Institutional Ownership in Foreign Shares: Is It Information Cost or rudence Requirment?

Abstract

We explore the question of whether the level of institutional ownership in foreign shares is explained by the information cost argument or the prudence requirement. We first present a model where the relative stock ownership of institutions to individuals is determined under information asymmetry and the prudence requirement. For empirical analysis, we look into ADRs traded in the NYSE, AMEX, and Nasdaq in 1995 and 1993. Our study reveals that institutional ownership in ADRs is extremely low (for example, around 1% in median for ADRs from developed countries), which is very surprising in the context of the information cost argument. This observation is consistent with the prediction from the prudence requirement. Looking for firm-level attributes that explain the magnitude of institutional ownership of ADRs, we find that beta and liquidity are associated positively with the level of institutional ownership of ADRs. The positive association of beta and the level of institutional ownership casts doubt on the textbook presumption that international investment is driven by diversification moive. Comparison with the level of institutional ownership in country funds suggests that liquidity alone cannot account for the low institutional ownership in ADRs.

JEL Classification: G11, G15, G20 Keywords: institutional ownership, prudence requirement, international investment, diversification, ADRs