Abstract

We study the different governance roles of foreign vis-à-vis local institutional investors in a market characterized by diffuse ownership and dominant controlling shareholders. Using data on China’s split share structure reform that floats the non-tradable shares, we find that Qualified Foreign Institutional Investors (QFIIs) have greater influence over the controlling state shareholders than local mutual funds. QFIIs are less prone to political pressure and are more likely to participate in arm’s-length negotiation and monitoring in state-controlled companies. The presence of QFII ownership shortens the reform duration and increases the compensation to minority tradable shareholders. Contrary to local mutual funds, the positive relation between state ownership and the compensation to tradable shareholders increases with the presence of QFII ownership. Furthermore, QFIIs increase the likelihood of revision in reform proposals among state-controlled companies. Domestic mutual funds seem to make earnest negotiation in non-state-controlled companies absent political pressure. Evidence suggests that involving foreign institutional investors in corporate governance practice can significantly reduce expropriation by controlling shareholders in emerging markets.