Foreign Institutional Ownership and the Choice between Public and Private Debt

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Abstract

The objective of this study is to examine the role of foreign institutional investors in firms’ choice of public and private debt financing. Using a large sample of firm-year observations from 40 countries around the world spanning 2004-2011, we find a significantly positive relationship between foreign institutional ownership and the propensity to access the public over the private debt market. However, we do not find such a relationship between domestic institutional ownership and the preference for public debt. Our results are robust to various specifications, including a 2SLS regression model in which several instruments are used, a change model for addressing reverse causality, and a quasi-natural experiment using the exogenous relaxation of foreign equity restrictiveness. Additional tests show that the positive effect of foreign institutional ownership on reliance on public debt is stronger for firms with improved voluntary disclosure, firms with higher levels of information asymmetry, and firms domiciled in countries with lower levels of creditor protection. Taken together, our findings suggest that foreign institutional investors play a vital role in facilitating firms’ public debt financing.

Authors

• Jinshuai Hu, Xiamen University

• Albert K Mensah, City University of Hong Kong

• Albert Tsang, Schulich School of Business, York University