Strategic Management JournalStrat. Mgmt. J., 27: 591–600 (2006)

Published online 23 January 2006 in Wiley InterScience (www.interscience.wiley.com). DOI: 10.1002/smj.523

RESEARCH NOTES AND COMMENTARIES

STRATEGIC INVESTMENTS IN JAPANESECORPORATIONS: DO FOREIGN PORTFOLIO OWNERSFOSTER UNDERINVESTMENT OR APPROPRIATEINVESTMENT?

PARTHIBAN DAVID,1* TORU YOSHIKAWA,2 MURALI D. R. CHARI3 andABDUL A. RASHEED4

1 Mendoza College of Business, University of Notre Dame, Notre Dame, Indiana,U.S.A.2 Lee Kong Chian School of Business, Singapore Management University, Singapore3 School of Business and Economics, Indiana University South Bend, South Bend,Indiana, U.S.A.4 College of Business Administration, University of Texas at Arlington, Arlington,Texas, U.S.A.

This paper investigates the effect of foreign ownership on strategic investments in Japanese cor-porations. Foreign owners are typically portfolio investors who frequently buy and sell sharesand hold diversified portfolios of small stakes in many firms. Prior research has presented twoconflicting perspectives on the role of such investors: (a) their frequent trading leads to pressurefor short-term returns that fosters underinvestment; (b) their active trading fosters appropriateinvestments. We investigated the relationship between foreign ownership and strategic invest-ments using dynamic panel data analysis of a sample of 146 Japanese manufacturing firms from1991 to 1997. We found that foreign ownership enhances strategic investments (in R&D and cap-ital intensity) to a greater extent when firms have growth opportunities than when they lack suchopportunities. We conclude that foreign ownership fosters appropriate investment. Copyright 2006 John Wiley & Sons, Ltd.

The 1990s marked a steep rise in global portfo-lio ownership, wherein foreign owners, typicallyinstitutional investors from the United States andUnited Kingdom invested in equities all over theworld (Useem, 1998). Foreign portfolio investorsusually have a large asset base, hold diversifiedportfolios of small stakes in many firms, andfrequently buy and sell shares (Davis and Steil,2001). Ownership structure has implications forlong-term strategic investments that are needed tobuild competencies and exploit growth opportuni-ties to maximize long-term profitability (Kochhar

Keywords: corporate governance; R&D; ownership*Correspondence to: Parthiban David, Mendoza College ofBusiness, University of Notre Dame, Notre Dame, IN 46556,U.S.A. E-mail: pdavid@nd.edu

and David, 1995). Prior research has presentedtwo conflicting perspectives on the role of suchinvestors: (a) their frequent trading leads to pres-sure for short-term returns that fosters underin-vestment (Porter, 1992); (b) their active tradingfosters appropriate investments (Allen, 1993). Wetest these competing perspectives by examining theeffect of foreign ownership on two types of strate-gic investments—R&D and capital intensity—inJapanese corporations.

FOREIGN OWNERSHIP IN JAPANESECORPORATIONS

Lee and O’Neill (2003) provide an overview ofownership structures and their effects on R&D

Copyright 2006 John Wiley & Sons, Ltd. Received 22 November 2002Final revision received 21 August 2005

592 P. David et al.

investments in Japanese corporations. About halfthe equity stakes of Japanese corporations is heldby stable domestic owners such as banks, insur-ance companies, and other corporations, oftenreciprocally. Stable owners do not frequently buyand sell shares for short-term gains, but implic-itly commit to hold a majority of their shares longterm. Many Japanese corporations are organizedinto business groups termed keiretsus, with a mainbank which is both a major lender and owner.The web of long-term relationships between stableowners, main banks, and keiretsu partners providesmonitoring while protecting managers from hos-tile takeover. Lee and O’Neill (2003) conclude thatlarge block owners foster appropriate R&D invest-ment. Their study, however, was confined to largeblock domestic owners, leaving the effects of for-eign owners unexplored.

Globalization of equity ownership by institu-tional investors in the United States and UnitedKingdom, economic liberalization easing restric-tions on foreign ownership of Japanese equities,and cheaper equity prices fueled a surge in for-eign ownership in Japanese corporations (Nitta,2000) from 5 percent in 1990 to over 13 percentin 1997 (Tokyo Stock Exchange, 2002). Althoughtheir aggregate ownership is high, foreign own-ers typically hold small blocks of shares. Out of atotal of 2376 firms listed in the Nikkei CorporateData Book in 1997, foreign owners were listedas major shareholders in only 36 firms. Aggre-gate ownership (Association of Japanese StockExchanges, 2002) and trading data (Tokyo StockExchange, 2002) for 1997 indicate that foreignowners held 13 percent of shares by market valuebut accounted for 23 percent of stock transac-tions; in contrast, stable owners such as corpo-rations and insurance companies held 25 and 14percent of equity, but accounted for just 3 and2 percent of stock transactions, respectively. Thesedata support the view that foreign investors ownrelatively small stakes and trade their shares fre-quently (Davis and Steil, 2001). For foreign own-ers, ownership of small stakes in multiple compa-nies across the world reduces risk through diversi-fication, and provides liquidity, i.e., the ability toeasily exit their holdings (Tesar and Werner, 1992).In Japanese corporations, foreign investors tendto be predominantly institutional investors fromthe United States and United Kingdom; in 1997investors from the United States and United King-dom held 32 percent and 39 percent of total foreign

shares respectively (Bank of Japan, 2004). Foreignowners are profit-driven market investors and lackthe close ties with firms enjoyed by stable domesticowners (Aguilera and Jackson, 2003; Charkham,1994).

Prior research on the effects of portfolio own-ers on strategic investments has generally studiedinstitutional investors in the United States. Empir-ical studies find that aggregate institutional owner-ship is positively associated with R&D (Baysinger,Kosnik, and Turk, 1991; Bushee, 1998; Wahal andMcConnell, 2000) but ownership by investmentfunds that trade more frequently is negatively asso-ciated both with R&D (Bushee, 1998; Hoskissonet al., 2002), and corporate entrepreneurship(Zahra, 1996). In the United States, institutionalinvestors can exert pressure through activism andby selling off their shares. Mass sell-offs can nega-tively impact stock prices, raise the cost of capital,and enhance the likelihood of a hostile takeover(Porter, 1992). Parrino, Sias, and Stark (2003)provide direct evidence that sell-offs by investorshas adverse consequences for managers includ-ing dismissal, as boards of directors act to retaininvestors.

Foreign portfolio owners in Japan share invest-ment characteristics similar to the U.S. institutionalinvestors studied in prior research: they have highaggregate ownership but low individual stakes andtrade frequently. A first step is to understand themultiple ways in which foreign owners can affectthe decisions and actions of Japanese corpora-tions. In Japan, unlike the United States, hostiletakeovers are rare because of a variety of socialand institutional constraints (Hoshi and Kashyap,2001). Nevertheless, the threat of sell-offs by for-eign owners can provide influence.

First, failure to satisfy foreign owners can in-crease the cost of capital. Ownership signals infor-mation about the level of information asymme-try and managerial opportunism, both of whichaffect the default risk and cost of debt capital(Bhojraj and Sengupta, 2003). Their high fre-quency of trading increases stock liquidity, thushelping to reduce information asymmetry and thecost of capital (Brennan and Tamarowski, 2000).Their presence indicates confidence that the firmis well managed, while sell-offs can signal thepossibility of managerial opportunism and poormanagement, thus increasing the likely threat ofdefault and raising the cost of debt capital. Priorresearch has shown that ownership by institutional

Copyright 2006 John Wiley & Sons, Ltd. Strat. Mgmt. J., 27: 591–600 (2006)

Research Notes and Commentaries 593

owners reduces the cost of debt capital in U.S.corporations (Bhojraj and Sengupta, 2003). Simi-larly, market liberalization to ease restrictions onforeign purchase of equities in emerging mar-kets leads to lower cost of capital (Henry, 2000).Appeasing foreign owners is important in rais-ing new capital because a major source of newfunding is bond issues, especially from foreignsources (Hoshi and Kashyap, 2001). Thus, failureto retain foreign owners may result in an increasedcost of capital and constrain managerial discre-tion.

Second, during the economic downturn in the1990s, foreign owners helped buy shares fromstable domestic owners that needed to exit theirholdings (Dvorak et al., 2001). After decades ofeconomic prosperity, the economic bubble burstin 1991, and the ensuing collapse of stock andland prices ushered a long period of economicstagnation and low annual growth rates of only1.7 percent between 1992 and 1997 (Economicand Social Research Institute, 2002). Low eco-nomic growth reduced business opportunities, hurtstock and land prices, and ultimately the procliv-ity of stable owners to maintain their long-termstakes (Dvorak et al., 2001). Several stable domes-tic owners were compelled to reduce their share-holdings in affiliated firms so that cash from stocksales could be used to offset losses. During the eco-nomic downturn, ownership by corporations andinsurance companies dropped from 46 percent in1990 to 39 percent in 1997 and foreign ownersstepped in to fill the breech, increasing their own-ership from 5 percent to 13 percent from 1990 to1997, thus helping stable domestic owners to cashout (Association of Japanese Stock Exchanges,2002).

Finally, failure to retain foreign owners mayaffect managerial incentives. As a majority ofshares are held by stable owners who seldom tradetheir shares, the active trading by foreign ownerscan significantly affect stock price despite theirrelatively small holdings. Foreign owners oftendemonstrate herding behavior (Kamesaka, Nof-singer, and Kawakita, 2002) and dissatisfactionwith individual firms can have a snowballing effectthat causes significant drops in stock prices in indi-vidual firms. Although the absence of a marketfor corporate control protects managers from thethreat of takeover, research has shown that man-agers in Japanese corporations are just as likely asU.S. managers to get pay cuts or lose their jobs on

account of poor stock performance (Kaplan, 1994).Managers are therefore likely to be responsive toforeign owners in order to maintain share pricesand avoid pay cuts and job loss.

These arguments suggest that managers inJapanese corporations need to be responsive toforeign owners. Japanese firms have, in fact,stepped up investor relations efforts to attract for-eign investors (Yoshikawa and Gedajlovic, 2002).Empirical research also provides some evidencethat foreign owners do matter and affect corporateoutcomes such as firm performance (Yoshikawaand Phan, 2003), layoffs (Ahmadjian and Robin-son, 2001), and wages (Yoshikawa, Phan, andDavid, 2005). We argue that share ownership andtrading by foreign owners (in the stock market)affect resource allocation in strategic investments(in the firm) and present two conflicting views onthe effect of foreign owners on strategic invest-ments.

Foreign owners foster underinvestment

Porter (1992) argues that frequent trading by port-folio investors imposes pressure for short-termreturns and causes underinvestment in long-termstrategic investments, leading to lower firm value.Froot, Scharfstein, and Stein (1992) explain thatportfolio investors benefit primarily from near-term changes in stock price and therefore trade oninformation that is likely to be quickly reflectedin the stock price. The presence of multiple for-eign owners seeking short-term returns can causeherding on short-term indicators that are unrelatedto long-term economic fundamentals, pressuringmanagers to pay undue attention to short-term indi-cators in a bid to retain foreign ownership. Forexample, foreign owners may rush to sell if short-term earnings shortfalls are interpreted as indica-tive of potential problems. Managers are thereforepressured to cut back on strategic investments inorder to pump up earnings so that investor con-cerns can be alleviated (Stein, 1989).

The potential for strategic investments to en-hance value is higher when firms have growthopportunities than when they lack such opportuni-ties. Thus, reduction in investment is more likelyto be detrimental and constitute underinvestmentwhen firms have growth opportunities than whenthey lack growth opportunities. Accordingly, for-eign owners are likely to foster underinvestmentwhen they reduce strategic investment to a greater

Copyright 2006 John Wiley & Sons, Ltd. Strat. Mgmt. J., 27: 591–600 (2006)

594 P. David et al.

extent in firms with growth opportunities than infirms lacking growth opportunities.

Foreign owners foster appropriate investments

Allen (1993) develops a competing perspective,arguing that frequent trading by small block for-eign owners, far from fostering underinvestment,may actually facilitate appropriate resource allo-cation. Allen argues that companies operating intoday’s hypercompetitive technological landscapewith rapid technological change face uncertaintyabout the nature and level of appropriate strategicinvestments. All of the knowledge needed to makeoptimal resource allocations is not available tomanagers but is dispersed in the economy (Hayek,1945). Accordingly, input from multiple parties islikely to be helpful in determining the appropri-ate level of long-term investments. Ownership bya large base of foreign portfolio investors providesmultiple owners with the incentive to monitor man-agers (Allen, 1993).

Although managers have more information thanany single investor, the stock market as a wholecan provide a superior mechanism for aggregat-ing the dispersed knowledge needed for resourceallocation (Grossman, 1995). The stock marketprovides incentives to investors to acquire knowl-edge, and by acting on the knowledge acquired,to disseminate it to other market participants. Thestock prices of firms will come to reflect this aggre-gated consensus of knowledge and firms that failto use this information in their investment deci-sions are likely to see their stock values decline.According to Dow and Gorton (1997), stock trad-ing can have both a ‘retrospective’ and a ‘prospec-tive’ role. The prospective role of the stock marketarises because of the aggregation of informationthat permits stock prices to provide knowledge onappropriate resource allocation. The retrospectiverole arises from the ability of stock trading to influ-ence managers. If managers fail to respond to thesignals sent through trading behavior, foreign own-ers can sell off their shares, and if managers wantto retain foreign owners, they are likely to makeappropriate strategic investments. We have notedthat the potential for value enhancement from addi-tional investment is higher when firms have growthopportunities than when they lack such opportu-nities. Accordingly, foreign owners are likely tofoster appropriate investment when they enhancestrategic investments to a greater extent in firms

with growth opportunities than in firms lackinggrowth opportunities.

Competing hypotheses on strategic investments

Prior research provides ambiguous guidance aboutinterpreting direct associations between ownershipand strategic investment. Some studies assumethat additional investments are invariably desir-able: positive associations between ownership andinvestment are interpreted as evidence of appro-priate investment, while negative associations areinterpreted as underinvestment (Baysinger et al.,1991; Bushee, 1998; Graves, 1988; Wahal andMcConnell, 2000). By contrast, studies using arestructuring perspective assert that agency prob-lems can lead to overinvestment by managers thatcan be checked by vigilant owners through restruc-turing: a negative association between ownershipand investment is viewed as appropriate foster-ing of restructuring, while positive associations areviewed unfavorably as fostering overinvestment(Bethel and Liebeskind, 1993). Interpreting directassociations between ownership and investmentpresents a serious challenge because the impli-cation of direct associations depends on assump-tions as to whether or not additional investmentsare desirable. In practice, additional investment isnot always desirable, but is appropriate only whenfirms have the potential to benefit from such invest-ment; determining whether additional investmentrepresents appropriate investment requires a meansto identify the desirability of additional investment.

Tobin (1969) proposed the ratio of market valueof capital to replacement value, termed Q, as ameasure of the desirability of additional invest-ment. Additional capital investments are desirablewhen market value exceeds the replacement costof capital (Q > 1) because this indicates the avail-ability of external opportunities wherein internalcapabilities can be leveraged such that investmentsgenerate greater returns than their cost. When Q

exceeds 1, each additional dollar of capital invest-ment has the potential to raise market value bymore than a dollar. Additional strategic invest-ments are appropriate because the market valuecreated from such investments is likely to exceedtheir cost. Conversely, when Q is less than 1,each additional dollar invested is likely to yieldless than a dollar in market value, and additionalinvestments become undesirable. Thus, benefitsfrom additional strategic investments are likely to

Copyright 2006 John Wiley & Sons, Ltd. Strat. Mgmt. J., 27: 591–600 (2006)

Research Notes and Commentaries 595

be greater for firms that have growth opportu-nity (Q > 1) than for those that lack them (Q ≤1).

The Q measure of growth opportunities has sev-eral advantages. First, it is an ex ante measurederived from forward-looking stock market expec-tations about the future, rather than an ex postmeasure of past growth. Second, it gauges growthopportunities for the firm by combining both exter-nal factors such as industry attractiveness, andinternal capabilities by which these external oppor-tunities can be exploited. Finally, Q has beenused as a measure of growth opportunities in priorgovernance research (David, Hitt, and Gimeno,2001; Lang, Ofek, and Stulz, 1996). In these stud-ies, the use of Q as a moderating variable helpsavoid the pitfalls arising from examining directeffects between ownership and investment. Forexample, David et al. (2001) show that investoractivism results in increased R&D in high-Qfirms and conclude that activist institutions facil-itate appropriate investment by increasing R&Dwhen such investments are desirable. Similarly,Lang et al. (1996) find that debt reduces capi-tal investments in low-Q firms and conclude thatdebt facilitates appropriate investment by reduc-ing capital investment when they are not desir-able.

We adopt a similar approach. Strategic invest-ments are more beneficial when firms have thepotential to benefit from such investment, i.e.,when firms have growth opportunities than whengrowth opportunities are unavailable. Accordingly,appropriate investment implies higher strategicinvestments when firms have growth opportunitiesthan when they lack growth opportunities, whileunderinvestment implies lower strategic invest-ment when firms have growth opportunities thanwhen firms lack growth opportunities. If foreignowners foster appropriate investment, then theyshould encourage strategic investments to a greaterextent when growth opportunities are present thanwhen growth opportunities are absent. Conversely,if foreign owners foster underinvestment, theyshould reduce strategic investments to a greaterextent when growth opportunities are present thanwhen growth opportunities are absent.

Hypothesis 1. Foreign ownership is more neg-atively associated with strategic investments inthe presence of growth opportunities than intheir absence (underinvestment).

Hypothesis 2. Foreign ownership is more pos-itively associated with strategic investments inthe presence of growth opportunities than intheir absence (appropriate investment).

Sample

The sample was chosen from the 200 largest indus-trial firms in Japan measured by sales in 1987.Several firms were dropped as they did not meetvarious criteria established for inclusion: four wereprivately held, 19 were not listed for part of theperiod studied, 12 changed their fiscal year-endsduring the sampling period and therefore did notconsistently report annual financial data over time,three were not listed in sources that provided dataon some of the variables, one was in the quasi-government sector, and eight were outside themanufacturing sector that is the focus of our study.Also, as our theory is developed for small blockportfolio owners, we carefully screened the namesof major shareholders indicated in the Japan Com-pany Handbook and eliminated eight firms withlarge block strategic foreign owners. Finally, wewere left with 146 firms observed over 7 yearsfrom 1991 to 1997.

Variables

The dependent variable, strategic investments, wascomputed as R&D intensity (R&D expense tosales) and capital intensity (capital expense tosales). Foreign ownership, the independent vari-able, is the percent shares held by foreign investorsobtained from the Japan Company Handbook.Growth opportunity is a dummy variable withvalue 1 when Q exceeds 1 and 0 otherwise. Q iscomputed as the ratio of market value (sum of mar-ket value of equity, book value of preferred stock,and book value of debt) to total assets (Chungand Pruitt, 1994). Several control variables thataffect strategic investments were also included:cash flow (Fazzari, Hubbard, and Peterson, 1988),major domestic owners (Lee and O’Neill, 2003),return on assets (Hundley, Jacobson, and Park,1996), debt to total assets (Lang et al., 1996), andfirm size. Cash flow is computed as sales lesscost of goods sold, selling, general, and admin-istrative expenditure, taxes, interest, and dividendpaid as a ratio of total assets (Fazzari et al., 1988).Firm size was computed as log of sales. Majordomestic ownership was the proportion of shares

Copyright 2006 John Wiley & Sons, Ltd. Strat. Mgmt. J., 27: 591–600 (2006)

596 P. David et al.

held by major Japanese financial and nonfinancialcompanies obtained from the Japan CompanyHandbook (Lee and O’Neill, 2003). All financialdata were obtained from Worldscope.

Analysis

The Arellano–Bond method, a statistical techniquedesigned for analyzing autoregressive-distributedlag models from panels with many cross-sectionalunits observed for relatively few time periodsvia General Method of Moments (GMM) esti-mates, has several advantages (Arellano, 2003).First, it controls for lagged values of the depen-dent variable as strategic investments are likelyinfluenced by prior levels. Second, panel data anal-ysis accounts for fixed effects from firm-specificheterogeneity that is constant over time, aris-ing, for example, from differences in firm-specificinvestment practices. Unobserved firm-specificheterogeneity is eliminated by first-differencing, orsubtracting the lagged values of regressors. Third,endogeneity issues that arise when explanatoryvariables are correlated with an error term are eas-ily addressed by using lagged values of the regres-sors as instruments of the first-differenced regres-sors. Finally, GMM estimation provides improvedestimates in the presence of the unknown het-eroscedasticity and autocorrelation that often arisein dynamic panels.

Results

Summary statistics and tests of the competinghypotheses are reported in Tables 1 and 2, respec-tively. The positive and statistically significant

interaction effect of foreign ownership with growthopportunities on R&D and capital intensity indi-cates that foreign owners foster strategic invest-ments to a greater extent when firms have growthopportunities than when firms lack growth oppor-tunities. This result is consistent with Allen’s viewthat foreign ownership fosters appropriate invest-ment and counter to Porter’s view that foreignownership fosters underinvestment. We also plotseparate regression equations for the two con-texts—availability of growth opportunities andabsence of such opportunities—in Figure 1 to pro-vide a visual illustration of the effect of foreignownership.

DISCUSSION AND CONCLUSION

We studied the effect of foreign ownership onstrategic investments in Japanese corporations bydeveloping and testing two competing perspec-tives. We found that foreign ownership is morepositively associated with strategic investments forfirms with growth opportunities than those lack-ing such opportunities. The relationship is robustacross both types of strategic investments studied:R&D and capital intensity. Our results run counterto concerns expressed by some scholars (Porter,1992) that owners that trade frequently pressurefirms to underinvest by cutting back on strate-gic investments when they are desirable. On thecontrary, our results support the view that foreignowners can foster appropriate strategic investmentsby increasing strategic investments when they aredesirable (Allen, 1993).

Governance research tends to focus on the roleof stable, large block owners that can monitor

Table 1. Descriptive statistics and correlations

Variables Mean S.D. 1 2 3 4 5 6 7 8 9 10

1 R&D intensity 3.46 2.30 0.022 Capital intensity 7.38 5.50 0.023 Industry R&D intensity 3.12 1.29 0.63 0.014 Industry capital intensity 6.84 3.09 −0.01 0.56 0.045 Cash flow 0.04 0.04 0.31 0.10 0.27 −0.086 Debt to total assets 0.34 0.16 −0.23 −0.10 −0.11 −0.06 −0.257 Log of sales 13.29 0.87 0.06 0.01 0.06 0.03 0.17 0.078 ROA 2.89 2.09 0.08 0.37 −0.01 0.37 0.44 −0.30 −0.039 Major domestic ownership 36.82 11.54 0.06 0.06 0.07 0.07 −0.16 −0.13 −0.32 −0.07

10 Foreign ownership 7.60 5.99 0.25 −0.05 0.23 −0.30 0.51 −0.30 0.20 0.16 −0.3311 Tobin Q dummy 0.51 0.50 0.01 0.18 −0.07 0.17 0.18 −0.09 −0.23 0.36 −0.06 0.05

N = 1022 firm years (146 firms × 7 years, balanced panel)

Copyright 2006 John Wiley & Sons, Ltd. Strat. Mgmt. J., 27: 591–600 (2006)

Research Notes and Commentaries 597

Table 2. Results of panel data analysis of strategic investments

Model 2R&D intensity

Model 4Capital intensity

R&D intensity 0.16∗∗∗

Capital intensity 0.12∗∗∗

Industry R&D intensity 0.65∗∗∗

Industry Capital intensity 0.91∗∗∗

Cash flow −1.55∗∗∗ −2.86Debt to total assets 0.37∗∗ 10.21∗∗∗

Log of sales −0.48∗∗∗ 7.53∗∗∗

ROA −0.02∗∗∗ 0.26∗∗∗

Major domestic ownership −0.01∗∗∗ 0.07∗∗∗

Foreign ownership −0.01∗∗∗ −0.15∗∗∗

Tobin Q dummy −0.11∗∗∗ −0.09Foreign ownership × Tobin Q dummy 0.01∗∗∗ 0.11∗∗∗

Wald χ 2 2781.31 1016.65

N = 1022 firm years (146 firms × 7 years, balanced panel)∗ p < 0.050; ∗∗ p < 0.010; ∗∗∗ p < 0.001

and gain direct influence in overseeing managersthrough ‘voice’ (Shleifer and Vishny, 1997). Wefind that foreign owners that hold diversified port-folios of small stakes in many firms and frequentlybuy and sell shares (‘exit’) can also have an impor-tant role in resource allocation. This result is con-sistent with a stream of macroeconomics researchthat has shown that factors that smooth the func-tioning of capital markets such as stock marketliquidity that facilitate easy exit can lead to effi-cient resource allocation (see Levine, 1997, for areview). More research is needed to understandthe role of ‘exit’ i.e., frequent buying and sellingof shares by foreign owners, in releasing infor-mation, providing monitoring and their effects onresource allocation in strategic investments withinfirms.

R&D investments are likely to be more benefi-cial when firms have growth opportunities imply-ing a positive association. Surprisingly, we founda negative association between growth opportuni-ties and R&D investments, indicating that firmswith growth opportunities have lower R&D invest-ments than those that lack such opportunities. Weinfer that Japanese firms lacking growth opportu-nities may have overinvested in R&D. Althoughsurprising, this result is consistent with consid-erable prior research on Japanese corporations.Japanese managers are aggressive in their strategicinvestments (Lazonick, 2002). Their stakehold-ers—stable owners and main banks—encourage along-term perspective (Yoshikawa et al., 2005) tothe extent of fostering overinvestment (Henderson

and Cool, 2003). They tend to value growth overprofit (Abegglen and Stalk, 1985) and weightlong-term returns more heavily in making strate-gic investments (Poterba and Summers, 1995).Japanese firms react to underperformance byincreasing R&D (Hundley et al., 1996), and per-sist in investing even when growth opportuni-ties are lacking (Thomas and Waring, 1999). Theprosperity of Japanese corporations during the1980s provided them considerable free cash, aswell as easy access to cheap debt financing, thathas the potential to exacerbate overinvestment(Kester, 1991). Interestingly, the negative associa-tion between Tobin’s Q and R&D is not unique toour study; similar results are reported by Lu andBeamish (2004). More research is needed to studythe strategic and governance aspects of possibleoverinvestment in Japanese corporations.

Interpreting direct effects of ownership on strate-gic investments (Baysinger et al., 1991; Wahaland McConnell, 2000) depends on assumptions asto whether strategic investments are desirable. IfJapanese firms have overinvested in R&D (as indi-cated by the negative association between growthopportunities and R&D), the negative associa-tion between foreign ownership and R&D sug-gests that foreign owners may be fostering cut-backs to align R&D investments with the firm’sgrowth opportunities. This result is consistent withrecent findings that foreign owners reduce strategicinvestments in human capital by reducing wages(Yoshikawa et al., 2005) and employees (Ahmad-jian and Robinson, 2001). More research is needed

Copyright 2006 John Wiley & Sons, Ltd. Strat. Mgmt. J., 27: 591–600 (2006)

598 P. David et al.

2.42.52.62.72.82.9

33.13.2

1

Foreign ownershipR

&D

inte

nsity Growth opportunities

available

Growth opportunitiesnot available

0

2

4

6

8

10

Foreign ownership

Cap

ital

in

ten

sity

Growth opportunitiesavailable

Growth opportunitiesnot available

2

1 2

(a)

(b)

Figure 1. Relationship between strategic investment and foreign ownership

to evaluate if foreign owners can play a useful rolein restructuring overinvestment in Japanese corpo-rations.

In our study, we emphasize interaction effects—not main effects. Figure 1 illustrates that for-eign ownership is positively associated with R&Dinvestment when growth opportunities are avail-able, and is negatively associated with R&D invest-ment when growth opportunities are unavailable.It appears that foreign owners foster appropri-ate investment, enhancing R&D investments whengrowth opportunities enhance the likely benefits,and reducing R&D investments when the lack ofgrowth opportunities threatens to limit the likelybenefits. Interestingly, the pattern for capital inten-sity is somewhat different. We find, consistentwith our hypotheses, that capital intensity is higherwhen growth opportunities are available than whenthey are absent. Nevertheless, the main effect offoreign ownership is to reduce capital intensity,presumably as a means to curtail overinvestment.Most of the prior research examining Porter’s viewhas focused on R&D intensity; more research isneeded to understand capital investments.

Recent ownership trends suggest that foreignowners are gaining importance all over the world(Useem, 1998). Our research suggests that thesesmall block foreign owners have important impli-cations for strategic investments by firms. This inturn has implications for global competitivenessand firm performance. Related research by

Aguilera and Cuervo-Cazurra (2004) finds that for-eign ownership spurs adoption of global gover-nance codes in a study of 49 countries, leadingto increased convergence across national borders.More research on foreign ownership worldwide islikely to help us better understand ownership struc-tures and their effects on governance, strategy, andperformance.

ACKNOWLEDGEMENTS

We would like to thank Associate Editor EdZajac, two anonymous reviewers, and Eric Tsang,Ed Levitas, Tyge Payne, Chris Shook, RichardPriem, Nandini Rajagopalan, Matt Bloom, and JonO’Brien for their many helpful comments on pre-vious drafts.

REFERENCES

Abegglen J, Stalk G. 1985. Kaisha: The Japanesecorporation . Basic Books: New York.

Aguilera RV, Cuervo-Cazurra A. 2004. Codes of goodgovernance worldwide: what is the trigger? Organi-zation Studies 25: 415–444.

Aguilera RV, Jackson G. 2003. The cross-nationaldiversity of corporate governance: dimensions anddeterminants. Academy of Management Review 28:447–465.

Ahmadjian CL, Robinson P. 2001. Safety in numbers:downsizing and deinstitutionalization of permanent

Copyright 2006 John Wiley & Sons, Ltd. Strat. Mgmt. J., 27: 591–600 (2006)

Research Notes and Commentaries 599

employment in Japan. Administrative Science Quar-terly 46: 622–654.

Allen F. 1993. Strategic management and financialmarkets. Strategic Management Journal , WinterSpecial Issue 14: 11–22.

Arellano M. 2003. Panel Data Econometrics . OxfordUniversity Press: Oxford.

Association of Japanese Stock Exchanges. 2002. StockDistribution Research (in Japanese).

Bank of Japan. 2004. Financial and economic statistics(21 March 2004).

Baysinger B, Kosnik R, Turk TA. 1991. Effect of boardand ownership structure on corporate R&D strategy.Academy of Management Journal 34: 205–214.

Bethel JE, Liebeskind J. 1993. The effect of ownershipstructure on corporate restructuring. Strategic Man-agement Journal , Summer Special Issue 14: 15–31.

Bhojraj S, Sengupta P. 2003. Effect of corporategovernance on bond ratings and yields: the role ofinstitutional investors and outside directors. Journalof Business 76: 455–475.

Brennan MJ, Tamarowski C. 2000. Investor relations,liquidity, and stock prices. Journal of AppliedCorporate Finance 12(4): 26–37.

Bushee B. 1998. The influence of institutional investorson myopic R&D investment behavior. AccountingReview 73: 305–333.

Charkham J. 1994. Keeping Good Companies: A Studyof Corporate Governance in Five Countries . OxfordUniversity Press: Oxford.

Chung KH, Pruitt SW. 1994. A simple approximation ofTobin’s Q. Financial Management 23(3): 70–74.

David P, Hitt MA, Gimeno J. 2001. The influence ofactivism by institutional investors on R&D. Academyof Management Journal 44: 144–157.

Davis EP, Steil B. 2001. Institutional Investments . MITPress: Cambridge, MA.

Dow J, Gorton G. 1997. Stock market efficiency andeconomic efficiency: is there a connection? Journalof Finance 52(3): 1087–1129.

Dvorak P, Guth RA, Singer J, Zaun T. 2001. Loose ends:frayed by recession, Japan’s corporate ties are comingunraveled. Wall Street Journal , Eastern edn A1.

Economic and Social Research Institute. 2002. http://www.esri.cao.go.jp/jp/sna/toukei.html [24 October2003].

Fazzari S, Hubbard RG, Peterson BC. 1988. Financingconstraints and corporate investments: comments anddiscussion. Brookings Papers on Economic Activity 1:141–206.

Froot KA, Scharfstein DS, Stein JC. 1992. Herd onthe street: informational inefficiencies in a marketwith short-term speculation. Journal of Finance 47:1461–1485.

Graves SB. 1988. Institutional ownership and corporateR-and-D in the computer industry. Academy ofManagement Journal 31(2): 417–428.

Grossman SJ. 1995. Dynamic asset allocation andthe informational efficiency of markets. Journal ofFinance 50: 773–789.

Hayek FA. 1945. The use of knowledge in society.American Economic Review 35: 519–530.

Henderson J, Cool K. 2003. Corporate governance,investment bandwagons and overcapacity: an analysisof the worldwide petrochemical industry, 1975–95.Strategic Management Journal 24(4): 349–373.

Henry PB. 2000. Stock market liberalization, economicreform, and emerging market equity prices. Journal ofFinance 55: 529–564.

Hoshi T, Kashyap A. 2001. Corporate Financing andGovernance in Japan . MIT Press: Cambridge, MA.

Hoskisson RE, Hitt MA, Johnson RA, Grossman W.2002. Conflicting voices: the effects of institutionalownership heterogeneity and internal governanceon corporate innovation strategies. Academy ofManagement Journal 45: 697–716.

Hundley G, Jacobson CK, Park SH. 1996. Effectsof profitability and liquidity on R&D intensity:Japanese and U.S. companies compared. Academy ofManagement Journal 6: 1659–1674.

Kamesaka A, Nofsinger JR, Kawakita H. 2002. Invest-ment patterns and performance of investor groups inJapan. Pacific-Basin Finance Journal 11: 1–22.

Kaplan SN. 1994. Top executive rewards and firmperformance: a comparison of Japan and the UnitedStates. Journal of Political Economy 102: 510–546.

Kester WC. 1991. Japanese Takeovers: The GlobalContest for Corporate Control . Harvard BusinessSchool Press: Boston, MA.

Kochhar R, David P. 1995. Institutional investors andfirm innovation: a test of competing hypotheses.Strategic Management Journal 17(1): 73–84.

Lang L, Ofek E, Stulz RM. 1996. Leverage, investment,and firm growth. Journal of Financial Economics 40:3–29.

Lazonick W. 2002. The Japanese economy and corporatereform: what path to sustainable prosperity? InCorporate Governance and Sustainable Prosperity ,Lazonick W, O’Sullivan M (eds). Palgrave: NewYork; 226–254.

Lee PM, O’Neill HM. 2003. Ownership structures andR&D investments of U.S. and Japanese firms:agency and stewardship perspectives. Academy ofManagement Journal 46: 212–225.

Levine R. 1997. Financial development and economicgrowth: views and agenda. Journal of EconomicLiterature 35: 688–726.

Lu JW, Beamish PW. 2004. International diversificationand firm performance: the S-curve hypothesis.Academy of Management Journal 47: 598–609.

Nitta K. 2000. Cross shareholdings and businessmanagement: an empirical analysis. Security AnalystsJournal 38(2): 72–93.

Parrino R, Sias RW, Stark LT. 2003. Voting with theirfeet: institutional ownership changes around forcedCEO turnover. Journal of Financial Economics 68:3–46.

Porter ME. 1992. Capital disadvantage, America’s failingcapital investment system. Harvard Business Review70(5): 65–82.

Poterba JM, Summers L. 1995. A CEO survey ofcompanies’ time horizons and hurdle rates. SloanManagement Review 37(1): 43–53.

Copyright 2006 John Wiley & Sons, Ltd. Strat. Mgmt. J., 27: 591–600 (2006)

600 P. David et al.

Shleifer A, Vishny RW. 1997. A survey of corporategovernance. Journal of Finance 52: 737–783.

Stein JC. 1989. Efficient capital markets, inefficient firms:a model of myopic corporate behavior. QuarterlyJournal of Economics 104: 655–670.

Tesar LL, Werner IM. 1992. Home bias and theglobalization of security markets. NBER WorkingPaper 4218; 1–52.

Thomas LG, Waring G. 1999. Competing capitalism:capital investment in American, German, and Japanesefirms. Strategic Management Journal 20(8): 729–748.

Tobin J. 1969. A general equilibrium approach tomonetary theory. Journal of Money, Credit andBanking 1: 15–29.

Tokyo Stock Exchange. 2002. Fact Book 2002 . TokyoStock Exchange: Tokyo.

Useem M. 1998. Corporate leadership in a globalizingequity market. Academy of Management Executive12(4): 43–59.

Wahal S, McConnell JJ. 2000. Do institutional investorsexacerbate managerial myopia? Journal of CorporateFinance 6: 307–329.

Yoshikawa T, Gedajlovic ER. 2002. The impact ofglobal capital market exposure and stable ownershipon investor relations practices and performance ofJapanese firms. Asia Pacific Journal of Management19: 525–540.

Yoshikawa T, Phan PH. 2003. The performance implica-tions of ownership driven governance reform. Euro-pean Management Journal 21: 698–706.

Yoshikawa T, Phan PH, David P. 2005. The impactof ownership structure on wage intensity inJapanese corporations. Journal of Management 31:278–300.

Zahra SA. 1996. Governance, ownership, and corporateentrepreneurship: the moderating impact of industrytechnological opportunities. Academy of ManagementJournal 39: 1713–1735.

Copyright 2006 John Wiley & Sons, Ltd. Strat. Mgmt. J., 27: 591–600 (2006)