Essays on stock market openness, cost of capital and investment

Student thesis: Doctoral Thesis

Abstract

This thesis examines the effects of stock market openness on the cost of equity capital and investment. Whilst theoretical models and extant empirical evidence suggest that emerging markets integration with global markets promotes risk sharing between domestic and foreign investors, reducing the cost of capital and increasing investments, other strands of research take a more critical stance, counter-arguing that integration is rather an imperfect process, with cost of capital benefits restricted to subsets of firms only, and that agency costs and weak levels of institutional development partially or fully impede gains from integration to be channeled to real investments. Motivated by this setup, this thesis contributes to the financial integration literature,in particular to the debate on the pros and cons of financial openness.The first essay studies the relationship between stock market integration and the cost of equity capital, using Brazil as a case study. The paper also places particular emphasis on the role played by asset characteristics in the process of integration. Taking imperfect integration as theoretical underpinning, international asset pricing models are estimated for stocks’ portfolios sorted by characteristics of size, book-to-market ratios, illiquidity, momentum, corporate governance and investability. Results show that stock market integration, as proxied by foreign stock ownership, reduces cost of equity capital, with larger benefits reaped by large caps, highly liquid stocks and strong governance firms. Results corroborate theoretical models of imperfectintegration, suggesting that integration brings beneficial effects on firms’ funding costs.In the second essay, the attention shifts to real economic effects of integration, with an investigationof the effects of stock market openness on corporate investment. Using a large sample offirms from 45 emerging and frontier markets, empirical investment models are estimated, employingdynamic panel data techniques. The analysis utilises two measures of stock openness, bothat country-level and at firm-level. At country-level, De Jure current-account openness indices,calculated by the International Monetary Fund are employed, whereas firm-specific De Factointegration is captured by foreign institutional stock ownership. Results suggest positive effectsof stock market openness on corporate investment, with findings remaining consistent across3both country and firm-level integration measures, and robust to endogeneity concerns. Strongereffects are found in countries with lower institutional development and higher expropriationrisks, consistent with the idea that the influx of foreign investors brings about improvements inmonitoring and governance standards. Results contribute important evidence that stock marketopenness, additionally to exerting positive effect on funding costs, also stimulates real economicactivity, by increasing firm-level investment.The third and last essay escalates the analysis to the macroeconomic level. The relationship between foreign portfolio equity capital flows and domestic aggregate investment is investigated,paying attention again to the role of institutional quality in this relationship. Cross-country static and dynamic panel data models are estimated, for a sample of 44 emerging and frontier markets.Results at the macro level corroborate the findings obtained at micro level, with equity inflows associated to increases in domestic investment, measured both as gross capital formation and as the growth rate of domestic capital stock per capita. Again, effects are stronger in countries with lower institutional development, consistent with firm-level evidence. In summary, results show that integration effects spillover from micro to macro level, benefiting the whole domestic economy by expanding countries' capital stock.
Date of Award1 Oct 2017
LanguageEnglish
Awarding Institution
  • University Of Strathclyde
SponsorsUniversity of Strathclyde
SupervisorDavid Hillier (Supervisor) & Ian Wooton (Supervisor)

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