Working Papers,
Copenhagen Business School, Department of International Economics and Management

Abstract: In the literature on corporate governance, large outside investors are generally observed to reduce agency costs of corporate governance by monitoring and disciplining managers. This paper separates large investors into foreign investors and government owned local financial institutions and argues that the later have higher degree of moral hazard. The empirical results of the paper, based on firm level panel data for 11 Indian industries, show that foreign investors contribute positively to corporate performance in terms of profitability while the government financial institutions contribute negatively. Reducing the role of government financial institutions and opening up of the equity markets to foreign investors under effective regulatory mechanisms should improve corporate governance in terms of increasing transparency in developing economies. This, in turn, contributes positively to economic growth.

Keywords: foreign equity; government financial institutions; corporate governance

26 pages, October 1, 2001

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