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The role of corporate governance in foreign investments

This article examines whether and how the corporate governance practices of firms affect foreign investors’ decisions to invest in their firms. Using a comprehensive data set of foreign equity holdings of mutual funds from 37 countries worldwide, we find that fund managers tend to tilt their portfolio weights towards firms with strong governance systems. Particularly, they invest more in foreign firms with good board characteristics and independent auditors. This result suggests that mutual funds, facing informational disadvantage in their foreign investments, prefer firms with better governance systems as a substitute for their own costly information acquisition and monitoring activities. Furthermore, firms with better governance structures attract more foreign investments irrespective of their country-level investor protection environments.