitalization on day t

[S.sub.Ft]([S.sub.Lt]) = foreign (local) tranche market capitalization on day t

[P.sub.Ft] ([P.sub.Lt]) = foreign (local) share closing price on day t

[N.sub.Ft]([N.sub.Lt]) = number of foreign (local) shares outstanding on day t

As a proxy for the liquidity of the foreign shares, I calculated the ratio of the trading volume of the foreign shares to the total trading volume for each day t. This is defined as the volume ratio:

[L.sub.t] = [V.sub.R] / [V.sub.Lt] + [V.sub.Ft] (3)

where

[L.sub.t] = volume ratio of foreign shares on day t

[V.sub.Ft] ([V.sub.Lt]) = trading volume of foreign (local) shares on day t

I also computed the Amnivest liquidity ratio as a measure of the liquidity of the foreign shares:

[A.sub.t] = [summation of] [P.sub.Ft] [V.sub.Ft] where t = -1 to -20 / 1000 [summation of] [absolutely value of % [Delta][P.sub.FT]] where t = -1 to -20 (4)

where

[A.sub.t] = Amnivest liquidity ratio of foreign shares on day t

[absolute value of % [Delta][P.sub.Ft]] = absolute percentage price change of foreign shares on day t

A high value for At denotes strong liquidity because a large dollar volume of foreign shares is traded with little price change. The horizon for the ratio is arbitrarily set at 20 trading days as it is one of two periods (the other being a three-month period) Amnivest Corporation computes for clients.

The volatility time series is estimated by a modified range-type estimator (Garman and Klass, 1980):

[[Sigma].sub.t] = [H.sub.Ft] - [L.sub.Ft] / 0.5 ([H.sub.Ft] + [L.sub.Ft]) (5)

where

[[Sigma].sub.t] = standard deviation of the return on the foreign shares on day t

[H.sub.Ft] ([L.sub.Ft]) = intraday high (low) price of the foreign shares on day t

C. Descriptive Statistics

Table 2 summarizes the descriptive statistics for the pooled time series for the 14 companies in the sample. Both the volume-ratio series and the volatility series exhibit little variation, as compared to the percentage premium, market capitalization, and Amnivest liquidity ratio series. I note that apart from the volatility series, the other four series tend to follow a normal distribution.

Table 3 gives the Pearson correlation coefficient matrix for the percentage premium on foreign shares and the other variables. The percentage premium on foreign shares is significantly and positively correlated at the 0.01 significance level with the market capitalization, the Amnivest liquidity ratio, the foreign ownership limit, the volume ratio, and the volatility ratio, in declining order of magnitude of the correlation.

Table 4 gives the Spearman rank correlation coefficient matrix. The non-parametric test results suggest that all the variables, except for the volume ratio, are significantly and positively correlated with the premium on foreign shares at the 0.01 significance level. Again, market capitalization, the Amnivest liquidity ratio, and the foreign ownership limit have high correlations with the premium on foreign shares at 0.47, 0.39, and 0.25, respectively.

Figure 5 plots the average daily premium for the sample of 14 companies over the three-year period, July 1991 through June 1994. The average premium hovered around 20% throughout the period. It drifted to below 10% in October 1992 for lack of interest in the broader market. In the bull market of October 1993, the average premium exceeded 40%. When the market subsequently consolidated in 1994, the average premium stabilized at the 20% level again.

When the individual daily premium for the 14 firms is charted, the larger firms like Singapore Press Holdings, Singapore Airlines, The Development Bank of Singapore, Overseas Chinese Banking Corporation, and United Overseas Bank tend to enjoy higher premia than average. For example, Singapore Airlines Foreign and Singapore Press Holdings Foreign registered premia that exceeded 80% in the bull market of 1993. On the other hand, the smaller firms' premia averaged 10%. There were occasions when the premium fell below the zero level. In the worst of market conditions, Kay Hian James Capel Foreign traded at a discount of 20% to its local counterpart. This and other similar observations of foreign shares trading at a discount to their local shares provide further evidence that the markets for local and foreign shares on the SES are segmented under no-arbitrage conditions after October 1990. Unlike the pre-October 1990 era when arbitrage opportunities did arise from time to time, investors can no longer arbitrage in the local and foreign share markets because local and foreign shares maintain their status no matter who holds them.

D. Analyses and Empirical Results

The time series of the different variables are pooled across the sample of 14 companies. First, I regress the percentage premium on foreign shares on the explanatory variables individually and then together in multiple regression analyses. The regression analyses are corrected for autocorrelation using the Durbin-Watson d-statistics and for heteroskedasticity using White's (1980) correction.(1) Table 5 summarizes the results of the regression analyses.

I find that market capitalization alone explains 21.3% of the cross-sectional variation of the premium on foreign shares in Equation (1). In the case of the Thai capital market, Bailey and Jagtiani (1994) found that market capitalization explains 9.2% of variation in the premium on foreign shares. It is significant that market capitalization is positively correlated with the premium. That is, the larger (smaller) the firm, the higher (lower) the premium on its foreign shares. This finding is consistent with the information availability argument. International brokerage houses are more likely to focus on the larger firms in their recommendations to overseas clients. Foreign investors, therefore, are better able to access information concerning the larger firms than the smaller ones. Larger firms therefore attract greater foreign interest than the smaller firms. Our finding is consistent with the hypothesis that firm size proxies for information availability to foreign investors.

In Equation (2), I find that the volume ratio explains only 0.4% of the cross-sectional variation in the premium. This measure of liquidity contrasts strongly with the Amnivest liquidity ratio in Equation (3), which explains 13.2% of the cross-sectional variation in the premium on foreign shares. In both cases, the liquidity [TABULAR DATA FOR TABLE 2 OMITTED] [TABULAR DATA FOR TABLE 3 OMITTED] [TABULAR DATA FOR TABLE 4 OMITTED] measures are positively correlated with the premium on foreign shares with a 0.01 significance level. However, I note that the Spearman rank correlation coefficient between the volume ratio and the premium on foreign shares is insignificant at the 0.10 level. This could explain the relatively weak explanatory power of the volume ratio in the regression analyses. The Amnivest liquidity ratio measures the average trading volume over a 20-day period that is associated with a unit-percentage-price change in the stock. Intuitively, foreign (and especially institutional) investors would prefer to trade in liquid stocks because they are better able to switch in and out of the market with minimal price changes. My finding is therefore consistent with the hypothesis that the more (less) liquid stocks would attract greater (less) foreign investor interest.

It is perhaps more interesting that the market capitalization is highly positively correlated with the Amnivest liquidity ratio but is much less strongly correlated with the volume ratio. Table 3 shows that the Pearson correlation coefficients between the market capitalization and the Amnivest and volume ratios are 0.86 and 0.44, respectively. Table 4 gives similar results: the Spearman rank correlation coefficients between the market capitalization and the Amnivest and volume ratios are 0.89 and 0.42, respectively. Therefore, another possible explanation for my findings exists. The positive relationship between the two liquidity measures and the premium on foreign shares could be spurious. It could be caused by the positive correlation between market capitalization and the liquidity measures. In other words, the liquidity measures could serve as proxies for market capitalization in the regression analyses. Since the volume ratio is much less strongly correlated with market capitalization than the Amnivest liquidity ratio, the regression analysis that uses the volume ratio as the explanatory variable would have a lower [R.sub.2] than the regression that uses the Amnivest liquidity ratio.

There is further evidence of this spurious relationship in Equations (5) and (6) in Table 5 when both market capitalization and the Amnivest liquidity ratio are included as explanatory variables in the regression analyses. The Amnivest liquidity ratio now becomes negatively correlated with the premium on foreign shares with a 0.01 significance level. While market capitalization alone could explain 21.3 % of the cross-sectional variation in the premium, the addition of the Amnivest liquidity ratio in Equation (5) does not increase the [R.sup.2] of the regression. It would appear that the Amnivest liquidity ratio has little incremental explanatory power when it is added to a regression that includes market capitalization.

This study suggests that liquidity and volatility effects cannot explain the cross-sectional variation in the premium on foreign shares on the SES. Specifically, I find that firm size dominates liquidity and volatility effects as proxies for information availability for foreign investors. The results indicate that firm size is a good proxy for information availability, especially where market segmentation may extend beyond share ownership to include information flows.

E. Comparison to Results for the Stock Exchange of Thailand

The results obtained in this study can be compared with those for the Stock Exchange of Thailand (SET). In the study by Bailey and Jagtiani (1994), both the relative and absolute volume measures are individually positively correlated with the premium on the foreign shares on the SET. Firm size is also found to have a positive price effect on the foreign shares. Of the three explanatory variables, the relative volume measure offers the highest explanatory power for the cross-sectional variation in the premium on foreign shares. The relative volume and absolute volume measures have an [R.sup.2] of 14.5% and 9.3%, respectively, as compared with an [R.sup.2] of 9.2% for firm size. What is more interesting is that when the three variables are used together with the foreign ownership limit as explanatory variables in regression analyses, firm size and the absolute volume measure become insignificant at the 0.05 level. The relative volume as a measure of liquidity remains significant at the 0.01 level. Bailey and Jagtiani (1994) note that "the results cannot completely separate the liquidity and information effects." I can only venture a guess that what may be better proxied by relative volume as a liquidity measure on the SET could be better proxied by firm size on the SES.

F. A Firm-Size Effect

The firm-size effect that is documented in this study is different from the firm size effect that is so often associated with Banz (1981) and Reinganum (1981). They document that small stocks systematically offer average rates of return that are significantly larger than those of larger firms with similar betas. Many mutual funds and institutions subsequently exploit this small firm effect by purchasing small capitalization stocks. Chan, Chen, and Hsieh (1985) investigate the firm-size effect and explain it in the framework of a multi-factor pricing model. They document that the variable that can explain a large portion of the firm-size effect is the sensitivity of asset returns to the changing risk premium. They argue that small firms are riskier than big firms under the dynamics of economic expansion and contractions, and that such firms involve [TABULAR DATA FOR TABLE 5 OMITTED] additional risks that have to be compensated for. This small firm effect is therefore explained under the assumption of integrated domestic and international markets.

In this instance, where evidence points to segmented markets for the local and foreign shares on the SES, I find that larger (smaller) capitalization stocks are associated with a larger (smaller) premium on foreign shares. Based on the findings in this study (and that by Bailey and Jagtiani, 1994), I would infer that foreign investors tend to purchase larger capitalization stocks on the SES (and SET).(2) For example, on December 31, 1994, SIA, UOB, and DBS ranked second, fourth, and fifth, respectively, by market capitalization among Singapore stocks. Of the 17 stocks in Table 1 with separate listings, six are ranked within the top-30 Singapore stocks by market capitalization on December 31, 1994.(3)

V. Conclusion

This study investigated the premium on foreign shares on the SES. I find that firm size is the most important factor explaining the cross-sectional variation in the premium on foreign shares. My findings suggest that firm size can be an efficient signal for information availability. The evidence suggests that information availability is an important consideration for foreign investors when they pick stocks on the SES. Liquidity and volatility measures appear to proxy for firm size, and their effects are subsumed by firm size.

This study suggests that imposing limits on foreign ownership on SES stocks is costly in terms of firm value. It is also important to note that most of these companies have other mechanisms in place that restrict share ownership. It is usual to find provisions in the articles of incorporation of a Singapore company that restrict any person or related group of persons from holding directly or indirectly more than 5% of the issued share capital of the company. In some cases, this limit is further restricted to 3%. Similar restrictions exist in other countries. Loderer and Jacobs (1995) and S and W note that Nestle of Switzerland allows foreign investors to buy its registered shares with a limit of 3% for any one investor or group of investors. One can therefore question whether it is costly for a firm or its regulators to impose a limit on foreign ownership, particularly when other restrictions already exist that limit foreign ownership.

My findings and those of Loderer and Jacobs (1995) and S and W suggest that removing the limit on foreign ownership for a company with separate listings would probably benefit the firm. Specifically, foreign ownership appears to add value to Singapore-listed companies. In a relatively open financial economy such as Singapore's, removing the limit on foreign ownership would allow all of the firm's shares to be priced in competitive, world-wide markets.

The results of this study have important implications especially for the Asian economies that are beginning to liberalize their financial markets. The issue of restrictions on foreign ownership inevitably arises with the on-going privatization of government-linked companies in Asia. Most would rather err on the conservative side, and impose restrictions on their stocks to prevent a loss of control to foreign investors. This study is relevant for governments and government-linked companies that may consider adopting or tightening such restrictions. Similarly, private corporations that currently have or are planning to have self-imposed restrictions on foreign ownership may want to review their decisions. This is especially so as companies in the developed economies, like Nestle, are already beginning to drop, or at least relax, such restrictions.

The author thanks Warren Bailey, Robert Bowman, workshop participants at the 1995 Inaugural National University of Singapore Seminar in Finance. as well as two anonymous referees for their valuable comments. All remaining errors are the author's.

1 I use the Prais-Weinstein (full generalized least squares, FGLS) method to estimate the regression if autocorrelation is present.

2 This inference is consistent with what was reported in the July 27, 1995, edition of the Straits Times: "United States institutions doubled their equity investments on the Singapore stock market last year to US$2.9 billion (S$4 billion), with interest focused on foreign tranches of blue-chip counters like Singapore Airlines (SIA), The Development Bank of Singapore (DBS), United Overseas Bank (UOB), and the Jardine Group, according to US-based research firm Technimetrics."

3 SIA, which ranks as the second-largest Singapore company (after Singapore Telecom), has had a premium on foreign shares as high as 80%. OCBC, UOB, and DBS, which rank after SIA in that order, have had premia in the range of 50% under bullish market conditions.

References

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Lam, S.S. and H.S. Pak, 1993, "A Note on Capital Market Segmentation: New Tests and Evidence," Pacific-Basin Finance Journal (September), 263-276.

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Reinganum, M.R., 1981, "Misspecification of Capital Asset Pricing: Empirical Anomalies based on Earnings Yields and Market Values," Journal of Financial Economics (March), 19-46.

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White, H., 1980, "A Heteroskedasticity-Consistent Covariance Matrix Estimator and Direct Test for Heteroskedasticity," Econometrica (May), 817-838.

Swee-Sum Lam is a Senior Lecturer in the Department of Banking and Finance, National University of Singapore.
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Author:Lam, Swee-Sum
Publication:Financial Management
Date:Mar 22, 1997
Words:6077
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