Foreign Ownership and Financial Performance: Evidence from Egypt

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. …