Foreign ownership and financial performance: evidence from Egypt.

Azzam, Islam ; Fouad, Jasmin ; Ghosh, Dilip K. 等

I. INTRODUCTION

The Egyptian Revolution in January 2011, which put an end to the thirty-year old regime of President Mubarak, has led to an overall condemnation of many of the economic policies and procedures of that period. Among the procedures that have been criticized are the numerous initiatives to encourage foreign ownership that include equal treatment for foreigners and domestic investors in terms of land and capital ownership, tax holidays for at least five years for foreign investors, and the exemption of some labor law articles for foreign firms operating in Free Zones.

From a macroeconomic perspective these policies have contributed to an increase in foreign ownership and an upsurge in Foreign Direct Investment (FDI) in Egypt, which is reflected in a rise of inward FDI from $38,925 million in 2006 to $73,095 million in 2010. In 2010, Egypt was ranked number 14 out of 116 developing economies, in attracting inward FDI (UNCTAD). The positive effect of foreign ownership is attributed to the ability of foreign-owned firms to increase capital, transfer technology and R&D, and improve managerial skills. However foreign ownership can also have a negative impact on the economy, when it is accompanied by "crowding out" of local companies, increased unemployment among local workers, and lower tax revenues due to tax holidays given to foreign firms.

There is a current debate in Egypt about the importance of foreign ownership in the Egyptian economy. While a group is stressing the importance of policies to increase foreign ownership as a means of improving financial performance of firms in Egypt and to achieve higher GDP growth rates, another group is rejecting these policies based on the perception that the financial performance of foreign ownership is not very different from domestic ownership. The second group is particularly found among Egyptian Labor Unions and Egyptian workers, who have been a main participant in the revolution because they lost their jobs due to privatization and foreign ownership.

The same debate has also been an issue of interest in the academic literature. The underpinnings of this topic are found in several theories, namely the agency theory, the resource-based theory and the institutional theory (Douma et al., 2006).The theories focus on explaining the link between ownership and financial performance in the context of developed countries and not necessarily the emerging and less developed countries. Bhagwati and Brecher (1980), Brecher and Bhagwati (1981) cogently deal with foreign ownership, trade and welfare, and they show that foreign ownership increases national welfare and national income of the host country. When at the national level the welfare and income increase, it is easy to recognize that at the corporate level everything is along the line. It is, however, not clear of the trajectory of the growth of welfare and corporate earnings, earning per share (EPS), and other issues. Foreign ownership with a domestic firm is like a merger of two firms, domestic and foreign. It is easy to prove that if this merger is done under fair deal, EPS increases if the domestic firm's price earnings ratio [(P/E).sub.d] exceeds the foreign firm's [(P/E).sub.F]. Ghosh, and Ghosh (1997) show, through their triangle, the optimum location, and optimum investment that involve pairing up firms' joint action. It is illustrated that paring of two or more firms--local and foreign--can make the joint ventures earnings-augmenting. Capital and skills can be extensive, synergy escalates, and that undoubtedly becomes beneficial for every entity involved. Norman and Jones (1979) convey the same result through a model of trade and unemployment in a context of general equilibrium.

In a different twist, in the context of determining optimum capital structure, particularly with reference to a search of pecking order as a dynamic leverage theory, Bagley and Yaari (1996), and Bagley, Ghosh, and Yaari (1998) present a class of diffusion models that mimic this behavior in a stochastically dynamic framework and show how to optimize a financing strategy by any static trade-off theory as input. It should be noted that Fischer, Heinkel, and Zechner (1989), and Mauer and Triantis (1994) have provided the dynamic leverage policy which is different from Bagley, and Yaari (1996), and Bagley, Ghosh, and Yaari (1998). Making use of Arrow, Karlin, and Scarf's (1958), and particularly, Arrow-Harris-Marschak dynamic model (Section III, 1958) and their (S, s) policy, we build the stochastic model of Weiner process with constant drift ([mu])and diffusion parameter ([sigma]) as follows:

dL = [mu]dt + [sigma]d[omega] (1)

where L is the state-control variable representing leverage index that is monotonically increasing with debt and decreasing with equity. We postulate endogenous barriers with asymmetric quadratic penalty function, symmetric transaction costs and no drift, one can get the expressions for s(L), S(L), u(L), [lambda](L), m(L), [upsilon](L) g(L), and [omega](L) It is postulated that L triggers a fixed transaction cost at each encounter with upper and lower barriers, as in (S, s), and generates an instantaneous penalty when on free traversal between barriers. The barrier points and the return point chosen to minimize expected total periodic cost are L = [beta] (upper barrier point) when the firm makes costly lump-sum readjustment in its debt equity position to the point, L = r, and issues stock and retires bonds in the amount of [beta]-r. If the leverage index hits the lower barrier, L = [alpha], there will be readjustment back to L = r by stock repurchase bankrolled by borrowing in the amount of r-[alpha].

The paradigm with endogenous barriers, symmetric quadratic penalty and transaction costs and no drift can be brought out as:

[MATHEMATICAL EXPRESSION NOT REPRODUCIBLE IN ASCII] (2)

and the scale function, S(L) is

S(L) = [integral] s(L)dL = L (3)

The probability of hitting the upper barrier before lower barrier, u(L), given that the process begins at an unspecified leverage, L is as follows:

u(L) = [S(L)-S([alpha])]/[s([beta])-S([alpha])] = [L-[alpha]]/[[beta]-[alpha]] (4)

And the speed density, m(L), computed from (3), is

m(L) = 1/[[[sigma].sup.2]s(L)] = 1/[[sigma].sup.2] (5)

From this value one can get the expected time to reach either barrier from any point L is [upsilon](L), by use of expressions (3)-(5), and here then

[MATHEMATICAL EXPRESSION NOT REPRODUCIBLE IN ASCII] (6)

Assuming penalty function, g(L), centered on the ideal leverage, [L.sub.0], where

g(L) = q(L-[L.sub.0]) q > 0 (7)

whose lowest value is g([L.sub.0]) 0 measures the instantaneous penalty incurred by any deviation from the ideal leverage, [L.sub.0]. However, the expected penalty incurred up to the first encounter with either barrier, [omega](L), when starting from any point L is

[MATHEMATICAL EXPRESSION NOT REPRODUCIBLE IN ASCII] (8)

The objective minimand then is

[MATHEMATICAL EXPRESSION NOT REPRODUCIBLE IN ASCII] (9)

where [kappa] [greater than or equal to] 0 is the fixed cost of transaction (assumed). A corporation's objective is to minimize the expected excess cost of capital by optimally choosing [alpha] = [??], [beta] = [??] and L = [??]. Because of the symmetry postulated, optimal return point is at the ideal leverage, [L.sub.0]--which is half-way between [??] and [??], and

[MATHEMATICAL EXPRESSION NOT REPRODUCIBLE IN ASCII].

Upon further simplification because of underlying assumption of symmetry, one can have the following:

[phi](L)= [[kappa][[sigma].sup.2]]/[[([L.sub.0]-[alpha]).sup.2]] + [[([L.sub.0] - [alpha]).sup.2]/6] q (9 *)

Minimization of [phi](L)with respect to a yields:

[??] = [L.sub.0] - [square root of ({[6[kappa][[sigma].sup.2]]/q]})] (10)

and

[??] = [L.sub.0] - [square root of ({[6[kappa][[sigma].sup.2]/q]})] (11)

Substitution of [??], [??], and [??] in the objective function results in:

[??] = [square root of ([2[kappa]q[[sigma].sup.2]/3])] (12)

which signifies that the cost of capital includes flotation and stock repurchase costs in stochastic structure and the cost of stochastic deviation from [L.sub.0]. Generalization of this basic paradigm into a model of leverage indifference with exogenous barriers, symmetric transaction costs and positive drift parameter gives rise to optimum return point:

[L.sup.*] = l/[epsilon] ln ([[e.sup.[beta][epsilon]] - [e.sup.[alpha][epsilon]]]/[[epsilon]([beta]-[alpha])]) (13)

and the optimal mean leverage is defined by:

[[??].sup.*] = [A + B]/C (14)

where

[MATHEMATICAL EXPRESSION NOT REPRODUCIBLE IN ASCII]

We can create other scenarios and paradigms. With foreign ownership these pecking orders maximize returns and minimize costs involved in pecking order, particularly for firms in less-developed countries.

Based on these theories some empirical results have found positive effects of foreign ownership on firm's performance (e.g., Willmore, 1986; Piscitello and Rabbiosi, 2005). Others have reached opposite results on the link between foreign ownership and financial performance (e.g., Kim and Lyn, 1990; Khawar, 2003).

This paper aims to contribute to the on-going debate to serve not only the policy-makers in deciding which path should be taken in emerging economies, but also the literature to fill the gap on the link between foreign ownership and financial performance in emerging countries and specifically Egypt. We believe that this paper is a unique contribution to the literature as it sheds the light on the impact of various degrees of foreign ownership on financial performance in Egypt.

Using a panel of 8,185companies in Egypt for the period of 2006-2010, we find that foreign ownership in Egypt has a significant positive impact on financial performance. The results show that foreign ownership significantly improves profits, an increase of 10% in foreign ownership increases the ROA and ROE by 2.3% and 2.1% respectively. Foreign ownership also has a significant and positive effect on debt (decreases debt), which can be explained by the ability of foreign owners to improve firms' access to finance.

The remainder of the paper is organized as follows: Section II contains the literature review. Section III describes the data and the sample construction. Section IV presents the empirical methodology. In Section V we show the empirical results and a discussion of these results and section VI concludes.

II. LITERATURE REVIEW

Vast literature compares the financial performance of foreign-owned firms to domestic-owned firms. The numerous studies are divided, while some show that foreign ownership has a significant and positive effect on performance, others find a negative impact. Willmore (1986) found that the financial performances of foreign-owned firms are superior to those of domestic firms. Doms and Jensen (1995) show that foreign-owned companies in the U.S. are more productive compared to domestic-owned. Goethals and Ooghe (1997) examine the effect of foreign ownership on Belgian companies. They find that foreign ownership significantly improves financial performance in Belgian companies. Chhibber and Majumdar (1999) compare the effect of foreign-owned firms in India to domestic on firm performance, and find that foreign ownership improves performance. In the adopted regression models they find a negative and significant effect of the debt ratios. Conyon et al. (2002) analyze the impact of foreign-owned companies on labor productivity in the UK in the period 1987-1996 and find a positive and significant impact of foreign-owned versus domestic-owned. Akimova and Schwodiauer (2004) find that foreign ownership improves firm's financial performance in Ukraine except for companies with relatively high concentrated foreign ownership. Their results show that the relationship between foreign ownership and firm performance is non-linear, reflecting an increase in firm performance with higher foreign ownership up till a certain degree ,and then the performance decreases when foreign ownership is close to majority ownership. Arnold and Javorcik (2005) reach similar results in their research on the relationship between foreign-owned firms and total productivity in Indonesia. Piscitello and Rabbiosi (2005) show the positive impact of ownership change on financial performance based on the data of Italian companies. Alan and Steve (2005) study the short and long term effects of foreign ownership on UK companies during the period 1984 to 1995. They show that foreign ownership has a significant and positive effect on financial performance.

Aydin et al. (2007) examine the effect of foreign ownership on financial performance on firms in Turkey; the results show a positive impact of foreign ownership on the firms' performance.

On the other hand, the study of Kim and Lyn (1990), covering 54 multinational companies in the period 1980-1984, show that foreign firms in the U.S are less profitable and have higher levels of debt compared to domestic firms. Aitken and Harrison (1999) used a data set of 43,010 observations covering firms in Venezuela in the period 1976-1989 to examine the impact of foreign-owned firms on firm performance. The findings show no evidence supporting the presence of technology spill-overs from foreign-owned firms to domestic-owned firms.

Konings (2001) tests the effect of FDI on the performance of firms in Bulgaria, Romania and Poland, for the period from 1993 to 1997. Their results show that foreign firms perform better only in Poland, compared to the domestic companies. Khawar (2003) finds that foreign ownership has no positive spill-over effect on the manufacturing sector in Mexico.

The study of Goerg and Stroebl (2003) indicates that foreign firms in Ireland are more likely to close down and this is similar to the results of Bernard and Jensen (2007) which focus on multinationals in the United States. Barbosa and Louri (2005) show that there is no significant difference in performance between domestically owned and MNCs operating in Portugal and Greece.

On the effect of foreign ownership on firm performance in Egypt there are a limited number of papers. Ben Naceur et al. (2007) investigate 95 firms in Egypt Morocco, Tunisia, and Turkey, and they find a positive impact of foreign ownership on profits and output. In another study, Omran et al. (2008) with a sample of 304 companies from four countries, namely Egypt, Jordan, Oman and Tunisia during the period 2000-2002 find no significant impact of foreign investors on firm performance. Omran (2009) examines 52 newly privatized companies in Egypt, and he finds that foreign ownership has a positive impact on firm performance.

Summarizing the numerous studies on the relation between foreign ownership and firm performance suggest that there is no conclusive result; therefore we aim to examine the effect of foreign ownership on the financial performance using a larger sample (8,185) of firms in Egypt and to evaluate how compatible the results are with pervious results. A major shortcoming of the majority of the literature is that the distinction is made between foreign-owned and domestic-owned firms, without differentiating between the various degrees of ownership. Only a limited number of studies (e.g., Blomstrm and Sjholm, 1999; Chhibber and Majumdar, 1999; Akimova and Schwdiauer, 2004) have investigated the effect of the degree of foreign ownership on firm performance, where the range of foreign ownership is divided into a number of subsamples referring to majority foreign ownership ,minority foreign ownership, and complete foreign ownership. To fill this gap in the literature we compare the effect of various degrees of foreign ownership on firm performance, with the use of six subsamples to refer to various degrees of foreign ownership ranging from zero foreign ownership to complete foreign ownership.

III. DATA AND VARIABLES DESCRIPTION

The data were collected from the database of the General Authority of Free Zones and Investment (GAFI) in Egypt. We started with a sample of 10,000 companies registered at GAFI, which was then reduced to 8,158 companies, as we restricted our sample to only include the companies with available financial statements for a minimum of two years within the period 2006-2010. This restriction and the removal of outliers resulted in the reduction of the number of observations to 19,865 observations .This total sample is divided into two sub-samples: the first sample includes 14,312 observations of companies without foreign ownership; while the second sample comprises 5,553 observations from companies with foreign ownership. The total sample is well-diversified as it includes small, medium and large companies with sizes (measured in terms of total assets) ranging from $1million to $794 million; and covers most of the economic sectors in the Egyptian Economy (the Agricultural Sector, Construction Sector, Financial Sector, Industrial Sector, Information Technology Sector, and Service Sector).The frequency of the data is annual.

Based on the literature review, we find that there is not a unified model framework that explains the relationship between foreign ownership and firm performance. We basically adopt the model by Mueller et al. (2003), with some adjustments to include control variables and accommodate for data availability (Caves, 1996). In this study the independent variables are return on assets (ROA), return on equity (ROE), and the debt ratio (DR). ROA is defined as the ratio of net income to total assets, and shows the ability of firms in generating income from assets. ROE is calculated as the ratio of net income to total equity, and indicates the efficiency of generating profits from shareholders' equity. These ratios are used extensively in the literature as measures of profits. DR is the ratio of total debt to total assets, and captures the leverage of the firm.

The independent variable is foreign ownership (FO), and it refers to the percentage of equity held by foreign owners in a company (Lee, 2008). The traditional approach of including the effect of foreign ownership is with the use of a dummy variable (Yudaeva et al., 2003). However, as the focus of the study is to compare various levels of foreign ownership, the traditional approach is inappropriate.

To deal with the possibility that a variety of variables can jointly affect firm performance and foreign ownership and hence cause correlation between them, we introduce a number of control variables in the model. We control for the size (S), measured by the natural logarithm of total assets (Zeckhouser and Pound, 1990). The importance of controlling for size is based on the results of Fama and French (1995), who have concluded that small firms have, on average, lower earnings (scaled by book value of equity) compared to large firms. This can be explained by the ability of large firms to utilize economies of scale and scope compared to small firms. The model includes another control variable, namely age (A), measured by the number of years since the company has been founded (Morck et.al, 1988).

We include other variables such as the asset turnover ratio (AT), measured as sales divided by total assets, current ratio (CR), which is the ratio of current assets to current liabilities, and net profit margin (NPM), which is the ratio of net income to sales. The definitions of all dependent and independent variables are found in Appendix 1.

Table 1 provides the summary statistics for the two subsamples. It shows the mean, median, and t-test for the significant difference in means, and the Wilcoxon test for the significant differences in medians for all variables.

The sample includes 14,312 companies without foreign ownership and 5,553 companies with foreign ownership during the period from 2006 to 2010.The mean and median of the foreign ownership ratio for the foreign firms is equal to 60%. The test-statistics for the significant difference in means and medians show that companies with foreign ownership have significantly higher ROA, ROE, NPM, and AT compared to companies without foreign owners. It is worth noting that companies with foreign ownership are significantly larger in size and older in age than companies without.

The mean (median) of the ROA is 6.9% (4.6%) for companies without foreign ownership compared to 7.9% (5.4%) for companies with foreign ownership. The mean (median) of the ROE for companies without and with ownership are 17.1% (12.9%) and 18.3% (14.6%), respectively. The mean (median) of net profit margin is significantly higher for companies with foreign ownership 3.7% (7.6%), compared to the mean (median) of companies without foreign ownership 1.6% (5%).

We also examine the effect of the different levels of foreign ownership on financial performance. Table 2 provides the results, that include the means and medians for six subsamples based on various degrees of foreign ownership, ranging from zero to 100%.The first sample covers the companies with zero foreign ownership, the second covers the companies with foreign ownership in the range from more than zero to 20%, the third sample includes firms with foreign ownership ranging from 20% to 40%. The fourth, fifth and sixth samples cover the ranges 40% to 60%, 60% to 80%, and 80% to 100% foreign ownership respectively. Table 2 shows that the means and medians for S, NPM and ROA for companies with zero foreign ownership and companies with 80% to 100% foreign ownership are relatively lower compared to other ranges of ownership. It is worth noting that the median of the ROA for companies at the zero degree of foreign ownership and the 100% foreign ownership are 4.5% and 4.7%, respectively. On the other hand the median for companies with foreign ownership reaches the highest level in the foreign ownership range 20%-40% at 6.6%. The medians of NPM for companies with foreign ownership in the range 20%-40% and 40%-60% are in the range between 7.8% and 10%, which are relatively higher when compared to the medians for companies with zero and 80% to 100% ownership (5% and 5.7%, respectively). To sum up, the results indicate that companies with highly concentrated domestic ownership (zero foreign ownership) and highly concentrated foreign ownership (80%-100%) are relatively less profitable.

After dividing the data into six different subsamples based on the foreign ownership ratio, we investigate the effect of foreign ownership on a company's performance in various sectors. Table 3 shows the effect of foreign ownership on a company's performance in seven different sectors which are the information technology sector, the construction sector, the financial sector, the service sector, the agricultural sector, the tourism sector, and the industrial sector. It provides the means, medians, and t-statistics for the significant difference in means between companies with and without foreign ownership in each sector. Our results show that companies with foreign ownership are relatively larger in size compared to companies without foreign ownership for all sectors. Foreign ownership has no significant effect on profitability for companies in the information technology sector, the construction sector, and the agricultural sector. Foreign ownership has a significantly positive effect on profitability of companies in the service sector, tourism sector, and the industrial sector while it has significantly negative effect on the profitability of companies in the financial service sector.

The means (medians) of ROA for companies in the financial sector without and with foreign ownership are 7.4% (4.7%) and 5.3% (2.7%), respectively. In the financial service sector, the ROE for companies without and with foreign ownership have means (medians) of 18% (12.9%) and 11.7% (9.6%), respectively. In the tourism sector, the means (medians) of ROA for companies without and with foreign ownership are 4.2% (2.9%) and 8.7% (5.3%), respectively. The means (medians) of ROE for companies in the tourism sector without and with foreign ownership are 9.7% (7.7%) and 17.3% (12.1%), respectively.

Foreign ownership significantly increases the debt ratio (DR) in companies in the construction and financial service sectors. This can be explained by the superior ability of foreign-owned firms to have access to finance.

Moreover, companies with foreign ownership in the service sector, the financial sector, and industrial sectors have the highest medians of foreign ownership ratios, while companies with foreign ownership in the agricultural and construction sectors show the lowest levels. In companies with foreign ownership, the medians of foreign ownership ratio in the service sector, financial sector, and the industrial sector are 75%, 60%, and 60%%, respectively, while the medians in the agricultural sector and construction sector are 42% and 49%, respectively. In addition, companies without foreign ownership in the information technology sector and service sectors have the highest means and medians of ROA and ROE, while companies without foreign ownership in tourism and agriculture sectors have the lowest means and medians of ROA and ROE. Firms with foreign ownership in the information technology sector and the service sector also have the highest means and medians of ROA and ROE, while companies with foreign ownership in the agricultural and financial sectors have the lowest. On the other hand companies in the financial sector are the largest in terms of size while, companies in the information technology sector are the lowest in size.

To summarize the results of the Table 3, we can conclude that while foreign ownership has a positive significant effect on profitability in some sectors(namely the service sector, the tourism sector and the industrial sector), it has a negative positive result in the financial sector, and no significant result in both the construction and agricultural sector. This signifies that the effect of foreign ownership on profitability is sector specific. The empirical evidence also shows that foreign ownership increases debt in the construction sector and the financial sector.

IV. EMPIRICAL METHODOLOGY

We examine the effect of foreign ownership on company profitability and debt using 8,158 companies during the period from 2006 to 2010. We estimate a panel data model with unbalanced data using the following two equations, each one separately:

[Profitability.sub.it]= [[beta].sub.0]+[[beta].sub.1][DR.sub.it]+ [[beta].sub.2] [FO.sub.it]+ [[beta].sub.3] [S.sub.it] (15)

[Debt.sub.it] = [[beta].sub.0] + [[beta].sub.1] [A.sub.it] + [[beta].sub.2] [AT.sub.it] + [[beta].sub.3] [CR.sub.it] + [[beta].sub.4] [FO.sub.it] + [[beta].sub.5] [NPM.sub.it] (16)

where i = 1, 2, 3, ..., n (number of firms) and t = 1, 2, ...,T (number of years). Equation (15) examines the effect of foreign ownership on company profitability, where return on assets (ROA) and return on equity (ROE) are used as measures of profitability. We control for the effect of two important variables on profitability which are the debt ratio (DR), and company size (S). In equation (16), we investigate the effect of foreign ownership on debt. This second equation includes the dependent variables asset turnover (AT), the current ratio (CR), foreign ownership (FO), net profit margin (NPM) and the control variable Age (A).

Consideration of endogeneity is essential to our analysis in an effort to identify the causality of the empirical relationships. Earlier studies have argued that firm's profitability and debt are endogenously determined. Also, it is essential to address the potential endogeneity between profitability and foreign ownership. It is more likely that companies with relatively better performance have relatively high foreign ownership; and at the same time, foreign ownership improves financial performance. We test for endogeneity in equations (15) and (16), using the Durbin-Wu-Hausman test, to identify whether profitability, debt, and foreign ownership are simultaneously determined. The null hypothesis to test is that an ordinary least squares (OLS) estimator of the same equation would yield consistent estimates: that is, any endogeneity among the regressors would not have deleterious effects on the OLS estimates. A rejection of the null hypothesis indicates that endogenous regressors' effects on the estimates are meaningful, and instrumental variables are required. Table 4 shows that we only reject this hypothesis in equation (15) when examining the endogeneity between debt and profitability. In other words we only have an endogeneity problem in equation (15) between profitability and debt, which we eliminate with the use of a two-stage least squares (2SLS) approach in that equation. We also introduce instrumental variables for debt in equation (15).The choice of the instrumental variables is very crucial as they should be highly correlated with debt; and also have no impact on profitability. We here selected the variables age, asset turnover, current ratio, and net profit margin as instrumental variables for debt.

After obtaining the fitted (estimated) values of the debt, we replace debt in equation (15) by its fitted values.

Greene (2002) and Wooldridge (2000) show that the 2SLS estimator is asymptotically efficient, making it a good candidate for maximum-likelihood estimations. For our panel regression setting, 2SLS is attractive compared with the simple seemingly unrelated regressions (SUR) method as it provides better identification in estimation. For robustness of our diagnostic tests, we test for causality between profitability, debt, and foreign ownership. We use the Granger (1969) causality test which is a technique for determining whether one time series is useful in forecasting another. Table 5 reports the Granger causality tests between profitability, measured by return on assets (ROA) and return on equity (ROE), debt ratio (DR), and foreign ownership (FO). Our results show that there is no causality between foreign ownership and profitability. Also, there is no causality between foreign ownership and debt. Profitability measured by ROA and ROE does not Granger cause debt, while debt causes ROA. This means we do not have a causality problem.

We use the Hausman specification test (1978)to search for the appropriate model, whether it is a fixed or a random effects model. If there is no significant correlation between the unobserved company-specific random effects and the regressors, then the random effects model is more appropriate. The Hausman test results are shown in Tables 6 and 7, and those results indicate that the fixed effect estimator is consistent for all the models.

V. Empirical Results

We estimate a two-stage least squares fixed effect panel model consisting of a sample of 8,158 companies for the period from 2006 to 2010. We use equation (15) to examine the effect of foreign ownership, debt, and sizes on company profitability, measured by ROA and ROE, and report the results in Table 6. The analysis of the results show that firm's borrowing has a significant and negative effect on financial performance measured by ROA and ROE which are consistent with a number of studies (e.g., Titman and Wessels, 1988; Tian and Estrin, 2007; Lin, Zhanga, and Zhu, 2009). This strong negative relationship between debt ratios and profitability can be explained by the risk and poor performance accompanied by the excessive use of debt. The results show that foreign ownership significantly improves performance. This result is consistent with some of the empirical evidence (e.g., Willmore, 1986; Goethals and Ooghe, 1997; Lui et al., 2000; Piscitello and Rabbiosi, 2005). Foreign ownership has a highly significant and positive effect on ROA and ROE. An increase of 10% in foreign ownership increases the ROA and ROE by 2.3% and 2.1%, respectively. Our results show that company size has a significant and positive effect on ROA and ROE. A company with a relatively larger size is relatively more profitable.

In equation (16), we examine the effect of foreign ownership on debt. Table 6 shows that foreign ownership has a significant and positive effect on debt. When a foreign investor owns shares in a company, he can help improve the company's access to finance. Moreover, net profit margin has a negative and significant effect on debt. As profitability increases, the firm's retained earnings increases leading to more cash and less dependence on external funds. This result is consistent with the empirical evidence shown by Lin, Zhanga, and Zhu (2009), who find a significant negative effect of profitability on firm's access to bank loans in China. Lastly the results indicate that the current ratio has a significant and negative effect on debt.

As a robustness test, we estimate equations (15) and (16), using a sample that only includes the companies with foreign ownership. The results are presented in Table 7 and are similar to the results based on the complete sample (companies with foreign ownership and companies without foreign ownership), and they affirm that our results are robust. In estimating equation (16), using only companies with foreign ownership, the results show that foreign ownership has no effect on debt.

VI. CONCLUSIONS

Literature is divided about the effect of foreign ownership on firm performance. In this paper, we explore this issue by use of a panel of 8,185 companies in Egypt for the period of four years from 2006 to 2010. The use of a robust panel data model, after controlling for firm's characteristics, shows that foreign ownership improves profitability significantly. Our results also indicate that foreign ownership has a significant and positive effect on debt, as foreign investors can improve the firm's access to finance.

When addressing the impact of various degrees of foreign ownership on firm performance, the evidence suggest that concentration of ownership whether domestic (zero foreign ownership) or foreign (80-100% foreign ownership) are associated with relatively low levels of firm performance. However, the increase of foreign ownership has a positive impact on firm performance up to a certain level, and then the firm performance decreases when the foreign ownership nears 100%.

When differentiating between the various sectors in the market, we find that our results are sector-specific; hence foreign ownership has a positive, negative or no effect on firm performance depending on the sector of the firm. Our findings suggest that firm's borrowing has a significant and negative effect on financial profitability. This can be understood as the excessive use of debt increases risk and may lead to poor performance. The results show that company size has a significant and positive effect on ROA and ROE, while net profit margin has a negative significant effect on debt. As profitability increases, the firm's retained earnings increases, and that leads to more cash and less dependence on external funds.

As a result of robustness test, we also examine the effect of different levels of foreign ownership on performance, using only companies with foreign ownership. We find that results are similar to the results using the complete sample, and that indicates that our results are robust. Generalization of these conclusions is dependent on the results of similar studies that examine the impact of foreign ownership on financial performance of firms operating in other emerging economies. Moreover the study at hand can be further developed with the use of a panel data Tobit model, and the use of other control variables. Future research should explore the effect of foreign ownership on factor productivity, and should further investigate the sectoral differences and the effect of various degrees of foreign ownership.

Appendix 1
Description of the variables

Variables Description

Age (A) Number of years since a firm is founded
Asset Turnover (AT) Ratio of sales to total assets
Current Ratio (CR) Ratio of current assets to current
 liabilities
Debt Ratio (DR) Ratio of total debt to total assets
Foreign Ownership (FO) Percentage of equity ownership held by
 foreign investors in a company
Net Profit Margin (NPM) Ratio of net income to sales
Return on Assets (ROA) Net income divided by total assets
Return on Equity (ROE) Net income divided by total equity
Size (S) Natural logarithm of total assets

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Islam Azzam (a), Jasmin Fouad (b), Dilip K. Ghosh (c) *

(a) Department of Management, American University in Cairo, AUCAvenue, Cairo, Egypt iazzam@aucegypt. edu

(b) Department of Management, American University in Cairo, AUC Avenue, Cairo, Egypt jfouad@aucegypt.edu

(c) The Institute of Policy Analysis, Rutgers University Gulf University for Science and Technology editor@tijof.com

* I would like to the Editor, K.C. Chen, and J.M. Sahut for their helpful comments as well as Easton Sheehan-Lee and Yan Gao for their capable research assistance. Financial support from the SSHRC and the Autorite des Marches Financiers is gratefully acknowledged.

Table 1
Summary statistics for companies with and without foreign ownership

Table (1) provides the summary statistics for a sample of 8,158
companies in the period 2006-2010.The total number of observations is
19,865 observations. In the first three columns we report
the means, medians and number of observations for the firms'
main financial indicators without foreign ownership. The next three
columns report the same for firms with foreign ownership .
Columns seven and eight test the hypothesis of no significant
difference in means (t-statistics) and medians (Wilcoxon test) with
and without foreign ownership. *,** and *** denote significance at
90%, 95% and 99% confidence level respectively. All variables are
defined in Appendix 1.

 Without Foreign Ownership

 Mean Median # of Obs.

Age 11.71 10.89 14,312
Asset Turnover 1.19 0.71 14,312
Current Ratio 2.95 1.31 14,312
Debt Ratio 0.10 0.00 14,312
Foreign Ownership 0.00 0.00 14,312
Net Profit Margin 0.02 0.05 14,312
Return on Assets 0.08 0.05 14,312
Return on Equity 0.17 0.13 14,312
Size 3.98 3.99 14,312

 With Foreign Ownership

 Mean Median # of Obs.

Age 13.30 11.07 5,553
Asset Turnover 1.01 0.79 5,553
Current Ratio 2.62 1.33 5,553
Debt Ratio 0.10 0.00 5,553
Foreign Ownership 0.59 0.60 5,553
Net Profit Margin 0.04 0.08 5,553
Return on Assets 0.08 0.05 5,553
Return on Equity 0.18 0.15 5,553
Size 4.43 4.44 5,553

 t-test for the Wilcoxon test for the
 difference in means difference in medians

 (With minus Without)

Age 13.35 *** 7.49 ***
Asset Turnover -8.89 *** 6.81 ***
Current Ratio -3.39 *** 0.21
Debt Ratio 0.19 4.21 ***
Foreign Ownership 202.64 *** 109.55 ***
Net Profit Margin 1.01 10.05 ***
Return on Assets 4.05 *** 4.49 ***
Return on Equity 2.58 *** 3.28 ***
Size 30.14 *** 28.33 ***

Table 2
Summary statistics for companies based on the range of foreign
ownership

This table provides the summary statistics for 8,158 companies in the
period 2006-2010(total number of observations is 19,865
observations). Table (2) shows six samples covering ranges of foreign
ownership starting from zero ownership and ending with 100% foreign
ownership. It reports the means, medians and number of observations
for the companies' financial indicators each of the six ranges of
foreign ownership. All variables are defined in Appendix 1.

 Zero Foreign Ownership

 Mean Median # of Obs.

Asset 1.199 0.790 14,312
Turnover

Current Ratio 2.960 1.319 14,312

Debt Ratio 0.100 0.000 14,312

Foreign 0.000 0.000 14,312
Ownership

Net 0.016 0.050 14,312
Profit Margin

Return 0.069 0.045 14,312
on Assets

Return 0.171 0.129 14,312
on Equity

Size 3.984 3.991 14,312

 Foreign Ownership
 between 0%-20%

 Mean Median # of Obs.

Asset 0.783 0.553 1,119
Turnover

Current Ratio 2.328 1.332 1,119

Debt Ratio 0.145 0.004 1,119

Foreign 0.080 0.080 1,119
Ownership

Net 0.093 0.082 1,119
Profit Margin

Return 0.065 0.052 1,119
on Assets

Return 0.145 0.117 1,119
on Equity

Size 4.613 4.705 1,119

 Foreign Ownership
 between 20%-40%

 Mean Median # of Obs.

Asset 0.931 0.704 758
Turnover

Current Ratio 2.962 1.446 758

Debt Ratio 0.110 0.000 758

Foreign 0.313 0.314 758
Ownership

Net 0.140 0.100 758
Profit Margin

Return 0.087 0.066 758
on Assets

Return 0.166 0.149 758
on Equity

Size 4.554 4.525 758

 Foreign Ownership
 between 40%-60%

 Mean Median # of Obs.

Asset 0.978 0.666 891
Turnover

Current Ratio 2.553 1.422 891

Debt Ratio 0.083 0.000 891

Foreign 0.507 0.500 891
Ownership

Net 0.062 0.078 891
Profit Margin

Return 0.084 0.060 891
on Assets

Return 0.192 0.143 891
on Equity

Size 4.303 4.327 891

 Foreign Ownership

 between 60%-80%

 Mean Median # of Obs.

Asset 1.019 0.598 669
Turnover

Current Ratio 2.711 1.321 669

Debt Ratio 0.118 0.000 669

Foreign 0.717 0.730 669
Ownership

Net 0.096 0.095 669
Profit Margin

Return 0.090 0.056 669
on Assets

Return 0.192 0.167 669
on Equity

Size 4.504 4.439 669

 Foreign Ownership

 between 80%-100%

 Mean Median # of Obs.

Asset 1.179 0.916 2,116
Turnover

Current Ratio 2.667 1.249 2,116

Debt Ratio 0.076 0.000 2,116

Foreign 0.973 1.000 2,116
Ownership

Net -0.058 0.057 2,116
Profit Margin

Return 0.078 0.047 2,116
on Assets

Return 0.203 0.161 2,116
on Equity

Size 4.342 4.336 2,116

Table 3
Summary statistics for companies based on industry

This table provides summary statistics for a sample includes 8,158
companies in the period 2006-2010 with a total number of
observations of 19,865. In this table, we break down the data based
on the industry. For each industry, the first six columns report the
means, medians and number of observations for companies' financial
indicators without and with foreign ownership. Column seven tests the
hypothesis of no significant difference in means (T-statistics) with
and without foreign ownership. *, ** and *** denote significance at
the 90%, 95%and 99% confidence level respectively. All variables are
defined in Appendix 1.

 Information Technology Sector

 Mean Median # of
 without without Obs.
 Foreign Foreign
 Ownership Ownership

Asset 1.389 1.165 693
Turnover

Current 3.743 1.714 693
Ratio

Debt 0.030 0.000 693

Foreign 0.000 0.000 693
Ownership

Net Profit -0.010 0.062 693
Margin

Return 0.098 0.075 693
on Assets

Return 0.204 0.201 693
on Equity

Size 3.628 3.579 693

 Information Technology Sector

 Mean Median # of t-test
 with with Obs. for the
 Foreign Foreign Difference
 Ownership Ownership in Means

Asset 1.317 1.037 262 -0.86
Turnover

Current 3.040 1.501 262 -1.74 *
Ratio

Debt 0.030 0.000 262 -0.01

Foreign 0.602 0.560 262 27.62 ***
Ownership

Net Profit 0.037 0.056 262 0.96
Margin

Return 0.076 0.069 262 -1.46
on Assets

Return 0.216 0.169 262 0.47
on Equity

Size 3.881 3.836 262 3.62 ***

 Construction Sector

 Mean Median # of
 without without Obs.
 Foreign Foreign
 Ownership Ownership

Asset 1.036 0.546 1606
Turnover

Current Ratio 2.954 1.280 1606

Debt 0.090 0.000 1606

Foreign 0.000 0.000 1606
Ownership

Net Profit 0.100 0.046 1606
Margin

Return 0.060 0.034 1606
on Assets

Return 0.170 0.119 1606
on Equity

Size 4.047 4.092 1606

 Construction Sector

 Mean Median # of t-test
 with with Obs. for the
 Foreign Foreign Difference
 Ownership Ownership in Means

Asset 0.641 0.335 366 -7.14 ***
Turnover

Current Ratio 2.587 1.375 366 -1.33

Debt 0.122 0.000 366 2.23 **

Foreign 0.491 0.490 366 26.91 ***
Ownership

Net Profit 0.161 0.078 366 0.46
Margin

Return 0.051 0.034 366 -1.19
on Assets

Return 0.154 0.122 366 -1.08
on Equity

Size 4.696 4.700 366 11.06 ***

 Financial Sector

 Mean Median # of
 without without Obs.
 Foreign Foreign
 Ownership Ownership

Asset 0.322 0.165 481
Turnover

Current Ratio 3.334 1.377 481

Debt 0.069 0.000 481

Foreign 0.000 0.000 481
Ownership

Net 0.226 0.314 481
Profit Margin

ROA 0.074 0.047 481

ROE 0.181 0.129 481

Size 4.578 4.540 481

 Financial Sector

 Mean Median # of t-test
 with with Obs. for the
 Foreign Foreign Difference
 Ownership Ownership in Means

Asset 0.272 0 453 -1.10
Turnover .080

Current Ratio 3.200 1.350 453 -0.35

Debt 0.103 0.000 453 2.08 **

Foreign 0.604 0.605 453 38.72 ***

Ownership
Net 0.218 0.290 453 -0.04

Profit Margin

ROA 0.053 0.027 453 -2.81 ***

ROE 0.117 0.096 453 -4.45 ***

Size 5.360 5.277 453 11.77 ***

 Service Sector

 Mean Median # of
 without without Obs.
 Foreign Foreign
 Ownership Ownership

Asset 1.566 1.115 5292
Turnover

Current Ratio 3.245 1.403 5292

Debt 0.066 0.000 5292

Foreign 0.000 0.000 5292
Ownership

Net 0.030 0.049 5292
Profit Margin

ROA 0.085 0.057 5292

ROE 0.214 0.173 5292

Size 3.626 3.589 5292

 Service Sector

 Mean Median # of t-test
 with with Obs. for the
 Foreign Foreign Difference
 Ownership Ownership in Means

Asset 1.411 1.060 1430 -3.71 ***
Turnover

Current Ratio 2.723 1.362 1430 -3.31 ***

Debt 0.063 0.000 1430 -0.49

Foreign 0.659 0.750 1430 72.98 ***
Ownership

Net -0.006 0.062 1430 -1.23
Profit Margin

ROA 0.094 0.066 1430 1.54

ROE 0.250 0.216 1430 3.51 ***

Size 3.994 3.995 1430 13.38 ***

 Agricultural Sector

 Mean Median # of
 without without Obs.
 Foreign Foreign
 Ownership Ownership

Asset 0.956 0.628 536
Turnover

Current Ratio 2.667 1.245 536

Debt 0.162 0.000 536

Foreign 0.000 0.000 536
Ownership

Net -0.125 0.044 536
Profit Margin

ROA 0.046 0.026 536

ROE 0.126 0.091 536

Size 4.208 4.209 536

 Agricultural Sector

 Mean Median # of t-test
 with with Obs. for the
 Foreign Foreign Difference
 Ownership Ownership in Means

Asset 0.731 0.539 236 -3.18 ***
Turnover

Current Ratio 2.073 1.111 236 -1.98 **

Debt 0.124 0 236 -1.31

Foreign 0.439 0.428 236 19.63 ***
Ownership

Net -0.046 0.059 236 0.81

Profit Margin

ROA 0.055 0.028 236 0.82

ROE 0.103 0.064 236 -1.05

Size 4.470 4.504 236 4.44 ***

 Tourism Sector

 Mean Median # of
 without without Obs.
 Foreign Foreign
 Ownership Ownership

Asset 0.857 0.315 1907
Turnover

Current 2.793 1.106 1907
Ratio

Debt 0.114 0.000 1907

Foreign 0.000 0.000 1907
Ownership

Net Profit -0.041 0.039 1907
Margin

ROA 0.042 0.029 1907

ROE 0.097 0.077 1907
Size 4.192 4.216 1907

 Tourism Sector

 Mean Median # of t-test
 with with Obs. for the
 Foreign Foreign Difference
 Ownership Ownership in Means

Asset 0.895 0.354 716 0.62
Turnover

Current 2.791 1.182 716 -0.01
Ratio

Debt 0.098 0.000 716 -1.09

Foreign 0.553 0.500 716 41.78 ***
Ownership

Net Profit 0.055 0.120 716 1.99 **
Margin

ROA 0.087 0.053 716 6.10 ***

ROE 0.173 0.121 716 5.92 ***

Size 4.300 4.331 716 2.60 ***

 Industrial Sector

 Mean Median # of
 without without Obs.
 Foreign Foreign
 Ownership Ownership

Asset 1.199 0.790 3797
Turnover

Current 2.960 1.319 3797
Ratio

Debt 0.100 0.000 3797

Foreign 0.000 0.000 3797
Ownership

Net Profit 0.016 0.050 3797

Margin

ROA 0.069 0.045 3797

ROE 0.171 0.129 3797

Size 3.984 3.991 3797

 Industrial Sector

 Mean Median # of t-test
 with with Obs. for the
 Foreign Foreign Difference
 Ownership Ownership in Means

Asset 1.013 0.714 2090 -9.83 ***
Turnover

Current 2.620 1.331 2090 -4.34 ***
Ratio

Debt 0.102 0.000 2090 0.46

Foreign 0.593 0.600 2090 124.70 ***
Ownership

Net Profit 0.031 0.075 2090 0.73

Margin 3.90 ***

ROA 0.079 0.053 2090

ROE 0.183 0.145 2090 2.57 ***

Size 4.441 4.450 2090 29.26 ***

Table 4
Endogeneity test

This table reports the Wu-Hausman F and Durbin-Wu-Hausman tests
for endogeneity of debt in panel data model in Equation 15.
We use a sample of 8,158 companies in the period 2006-2010 with a
total number of observations of 19,865. The dependent variables
are return on assets (ROA) and return on equity (ROE). [rho]-values
are reported in parentheses. *, ** and *** denote significance
at the 90%, 95% and 99% significance level respectively.

Equation (1) (1)
 Endogeneity Endogeneity of
 of Debt Debt
 in Equation in Equation
 1 using ROA 1 using ROE

Wu-Hausman F test 1530 652
 (0.00) *** (0.00) ***

Equation (1) (2)
 Endogeneity of Endogeneity
 Foreign of Foreign
 in Equation in Equation 2
 1 using ROA

Wu-Hausman F test 6.3 5.7
 (0.12) (0.22)

Table 5
Granger causality tests

This table shows results from the Granger causality tests between
foreign ownership, debt and profitability, measured by ROA
and ROE, using a sample includes 8,158 companies in the
period 2006-2010 with a total number of observations
 of 19,865. *, ** and *** denote significance at the 90%, 95%
and 99% significance level, respectively.

Null Hypothesis F-Statistics Probability

ROA does not Granger Cause Debt 0.102 0.749
Debt does not Granger Cause ROA 74.894 *** 0.000
ROE does not Granger Cause Debt 0.008 0.927
Debt does not Granger Cause ROE 0.061 0.804
ROA does not Granger Cause 2.244 0.110
 Foreign Ownership
Foreign Ownership does not 0.362 0.547
 Granger Cause ROA
ROE does not Granger Cause 0.188 0.664
 Foreign Ownership
Foreign Ownership does 0.015 0.901
 not Granger Cause ROE
Debt does not Granger Cause 0.640 0.423
 Foreign Ownership
Foreign Ownership does not 0.031 0.858
 Granger Cause Debt

Table 6
Estimates of the 2SLS fixed-effects panel model using the whole
sample

This table reports the estimates from the two stage least squares
fixed-effects panel data models in equations (15) and (16). We use
a sample of 8,158 companies in the period 2006-2010 with a total
number of observations of 19,865 observations. The dependent variables
are return on assets (ROA), return on equity (ROE), and the debt
ratio (DR). Z-statistics are reported in parentheses. *, ** and ***
denote significance at the 90%, 95% and 99% significance level
respectively. All variables are defined in Appendix 1.

Equation (15) (15) (16)

 ROA ROE Debt

Asset Turnover -0.0017
 (-0.92)

Current Ratio -0.0008
 (-2.57)***

Debt -5.2446 -5.2473
 (-32.33) *** (-15.49) ***

Foreign Ownership 0.2356 0.2153 0.0462
 (13.81) *** (6.04) *** (2.17)**

Net Profit Margin -0.0043
 (-3.43)***
ROA

ROE

Size 0.0442 0.1143
 (9.31) *** (11.52) ***

Industry Controlled Controlled Controlled

No. Of Observations 19,865 19,865 19,865

No. Of Groups 8158 8158 8158
Hausman Test for Random 134.8 45.5 68.3
Effect (Chi-Square)

Hausman Test for Random (0.00) (0.00) (0.00)
Effect (p-value)

Table 7
Estimates of the 2SLS panel model using only companies with
foreign ownership

This table reports the estimates from the two stage least squares
panel data models in Equations 15 and 16. We use a sample of 2002
companies with non-zero foreign ownership in the period 2006-2010
with a total number of observations of 5597. The dependent
variables are return on assets (ROA), return on equity (ROE), and
debt ratio. Z-statistics are reported in parenthesis *, ** and ***
denote significance at the 90%, 95% and 99% significance level.
All variables are defined in Appendix 1.

Equation (15) (15) (16)

 ROA ROE Debt

Asset Turnover -0.009
 (-1.63)
Current Ratio -0.001
 (-0.91)
Debt -5.851 -6.655
 (-21.12)*** (-16.33)***
Foreign Ownership 0.152 0.151 0.020
 (7.13)*** (8.18)*** (0.56)
Net Profit Margin -0.002
 (-0.90)
ROA
ROE
Size 0.075 0.070
 (9.02) *** (10.71) ***
Industry Controlled Controlled Controlled
No. Of Observations 5553 5553 5553
No. Of Groups 2202 2202 2202
Hausman Test for Random 35.57 7.69 22.60
 Effect (Chi-Square)
Hausman Test for Random (0.00) (0.052) (0.00)
 Effect (p-value)