Investors shy away from nontransparent countries, businesses

by Matthew Davis

National Bureau of Economic Research

sbj@sbj.net

Whenever economic performance falters in emerging markets, analysts are frequently heard lamenting what they call a "lack of transparency."

What they mean is that some countries and the corporations that operate there may contribute to their woes by failing to fully disclose information about financial and economic conditions while also being less-than-clear about the laws and regulations that govern their markets.

For example, governments might be viewed as withholding information on (or being vague about) debt levels, fiscal policies and regulatory requirements, while companies may be seen as stingy with financial disclosures.

In Transparency and International Investment Behavior, NBER Working Paper No. 9260, co-authors R. Gaston Gelos and Shang-Jin Wei find that, at least when it comes to attracting much-needed foreign capital, a lack of transparency indeed may affect economic performance by repelling international investors.

"There is relatively clear evidence that low transparency ... tends to depress the level of international investment," they said.

Gelos and Wei reach this conclusion after synthesizing data from various international surveys that assess government and corporate candor in addressing economic and financial conditions.

For governments, the authors were interested in data measuring the "transparency and predictability" of broad economic policies in addition to the "frequency and timeliness" of information releases. In seeking data on corporate transparency, Gelos and Wei hoped to "capture as accurately as possible the notion of information quality and availability."

They then took their ratings of corporate and government transparency and compared them to the monthly investment decisions of up to 90 global funds that invest in emerging economies between 1996 and 2000.

What the data show, according to Gelos and Wei, is that "without exception" a country's lack of transparency "is associated with lower exposure of emerging market funds."

For example, looking at a sample of emerging market funds, the authors find that Venezuela accounted for about 0.4 percent of the investment portfolio. But they state that it could "achieve an increase in weight in fund portfolios by 1.7 percentage points if it increased its transparency to Singapore's level."

In other words, the international portfolio investment to Venezuela would have increased by 300 percent.

They also find a "moderate amount of evidence" that a lack of transparency makes investors more likely to engage in herding behavior; that is, when dealing with less transparent countries, investment decisions are more likely to be determined by what other fund managers are doing as opposed to a rational, independent assessment of market fundamentals.

This lemming-like activity, in which investors suddenly take their money and run en masse, often is cited as contributing to economic instability by exacerbating crises in emerging markets. Indeed, Gelos and Wei find that during economic crises, fund managers "flee non-transparent countries and invest in more transparent ones."

Finally, Gelos and Wei observe that a lack of transparency seems to make investors somewhat suspicious of economic news.

While investors elsewhere routinely react to economic news by immediately reconfiguring their portfolios, in less transparent economies, the authors find, "fund managers may want to wait for further confirmation before engaging in a costly reallocation of assets."