Finance & Accounting Aug 5, 2013
Who Does Better Business in China?
Foreign investors can do just fine
With over 1.3 billion people, China’s population is the world’s largest. The nation’s economy, estimated at over 8 trillion U.S. dollars, is the world’s second largest—and quickly growing. “China is one of the largest emerging markets, and emerging markets are something everyone’s eyes are on now,” says Yi Qian, an assistant professor of marketing at the Kellogg School. Despite the allure of a promising market, however, many foreign investors may be reluctant to invest due to intimidatingly large language and cultural differences.
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In addition, many people believe that ethnic Chinese investors have an advantage when it comes to investing in Chinese companies. After all, the researchers write, ethnic ties “help to bridge the information gap, and they contribute to contract enforcement in environments where legal institutions are underdeveloped.” Hard evidence for the advantage is lacking, however, Qian says. And in a new study, she and her coauthors actually find that the opposite is true: over time, foreign investors do just as well or better than ethnic Chinese when they invest in Chinese companies.
Does Ethnic Background Matter?
With coauthors Yasheng Huang from the Massachussets Institute of Technology and Li Jin from Oxford University, Qian investigated foreign direct investment, or FDI. In FDI, foreign investors typically purchase outright, set up a joint venture with, or buy stock in a local business. Regardless of how FDI is implemented, investors acquire significant shareholder rights and take an active role in shaping the company’s future. (To be considered an FDI under Chinese law, a single foreign investor has to hold a minimum of 25% of the company’s equity.) The researchers wondered: Would investors from Taiwan, Hong Kong, and Macau—places mainly populated with people who are ethnically Chinese—have more success than “true” foreign investors from elsewhere?
“As the firm ages, the ethnic Chinese enterprises underperform compared to the true foreign investments.” — Yi Qian
Qian and her colleagues examined data from 1998 to 2005 from the China Industry Census, a large database containing all Chinese businesses that bring in more than $600,000 U.S. dollars each year. The researchers assessed the success of the companies over the seven-year period, taking into account net margins, export to sales ratios, equity, profits, and total assets, among other variables. They then compared the foreign FDIs to the companies with investors who were primarily ethnic Chinese.
The researchers found—contrary to popular belief—that in the long run, companies with ethnically Chinese investors did no better than businesses with true foreign investors. “In fact,” Qian says, “as the firm ages, the ethnic Chinese enterprises underperform compared to the true foreign investments.”
The Dwindling Advantage of Ethnic Chinese Investors
Why? It seems to be the case that true foreign investors tend to invest more in what Qian calls “intangibles.” These are assets that do not have the physical structure of, for instance, a piece of machinery, but are important to a company nonetheless: building a brand name or investing in human resources. For instance, companies with primarily ethnic Chinese investors may be more likely to “recruit employees on the basis of family and kinship ties rather than on the basis of technical and managerial skills,” the researchers write.
Once Qian and her colleagues corrected for these intangibles, ethnic Chinese investors’ disadvantage melted away. “So the ethnic Chinese investors were on par with the true foreign investors,” she says. “That again speaks to the fact that the mechanism for that dwindling advantage of the ethnic Chinese investors over time is really … the lack of long-term investment.”
Knowing that ethnic Chinese investors do not have an advantage over other investors could have an “instrumental encouraging effect on nonethnic foreign investors here in the U.S.,” says Qian. Americans and other foreigners with the desire and the resources to invest, in other words, should not let their ethnicity hold them back.
Huang, Yasheng, Li Jin and Yi Qian. Forthcoming. “Does Ethnicity Pay? Evidence from Overseas Chinese FDI from China.” Review of Economics and Statistics.
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