Determinants of Sovereign Wealth Fund Cross‐Border Investments

• Date: 01 November 2013
• Published date: 01 November 2013
• DOI: http://doi.org/10.1111/fire.12015

The Financial Review 48 (2013) 539–572

Determinants of Sovereign Wealth Fund

Cross-Border Investments

William L. Megginson∗

University of Oklahoma

Miao You

Party Schoolof the Central Committee of the CPC

Liyan Han

School of Economics and Management, BeiHang University

Abstract

Using a sample of 1,590 purchases of stock by sovereign wealth funds (SWFs) in listed

firms in 78 target countries between 1985 and 2011, we study the country-level determinants

of SWF cross-border investment. We find that SWFs from countries with high levels of

openness and economic development, but with less developed local capital markets, will

make more cross-country transactions, while target countries with higher levels of investor

protection and more developed capital markets will attract more SWF investment.Our findings

support the investment facilitation hypothesis, suggesting that SWFs act purely or principally

as commercial investors facilitating cross-border corporate investment.

∗Corresponding author: Price College of Business, 307 West Brooks, 205A Adams Hall, The Univer-

sity of Oklahoma, Norman, OK 73019-4005; Phone: (405) 325-2058; Fax: (405) 325-7688; E-mail:

wmegginson@ou.edu.

The manuscript was first completed while Miao You was a visiting scholar in University of Oklahoma.

This paper is sponsored by National Natural Science Foundation of China (No. 70831001). Wealso thank

the Center for Financial Studies at the University of Oklahoma’s Price College of Business for financial

and research.

C2013 The Eastern Finance Association 539

540 W. L. Megginson et al./The Financial Review 48 (2013) 539–572

Keywords: sovereign wealth funds, cross-border investment, investment facilitation hypoth-

esis, political influence hypothesis

JEL Classifications: G15, G32, G38

1. Introduction

Can governments ever act as objective, commercially oriented global investors

managing their nation’s wealth as financial fiduciaries? At least 30 national govern-

ments are conducting such a natural experiment in real time as sponsors of sovereign

wealth funds (SWFs), which invest internationally in stocks, bonds, and real estate

in search of a higher financial return than offered by investment solely in sovereign

bonds. These funds, which were assigned their vivid moniker by Andrew Rozanov

eight years ago (Rozanov, 2005), now control over $5 trillion in investable assets by

some estimates and are growing more rapidly than any other class of large global

investor—and thus appear set to be major international investors for the foreseeable

future.

SWFs first entered popular discourse during spring 2007, when the newlyformed

China Investment Corporation (CIC) purchased a $3 billion, nonvotingequity stake in

Blackstone Group immediately prior to the group’s highly touted (but subsequently

under performing) initial public offering. Later that same year, and again in early

2008, SWFs surged to the forefront of financial policy discussions when several,

mostly Persian Gulf-based SWFs, effectively rescued the western banking system

by purchasing some $60 billion worth of newly issued stock in top American and

European banks at the height of the subprime mortgage crisis. In total, SWFs invested

almost $90 billion in the stock of U.S. and European financial institutions between

July 2005 and October 2008, and CIC injected an additional $40 billion into recap-

italizing two state-owned banks in late 2007 and 2008; so, these funds collectively

invested more new capital into the world’s financial institutions recently than any

other single entity except the U.S. government.

These episodes highlight both the sheer financial firepower that SWFs were

believed to control and just how dependent on them western financial economies

had become, and vice versa. Early comments by public officials and analyses in

the popular press tended to be very hostile toward SWFs, emphasizing perceived

problems associated with their growth.1Political opposition to SWFs was exemplified

by Chancellor Angela Merkel who, in June 2007, publicly complained about Russian

SWFs buying pipelines and energy infrastructure in Europe, and by rising debate

1For example, see Lawrence Summers, “Sovereign Wealth Funds Shake the Logic of Capitalism,”

Financial Times,July 30, 2007; Steven R. Weisman, “Concern about ‘Sovereign WealthFunds’ Spreads to

Washington,International Herald Tribune, August 20, 2007, and Krishna Guha, “Warning overSovereign

Wealth Funds,” FinancialTimes, June 22, 2007.

W. L. Megginson et al./The Financial Review 48 (2013) 539–572 541

regarding SWFs in the U.S. Congress. In particular, the U.S. Senate Committee on

Banking, Housing and Urban Affairs met in November 2007 to discuss the impact of

SWFs and other foreign government investments in the United States.

Several issues were raised by critics of SWFs: the possibility that their capital

could be used to further political purposes and target strategic acquisitions (Ferreira

and Matos, 2008; Chhaochharia and Laeven, 2009; Karolyi and Liao, 2010; Knill,

Lee and Mauck, 2012); the risk of equity price bubbles arising from the sheer size of

SWF investments and the related decline in demand for Treasury bonds; the risk of

an increase in volatility of financial markets; the possibility that SWFs might have

a detrimental effect on corporate governance because of political motives or lack of

sophistication; and the risk of the emergence of a new form of financial protectionism

as a reaction to SWFs. However, the criticism most often mentioned was the lack of

transparency about SWFs and their investment policies—and this criticism lingers

to the present day. There was also great concern that SWFs were growing at what

appeared to be an exponential rate. There was a widespread fear that SWFs would

not act as strictly commercially minded investors, seeking only the highest possible

financial return, but would instead be forced to invest strategically by home-country

governments seeking political influence or access to foreign technology. Alterna-

tively, as foreign, state-owned investment funds, any posture that SWFs take other

than being purely passive investors might generate political pressure or a regulatory

backlash from recipient-country governments. Even when SWFs did take major-

ity stakes—which Miracky, Dyer, Fisher, Goldner, Lagarde and Piedrahita (2008)

show occurred almost exclusively when SWFs invested in domestic companies—the

funds rarely seemed to challenge incumbent managers. Woitdke(2002) shows similar

behavior by public-sector pension funds in the United States.

On the other hand, SWFs do not appear fundamentally dissimilar to other in-

ternationally active investment vehicles, such as pension funds, buy out funds, and

mutual funds, which have been extensively researched by financial economists such

as Woidtke (2002), Aggarwal, Klapper and Wysocki (2005), and Chen, Harford and

Li (2007). In important ways, SWFs appear quite similar in structure and expressed

objectives to hedge funds—studied by Klein and Zur (2009), Ferreira and Matos

(2007), and, especially, Brav, Jiang, Thomas and Partnoy (2008)—who find SWFs

are also stand-alone, unregulated pools of capital, managed by investment profes-

sionals, and often take large stakes in publicly traded companies. SWFs can increase

the liquidity of financial markets, especially in the private equity industry. If SWFs

are really just large, commercially minded financial investors, there is no compelling

reason to establish regulatory barriers to their inward investments, demand greater

disclosures from them than demanded of other investors, or assess their financial

performance any differently than one would a private pension fund or hedge fund.

Prior empirical research mainly focuses on how SWFs create value by investing

in target companies, using event study methodology to study the stock prices changes

of publicly listed companies targeted by SWFs. Kotter and Lel (2010), Bernstein,

Lerner and Schoar (2009), and Bortolotti, Fotak and Megginson (2010) find SWFs