There are competing theories as to whether letting outsiders into domestic stock markets is a good or a bad thing. On the one hand they bring best practices that assist in a market’s orderly development; but, on the other, they may introduce volatility that results in an undesirable higher long-term cost of capital.
Writing in an article in the latest edition of the Financial Analysts Journal Liao Peng, Liguang Zhang and Wanyi Chen (from the Southwest University of Finance and Economics (Chengdu), the Chongqing University of Technology and SILC Business School (University of Shanghai) respectively found a natural experiment in China that contributes usefully to the debate.
In 2014 the first of China’s ‘connect’ programs was launched allowing overseas investors de facto direct and broad access to domestically traded stocks on the Shanghai Stock Exchange; and, the researchers found, corporate investment efficiency improved significantly after this reform.
The enterprises most affected were:
- Those without former foreign ownership
- Those with low prior analysts’ coverage
- Privately owned businesses (i.e. non-SOEs)
The transmission mechanism was mainly (improved) corporate information disclosure and (better) corporate governance. Specifically via reduced management of accrual earnings and a decrease in excess management compensation.
The researchers note how effective letting outsiders in can be in terms of increased efficiency compared to, say, trying to endlessly legislate better behavior in a closed market. Therefore, there are useful lessons here for less-well-developed capital markets elsewhere.
They end with a checklist for companies in a market where higher standards are being progressed if they want to stay of interest to new entrants and existing investors alike. They should:
- Increase their use of analysts, social media and other information dispersal channels to improve overall transparency
- Take advantage of the new interest to improve capital structure by encouraging a new investor base to grow
- Take the opportunity of greater interest to establish long term restraints and incentives to reduce ‘agency’ effects and concerns
Always good to find the right-thing an efficiency into the bargain.
Happy Sunday.
[This link Investment Efficiency will take you to a summary of the paper at the CFA Institute’s website. I can send you the full text if you’re not a Member and don’t have access. Just ping me at nial@chinadream.asia]