Over the past decade, Japanese financial institutions and corporations have decreased their stock holdings in Japanese listed companies, while holdings by foreign investors have increased steadily. Recent studies argue that foreign ownership can enhance firm value, but this argument has been questioned due to potential reverse causality in that foreign institutional investors tend to possess stocks of high performing firms. This paper uses the identification of simultaneous equations through heteroskedasticity from Rigobon (2003) to investigate the causal relationship between foreign ownership and firm value. The main features of this estimation method are that we do not need to impose exclusion restrictions on explanatory variables and that we can utilize the heteroskedasticity resulting from the positive skewness of distributions of the foreign ownership ratio and Tobin's Q (a proxy for firm value). We find that foreign investors increase their stock holdings as firm value declines, while an increase in foreign ownership leads to higher firm value. We also confirm the importance of taking the endogeneity of both variables into account in the estimation, since the effect of foreign ownership on firm valuation is much greater than when this is not taken into account.
