Daily Archives: August 6, 2007

The ‘Home Bias’ Effect and International Investments

Continuing with the impromptu delusions theme, that started with Managerial Delusions two weeks ago and continued with What Got You Here Won’t Get You There last week, this week we discuss another recent article from Knowledge @ Wharton, The Impact of Good Governance on International Investing: The ‘Home Bias’ Effect and Other Issues.

The article, which discussed the important of good corporate governance and how it can enhance the attractiveness of one country’s financial markets relative to another’s, also discussed the ‘home bias’ effect, which is the tendency for investors to buy shares in companies based in their own countries despite the globalization of financial markets.

It referenced a paper by Frank Warnock, a professor of business administration at the University of Virginia’s Darden Business School, Rene M. Stulz, a professor of finance at Ohio State University, and Bong-Chan Kho, a professor in the College of Business Administration at Seoul National University, titled “Financial Globalization, Governance, and the Evolution of the Home Bias” that found that, despite the disappearance of many barriers to international investment, the home bias of U.S. investors towards the 46 countries with the largest stock markets did not fall from 1994 to 2004.

There are often a number of reasons for a ‘Home Bias’, including barriers to investment, hedging motives, access to information, behavioral biases, and, as suggested by the authors, “optimal insider ownership”. The “optimal insider ownership” theorizes that since foreign investors can only own shares not held by insiders, there will be a home bias toward countries in which insiders own a large corporate stake.

Regardless of the reasons, it’s an important bias, or delusion, to be familiar with. Considering that the US population is about 301 Million, or 4.56% of the world’s population which is about 6,602 Million, even though the US currently accounts for roughly 19.91% of the gross world product (1,313 billion of the 6,595 billion), this percentage is only going to continue to fall as the GDP of the current low cost country poster children, and India and China in particular, continue to rise. (Statistics from The World Factbook.)

Furthermore, when you consider that even five years after the introduction of the stringent Sarbanes-Oxley act, foreign companies are continuing to delist from American Stock Exchanges on a regular basis (and just last week, over on the European Leaders in Procurement Blog, Richard Edwards points out how Sarbox Sends Another Blue Chip Running For The Hills), it’s obvious that investment is going to continue to diversity globally as time marches on.

But the home bias doesn’t just affect individual investors or investment funds, it affects global sourcing teams as well. In this context, the home bias reflects the natural tendency of the sourcing team to continue sourcing, and investing, in countries, and suppliers, from which they have previously sourced. Even when the team accepts that they need a new lower cost or higher value source of supply, they’ll look first at countries they are currently doing business in and the competition to their current suppliers. Although the team should consider these sources, as well as the impact of a strategic investment in their current supply base to decrease costs or increase value, the team should also consider sources in new countries and subject them to the same, unbiased, evaluations that their current suppliers are subject to. Only then will the sourcing team truly be able to identify the best source of value.