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Institutions, Corporate Governance and Capital Flows

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  • Mukherjee, Rahul

Abstract

Countries with weaker domestic investor protection hold less diversified international portfolios. An equilibrium business cycle model of North-South capital flow with corporate governance frictions between outside investors and corporate insiders explains this phenomenon through two channels. First, weak governance leads to concentrated ownership in the South because international diversification by insiders is penalized by lower stock market valuation. This reduces the float portfolio, or the supply of South assets. Second, weak governance tilts the demand of South outside investors towards domestic assets to hedge labor income risk. This is due to a higher share of labor in income, which increases labor income risk. In addition, the dynamics of investment under insider control leads relative dividend and labor income to be more negatively correlated in the South, making domestic assets a better hedge against local labor income risk. I find that the insider ownership and hedging channels are responsible for at least 29% and 11%, respectively, of the cross-country variation in international diversification. Thus, weak institutions lower international diversification primarily through concentrated ownership of firms, with outsider hedging also playing a quantitatively significant role.

Suggested Citation

  • Mukherjee, Rahul, 2015. "Institutions, Corporate Governance and Capital Flows," Journal of International Economics, Elsevier, vol. 96(2), pages 338-359.
  • Handle: RePEc:eee:inecon:v:96:y:2015:i:2:p:338-359
    DOI: 10.1016/j.jinteco.2015.03.001
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    Cited by:

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    2. Ning Zhang, 2018. "Asset home bias in debtor and creditor countries," Working Papers 2019-11, Business School - Economics, University of Glasgow.
    3. Coeurdacier, Nicolas & Gourinchas, Pierre-Olivier, 2016. "When bonds matter: Home bias in goods and assets," Journal of Monetary Economics, Elsevier, vol. 82(C), pages 119-137.
    4. Vo, Xuan Vinh & Nguyen, Dong Phong & Ho, Viet Tien & Nguyen, Trung Thong, 2017. "Where do the advanced countries invest? An investigation of capital flows from advanced countries to emerging economies," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 51(C), pages 142-154.
    5. Ning Zhang, 2019. "Asset home bias in debtor and creditor countries," 2019 Meeting Papers 850, Society for Economic Dynamics.
    6. Zhang, Ning, 2019. "Country portfolios under global imbalances," European Economic Review, Elsevier, vol. 119(C), pages 302-317.
    7. Joseph Steinberg, 2018. "International Portfolio Diversification and the Structure of Global Production," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 29, pages 195-219, July.
    8. Nicolas Coeurdacier & Pierre-Olivier Gourinchas, 2015. "When Bonds Matter: Home Bias in Goods and Assets," SciencePo Working papers Main hal-03470191, HAL.
    9. repec:hal:spmain:info:hdl:2441/5djvq5crl99rmab9vc66fecm3h is not listed on IDEAS
    10. Hari Venkatesh & Jyoti Kumari & Gourishankar S. Hiremath & Hiranmoy Roy, 2021. "Foreign Institutional Investors: Fair-Weather Friends or Smart Traders?," Journal of Quantitative Economics, Springer;The Indian Econometric Society (TIES), vol. 19(2), pages 291-316, June.
    11. Coeurdacier, Nicolas & Gourinchas, Pierre-Olivier, 2016. "When bonds matter: Home bias in goods and assets," Journal of Monetary Economics, Elsevier, vol. 82(C), pages 119-137.
    12. repec:hal:spmain:info:hdl:2441/c8dmi8nm4pdjkuc9g821o6lsg is not listed on IDEAS
    13. repec:hal:spmain:info:hdl:2441/5glg8brs7n87c8vqcn2qok0961 is not listed on IDEAS
    14. Ning Zhang, 2018. "Asset home bias in debtor and creditor countries," Working Papers 2019_11, Business School - Economics, University of Glasgow.

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    15. repec:hal:spmain:info:hdl:2441/5glg8brs7n87c8vqcn2qok0961 is not listed on IDEAS
    16. Nicolas Coeurdacier & Hélène Rey, 2013. "Home Bias in Open Economy Financial Macroeconomics," SciencePo Working papers hal-03473901, HAL.
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    More about this item

    Keywords

    Home bias; Capital flows; Portfolio allocation; Institutional quality; Corporate governance;
    All these keywords.

    JEL classification:

    • F21 - International Economics - - International Factor Movements and International Business - - - International Investment; Long-Term Capital Movements
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

    Statistics

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