Global Standards and Emerging Markets : The Institutional Investment Value Chain and Calpers' Investment Strategy

Institutional investors, primarily pension funds, dominate global financial markets. Increasingly, these investors are turning their attention to emerging markets and applying both traditional financial and non-financial metrics to their investment decisions. Following the 1998 Asian Financial Crisis, many large institutional investors have come to believe non-financial attributes, particularly in emerging markets, can both indicate potential equity premia and more importantly, be used as risk management tools within investment portfolios. These investors apply non-financial criteria not only to individual firms in emerging markets, but also to whole countries' corporate practices. Countrywide indices such as PricewaterhouseCoopers' Opacity Index back up such investor intuition. While countries and their regulatory regimes are central to external capital investment decisions, convergence to global standards occurs when key actors in the investment value chain demand levels of corporate and social behaviour greater than those currently consistent with countries' regulatory frameworks. We establish this claim through three critical pieces of analysis. First, we show that countries' legal origins are no longer strong determinants for achieving the global standards required for investment in emerging markets (for importance of legal origin see La Porta et. al. 1997). Second, we demonstrate that emerging market countries, when excluded from foreign investment, improve their corporate practices and standards in order to attract that investment in the future. Third, we find that convergence to global standards is not strongly influenced by the wealth of the emerging market country, but rather as a direct reaction to exclusion from foreign investment in the previous period. We examine country-specific investment decisions taken by institutional investors in emerging markets with particular reference to the California Public Employees Retirement System (CalPERS) to test this hypothesis