The corporate governance consequences of small shareholdings: Evidence from sovereign wealth fund cross-border investments

Abstract

Research Question/Issue: Existing research on sovereign wealth funds (SWFs) has largely explored how they affect target firm value, overlooking the role they play in corporate governance. This paper examines the impact of SWFs' cross-border equity acquisitions on targets' corporate governance and the role the institutional environment of SWF countries plays in shaping this impact. Research Findings/Insights: We use a difference-in-differences approach and find that, on average, SWF investments are negatively related to target firms' corporate governance. This impact holds for small SWF cross-border equity investments only and is stronger for firms that are weakly governed and for those located in jurisdictions with weak shareholder protection. The negative relation is more pronounced when SWFs' home countries have lower-quality investor protection, corruption control, governmental effectiveness, and law enforcement than their host countries. We find further that SWF investments are positively associated with target firms' earnings management and negatively associated with investment efficiency. Finally, target firm value is found to decrease after SWF investments. Theoretical/Academic Implications: The evidence that SWFs' small equity investments are detrimental to target firms' corporate governance is broadly consistent with the view that SWFs are passive investors. Managers can exploit this passivity, as evidenced by higher earnings management, reduced investment efficiency, and lower firm value. Practitioner/Policy Implications: This study has important policy implications for investors, SWF managers, and policymakers. The passive role of SWFs in corporate governance should prompt minority shareholders to look for alternative monitoring mechanisms. Moreover, SWF managers may realize the need to target firms with strong corporate governance at the outset to compensate for the post-acquisition decline. Host country policymakers may need to condition SWF investments on commitments to improve the corporate governance of investee firms, which would be akin to the performance requirements imposed on inward foreign direct investment (FDI). This is particularly relevant for SWFs from countries with weak institutions that are targeting countries with strong institutions.