Migration, Spillovers, and Trade Diversion: The Impact of Internationalization on Stock Market Liquidity

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1 Migraion, Spillovers, and Trade Diversion: The mpac of nernaionalizaion on Sock Marke Liquidiy Ross Levine and Sergio L. Schmukler Firs Draf: February 10, 2003 This draf: March 30, 2003 Absrac Wha is he impac of firms ha cross-lis, issue deposiary receips, or raise capial in inernaional sock markes on he liquidiy of remaining firms in domesic markes? Using a panel of over 3,200 firms from 55 counries during , we find ha inernaionalizaion reduces he liquidiy of domesic firms hrough wo channels. Firs, he rading of inernaional firms migraes from domesic o inernaional markes and he reducion in domesic liquidiy of inernaional firms has negaive spillover effecs on domesic firm liquidiy. Second, here is rade diversion wihin domesic markes as liquidiy shifs ou of domesic firms and ino inernaional firms. JEL classificaion codes: G15, F36, F20 Keywords: inernaional finance; inernaionalizaion; sock markes; liquidiy; cross-lising; deposiary receips; ADRs; GDRs Levine: Universiy of Minnesoa and he NBER Schmukler: World Bank We hank Taiana Didier for ruly ousanding research assisance. We received very helpful commens from Gordon Alexander, Luca Benzoni, Sijn Claessens, Valery Polknichenko, Helene Rey, and Frank Warnock. For help wih he daa, we are graeful o Pamela Doin, Monica Erpen, Dori Flanagan, Angela Marshall, Richard Webser-Smih, and Cheryl Workman. Levine is graeful for generous financial suppor from he BS Gamma Foundaion. Schmukler hanks he World Bank Lain American Regional Sudies Program and Research Suppor Budge for financial suppor. The findings, inerpreaions, and conclusions expressed in his paper are enirely hose of he auhors and do no necessarily represen he views of he World Bank.

2 . nroducion This paper assesses he quesion: wha is he impac of firms ha paricipae in inernaional sock markes on he liquidiy of he remaining firms in he domesic sock marke? An exensive lieraure examines inernaional firms, he firms ha paricipae in inernaional markes by issuing deposiary receips, cross-lising, or raising new capial (e.g., Alexander, Eun, and Janakirananan, 1987, 1988; Foerser and Karolyi, 1998, 1999, 2000; Miller, 1999; Doidge, Karolyi, and Sulz, 2002; and he review by Karolyi, 1998). This paper, insead, focuses on he impac of inernaionalizaion on domesic firms, he firms ha do no inernaionalize. Theory provides conflicing predicions abou he impac of inernaionalizaion on he liquidiy of domesic firms. Consider firs he migraion and spillover argumen. According o he migraion view, inernaionalizaion will induce a shif in he rading of inernaional firms ou of he domesic marke and ino inernaional markes. This may occur because foreign markes have lower ransacion coss and are more liquid (Chowdhry and Nanda, 1991). Spillovers means ha a drop in he domesic rading of inernaional firms hurs he liquidiy of domesic firms. 1 This could occur because of fixed coss associaed wih operaing a marke, running brokerage firms, clearing and seling ransacions, ec. Thus, a drop in he domesic rading of inernaional socks increases he per rade cos of domesic sock ransacions. Liquidiy spillovers could also occur if invesors shif heir rading o inernaional markes. For example, invesors may seek o diversify counry-specific risk. Thus, when some firms cross-lis or issue deposiary receips in inernaional markes, invesors may aain counry-specific diversificaion hrough hese liquid inernaional markes and herefore reduce heir rading in 1 Chordia, Roll, and Subrahmanyam (2000) argue ha liquidiy is more han an aribue of a single securiy. ndividual liquidiy ends o co-move wih marke liquidiy. 1

3 domesic markes. 2 This involves a shif ou of rading domesic socks on domesic exchanges and ino rading inernaionalized socks on inernaional exchanges. Combined, migraion and spillovers imply ha inernaionalizaion reduces he domesic liquidiy of inernaional firms due o migraion, and he resulan drop in aggregae domesic liquidiy reduces he liquidiy of domesic firms due o spillovers. Some disagree wih he migraion and liquidiy spillover view and insead argue ha inernaionalizaion improves domesic marke liquidiy. n conras o he migraion view, Hargis (2000) argues ha cross-lising can ransform a segmened equiy marke wih low liquidiy ino an inegraed marke wih high liquidiy. Similarly, Alexander, Eun, and Janakiramanan (1987) and Domowiz, Glen, and Madhavan (1998) hold ha inernaionalizaion may acually simulae domesic rading of inernaional firms due o he increased inegraion of markes. Also, if inernaionalizaion increases ransparency, his could increase he domesic rading of inernaional firms wih posiive spillover effecs for he res of he domesic marke. Oher skepics of he migraion spillover view could quesion he exisence of liquidiy spillovers, or doub he economic imporance of he impac of aggregae rading on he liquidiy of domesic firms. Thus, i is an empirical quesion as o wheher inernaionalizaion induces migraion and spillovers, or wheher inernaionalizaion booss he liquidiy of domesic firms. Second, consider he domesic rade diversion view, which argues ha inernaionalizaion induces a composiional shif in domesic marke rading. Firms ha inernaionalize may become more aracive o hose rading in domesic markes because of improvemens in repuaion, higher disclosure sandards, he availabiliy of more analyss ha generae more informaion, and he expansion of he shareholder base in he conex of 2 Ahearne, Griever, and Warnock (2003) and Edison and Warnock (2003) show ha U.S. invesors focus on firms ha have inernaionalized. 2

4 segmened markes. 3 Thus, raders in he domesic marke may shif heir rading ou of domesic firms and ino he domesic rading of inernaional firms. All else equal, his domesic rade diversion implies less rading of domesic firms and greaer rading of inernaional firms in he domesic marke. However, some heories conflic wih he rade diversion view and insead argue ha inernaionalizaion may enhance inegraion and hereby boos liquidiy of domesic firms (e.g., Alexander, e al., 1987; Domowiz, e al., 1998; Hargis, 2000). This could occur because inegraion increases he liquidiy of all firms in he local markes. Moreover, inegraion may induce a composiional shif in domesic marke liquidiy oward domesic firms as he rading of inernaional firms migraes abroad. Again, heory provides conflicing predicions abou he impac of firms ha choose o inernaionalize on domesic firms. To sudy he effecs of inernaionalizaion on domesic liquidiy, his paper uses informaion on 3,253 domesic firms and 640 inernaional firms across 55 emerging marke counries during he years 1989 o To measure liquidiy, we use he urnover raio, which equals he value of a firm s ransacions in a marke divided by he marke capializaion of he firm in he domesic marke. We use ransacions daa because bid-ask spreads are unavailable for our large panel of counries. The paper firs examines he direc impac of inernaionalizaion on he liquidiy of domesic firms. Using annual, firm-level daa, we regress he liquidiy of domesic firms on he share of inernaional firms in he domesic marke as well as counry and year dummy variables. While we canno eliminae he possibiliy ha an omied facor is driving he resuls, we can conrol for an array of firm-specific and counry specific rais. We do a variey of robusness checks conrolling for firm-specific characerisics (such as firm size, sales, firm profis, he 3 See, Baker, Nofsinger, and Weaver (2002), Coffee (1999), Lang, Lins, and Miller (2002), Meron (1987), Pores and Rey (1999), and Reese and Weisbach (2001). Also, Bailey, Karolyi, and Salva (2002) find ha earnings releases impac he price and volume of inernaional firms significanly more han domesics firms. 3

5 firm s indusry ec.) and various counry-specific facors (e.g., rading of ha counry s shares on inernaional exchanges, economic developmen, legal sysem efficiency, inernaional capial flow openness, inflaion, ec.). The resuls are consisen across numerous specificaions. The daa indicae ha as more firms become inernaional, his lowers he liquidiy of domesic firms. This resul is robus o conrolling for numerous firm-specific and counryspecific rais. These iniial resuls, however, do no shed ligh on he mechanisms hrough which inernaionalizaion hurs he liquidiy of domesic firms. Nex, he paper sudies he channels hrough which inernaional firms affec he liquidiy of domesic firms. We sudy boh he (1) migraion and liquidiy spillover channel and (2) he domesic rade diversion channel. Thus, we seek o explain he mechanisms hrough which inernaionalizaion influences he liquidiy of domesic firms. To sudy he migraion and liquidiy spillover channel, we (a) assess wheher he rading of inernaional firms migraes from domesic o inernaional markes and (b) es wheher he domesic rading of inernaional firms influences he liquidiy of domesic firms. We find evidence of migraion: as he fracion of inernaional firms rises, he rading of inernaional firms shifs from domesic markes o inernaional markes. Tha is, as more firms inernaionalize, domesic liquidiy of inernaional firms falls. Furhermore, we find evidence of liquidiy spillovers. The domesic rading of inernaional shares is srongly, posiively relaed o he liquidiy of domesic firms. Thus, he daa are consisen wih migraion and spillover view: as he liquidiy of inernaional firms in he domesic marke dries up because of migraion, he liquidiy of domesic firms diminishes because of spillovers. The migraion and liquidiy spillover channel, however, is no he only mechanism hrough which inernaionalizaion hurs he liquidiy of domesic firms. n paricular, we find 4

6 ha inernaionalizaion is negaively associaed wih he liquidiy of domesic firms even afer conrolling for he migraion and spillover channel. Thus, we need o look beyond migraion and spillovers o undersand fully he impac of inernaionalizaion on he domesic marke. Finally, we examine he domesic rade diversion channel. The daa sugges ha as firms inernaionalize, he domesic marke inensifies is rading of hose inernaional shares, while rading of firms ha do no inernaionalize wanes. This does no overurn he resul menioned above: inernaionalizaion reduces he domesic liquidiy of inernaional shares. This resul is consisen wih heories ha emphasize ha when a firm inernaionalizes his enhances is repuaion, ransparency, and shareholder base in ways ha make i more aracive relaive o domesic firms. n sum, domesic rade diversion is anoher mechanism hrough which inernaionalizaion reduces he liquidiy firms ha do no inernaionalize. This paper s assessmen of he impac of inernaionalizaion on he liquidiy of domesic firms is relaed o, hough disinc from, a large lieraure on inernaionalizaion. Firs, some research analyzes he impac of marke inegraion on economic growh, invesmen, and asse pricing. 4 n his paper, we do no focus on financial inegraion broadly defined. Raher, we examine he impac of he decision of one se of firms o cross-lis, issue deposiary receips, or raise capial abroad on he liquidiy of he domesic firms ha do no inernaionalize. 5 Second, an exensive lieraure sudies he effecs of inernaionalizaion on inernaional firms. Some papers examine he volume and liquidiy of inernaional firms in local markes afer firms crosslis or issue deposiary receips. 6 Oher researchers sudy he impac of inernaionalizaion on 4 See Bekaer and Harvey (1995, 2000), Bekaer, Harvey, and Lundblad (2001, 2002), Henry (2000), Levine and Zervos (1998a,b), and Marin and Rey (2000). 5 Various publicaions voice concerns of markes becoming illiquid (e.g., Bovespa, 1996; Financial Times, 1998; and Lain Finance, 1999; The Economis, 2000; and he Federaion des Bourses de Valeurs, 2000). 6 See Foerser and Karolyi (1998, 2000), Hargis (1998), Noronha, Sarin, and Saudagaran (1996), and Pulakonak and Sofianos (1999). 5

7 sock prices, he cos of capial, and growh opporuniies. 7 A relaed line of research analyzes he effec of inernaionalizaion on asse size, growh, financing consrains, and he financial srucure of firms ha issue deposiary receips or cross-lis. 8 Alhough in he course of our research we assess he impac of he liquidiy of inernaional firms on he domesic liquidiy of hose inernaional firms, he focus of our research is differen. We concenrae on examining he impac of inernaionalizaion on he liquidiy of domesic firms. Only wo previous sudies examine specifically he effecs of inernaionalizaion on domesic firms. Moel (2001) finds a negaive associaion beween he fracion of a counry s socks ha issue American deposiary receips (ADRs) and domesic marke liquidiy. Karolyi (2003) also finds a negaive link beween ADRs and domesic marke size and liquidiy. This paper conribues o he lieraure on inernaionalizaion and he liquidiy of domesic socks in a number of ways. Firs, his is he firs paper o dissec he channels hrough which inernaionalizaion influences he liquidiy of domesic socks. Thus, we evaluae he imporance of he migraion/spillover channel and he rade diversion channel. Second, in examining he poenial channels hrough which inernaionalizaion influences domesic sock liquidiy, we examine he impac of firms ha inernaionalize on boh (a) he rading of inernaional firms in he domesic marke and (b) he liquidiy of domesic firms. Thus, besides conribuing o he recen lieraure on he effecs of inernaionalizaion on domesic firms, we also use our new daabase o augmen he more esablished lieraure on inernaional firms. Third, we subsanially expand he sample size. Our daa cover 55 counries, which almos doubles he number of counries used in previous sudies (e.g., Moel, 2001, examines 28 7 See Alexander, Eun, and Janakiramanan (1988), Demirguc-Kun and Maksimovic (1998), Errunza and Miller (2000), Foerser and Karolyi (1993, 1999), Miller (1999) and Sulz (1999). 8 See Claessens, Klingebiel, and Schmukler (2002a), Pagano, Roell, and Zechner (2002), and Schmukler and Vesperoni (2001). 6

8 counries and Karolyi, 2003, sudies 12). Fourh, we exend he coverage of he inernaionalizaion process by moving beyond he ADR marke in New York. Specifically, we compile daa on capial raisings ha include global deposiary receips, cross-lisings, and privae placemens in oher inernaional markes. Thus, we can more precisely classify companies as inernaional or domesic. Fifh, we collec informaion on he inernaional rading aciviies of inernaional firms. Tha is, we do no simply examine wheher a firm is lised abroad or no; we incorporae ime-vary rading daa. This has wo advanages: (a) we conrol for counry-specific news ha influences global rading of ha counry s shares and (b) we assess how he imevarying exen of inernaionalizaion impacs domesic markes. Sixh, we conrol for firm specific characerisics, including firm size and oher rais, o isolae he marginal impac of inernaionalizaion on firm liquidiy while holding firm-specific facors consan. Finally, we sress a limiaion of his paper s analyses. We find ha inernaionalizaion reduces he liquidiy of domesic firms. We do no, however, examine he ne effec of inernaionalizaion (Hargis and Ramanlal, 1998). Specifically, many researchers show ha inernaionalizaion benefis hose firms ha choose o inernaionalize. Furhermore, research finds ha domesic marke liquidiy is imporan for he cos of capial, firm performance, and economic growh. 9 Thus, if inernaionalizaion helps inernaional firms and hurs domesic firms, a criical quesion emerges: wha is he ne effec for he domesic economy of firms ha cross-lis, issue deposiary receips, or raise capial abroad? We leave his for fuure research. The res of he paper is organized as follows. Secion discusses he daa. Secion presens he resuls. Secion V concludes. 9 See Amihud and Mendelson (1986), Demirguc-Kun and Maksimovic (1998), Levine and Zervos (1998a), and Beck and Levine (2003). 7

9 . Daa daa: To assess he impac of inernaionalizaion on domesic socks, we need he following 1. firm-level daa on he inernaional equiy aciviies of firms, including a. daes of capial raisings, cross-lising, and deposiary receips, b. inernaional rading daa, 2. firm-level daa on domesic sock ransacions, 3. firm-level daa on a range of firm aribues, and 4. counry-specific daa on macroeconomi insiuional, and financial condiions. An imporan conribuion of his paper is ha we collec considerably more daa on he inernaional equiy marke aciviies of companies han pas sudies. The daa for idenifying each firm s inernaional aciviies come from wo main sources: he Bank of New York and Euromoney. Besides he Bank of New York s sandard daabase (he Complee Deposiary Receip Direcory) ha conains informaion on curren deposiary receip aciviies, he Bank of New York gave us access o heir hisorical daabases and repors on (i) deposiary receip program iniiaion daes, (ii) erminaion daes (if any), (iii) capial raisings, and (iv) rading aciviies. These daa form a comprehensive daabase on American and Global deposiary receip programs. The hisorical daa sar in January 1956, bu he vas majoriy of programs begin afer We augmen he informaion on daing he iniiaion of inernaional equiy marke aciviies wih daa from Euromoney. They provide he daes when firms raise equiy capial in inernaional capial markes, including cross-lisings and issuance of global deposiary receips. Thus, he Euromoney daa subsanively enhances our abiliy o idenify firms ha inernaionalize. The Euromoney daabase covers 8,795 cross-border equiy issuance and crosslising operaions from 5,665 firms in 86 counries over he period January April n erms of rading, we had access o daa from he London and Frankfur Sock Exchanges (LSE 8

10 and FSE respecively) on he rading of deposiary receips and cross-lised firm. However, LSE rading daa for hese firms do no begin unil 1997 and he daa for he FSE do no sar unil Thus, hey canno be usefully incorporaed ino our panel sudies ha race he impac of inernaionalizaion on he liquidiy of domesic socks and also assess he dynamic effecs of rading in inernaional markes on he domesic marke. Thus, consisen wih exising sudies, we do no include LSE and FSE rading daa. This will underesimae he amoun of rading abroad, bu his is unlikely o bias sysemaically he resuls in a paricular direcion. See Claessens, Klingebiel, and Schmukler (2002b) for a descripion of some rends on he inernaionalizaion of sock markes as well as heir relaion o counry characerisics. Consisen wih our objecive of assembling a broad daabase on inernaionalizaion, we classify firms as inernaional if hey (1) issue deposiary receips, (2) cross-lis, or (3) raise capial hrough privae placemens abroad. The firs wo clearly involve ongoing rading of domesic socks in foreign counries. However, raising capial hrough privae placemens is differen because he new shares are no necessarily raded abroad. Thus, he issuing of deposiary receips and cross-lising may involve he wo poenial channels discussed in he nroducion: migraion/spillovers and rade diversion. Raising capial abroad in he absence of cross-lising, however, will only poenially involve rade diversion in he domesic marke since simply raising capial abroad canno induce migraion. As noed below, we confirm his paper s findings wih various sub-samples. The firm-level domesic sock marke rading daa are from he Sandard & Poor s Emerging Markes Daa Base (EMDB), which was formerly colleced by he nernaional Finance Corporaion. n cross-checking wih counry sources, he EMDB is very accurae, bu for Argenina, we discovered ha he EMDB informaion is inconsisen over ime. Thus, unlike 9

11 previous sudies, we circumven his problem by collecing he daa direcly from he Buenos Aires Sock Exchange. The EMDB provides daa on domesic marke capializaion and domesic value raded in curren U.S. dollars by firm. Alhough he EMBD is he mos comprehensive daabase on firm-level rading of equiies around he world, he EMDB focuses mosly on emerging markes and does no include 100 percen of local firms (e.g., while varying by counry, he EMDB ypically covers abou 70 percen of marke capializaion). We also use balance shee daa on each firm o conrol for firm-specific characerisics ha may influence liquidiy. Thus, we conrol for indusry effecs, firm size effecs, and firm sales in assessing he impac of inernaionalizaion on he liquidiy of firms in he domesic marke. For simpliciy, in he resuls discussed below, we presen he resuls conrolling for firm size, bu he resuls are robus o conrolling for he oher firm-specific effecs. We obain hese daa from he Worldscope daabase (Thomson Financial Company). The firm-level daa on domesic sock marke rading, he firm-level balance shee informaion, and inernaional equiy aciviies are all mached a he firm level over he period Appendix Table 1 liss he 55 counries in he sudy and he number of domesic and inernaional firms per counry, as well as summary saisics of he main variables under sudy. n oal, we have over 18,000 firm-year observaions. Appendix Table 2 provides addiional informaion on daa sources. 10 As a robusness check, we also conrol for counry-specific informaion. Daa are from he World Bank s World Developmen ndicaors. Daa on he efficiency of each counry s legal sysem are obained from he nernaional Counry Risk Guide (Poliical Risk Services). nformaion on official resricions on inernaional capial flows is from he nernaional 10 Noe, ha some counries in our sample do no have any inernaional firms. We keep hese in he sample as a conrol sample. mporanly, we confirm his paper s resuls when we eliminae counries wih zero or only one inernaional firm. 10

12 Moneary Fund s Annual Repor on Exchange Arrangemens and Exchange Resricions. n addiional ess, we conrol for economic growh, inflaion, real ineres raes, erms of rade changes, ime rend, and alernaive measures of capial accoun openness ha we describe below. Alhough our daa have he limiaions noed above, he daabase has several advanages over previous work. Firs, he daa cover 55 counries, which as we noed earlier almos double he number of counries used in previous sudies and increase he power of our ess. Second, our daase includes informaion on he inernaional equiy marke aciviies of firms beyond deposiary receips in New York. We collec informaion on issuance of equiy, including cross-lising, in major financial markes. Thus, we can much more accuraely idenify which firms have inernaionalized. Third, we collec informaion on he inernaional rading aciviies of each firm wih a deposiary receip program. Thus, in assessing he impac of inernaionalizaion on domesic marke liquidiy, we move beyond considering wheher a company has inernaionalized or no. By incorporaing ime-vary rading daa, we can assess he dynamic effecs of inernaionalizaion. 11

13 . Mehodology and Resuls This secion empirically examines he impac of inernaional firms, hose ha issue deposiary receips, cross-lis, or raise new capial abroad, on domesic firms, hose ha do no inernaionalize. To do his, we firs examine wheher inernaionalizaion has a direc effec on he liquidiy of domesic firms? Second, we examine wheher inernaionalizaion affecs domesic liquidiy hrough he migraion and spillover channel. Third, we es wheher inernaionalizaion influences he liquidiy of domesic firms hrough rade diversion. A. Direc Effec 1. Mehod To examine wheher inernaionalizaion is direcly relaed o he liquidiy of domesic equiies, we esimae he following regression using feasible generalized leas squares wih sandard errors ha are robus o heeroskedasiciy. T D j, γ 1 S + γ 2 Tc, + θ ' M + λ1 Fj, + δ1 nc + δ 2 τ + ε j, =. (1) D T j c,, is he urnover raio of domesic firm j in counry c in year, which equals he oal value of rades of firm j s sock during year divided by firm j s marke capializaion. 11 The superscrip D designaes ha i is a domesic firm during he enire sample period, i.e., i never inernaionalizes. We define he dependen variable in his way because we wan o examine he effecs of inernaionalizaion on he firms ha rely on he domesic marke hroughou he sample period. By focusing on hose firms ha never access inernaional capial markes, we es how heir liquidiy changes as oher firms inernaionalize. n all regressions, we conrol for 11 Since in some cases he value raded is zero, we use he naural logarihm of one plus he urnover raio in he regressions. An alernaive measure of liquidiy is he number of shares raded in one year divided by he number of shares ousanding. This alernaive absracs from price changes. Bu, i is impossible o usefully aggregae across differen socks o obain counry-level liquidiy measures using his alernaive measure. 12

14 counry and ime effecs ( n space. c and τ respecively), bu do no repor hese in he ables o save S is he share of inernaional firms in counry c a ime. Thus, S is he number of inernaional firms from counry c a ime divided by he oal number of firms lised in he domesic marke for counry c a ime. n compuing S, a firm is considered an inernaional firm from he year i issues a deposiary receip, cross-liss, or raises capial abroad. f, however, he firm erminaes is deposiary receip lising or de-liss from an inernaional exchange, hen he numeraor of S falls by one. 12 T, is he aggregae urnover raio of counry c s inernaional firms in inernaional c equiy markes a ime. Thus, T, equals he aggregae value raded of all of counry c s c inernaional firms in inernaional markes divided by he marke capializaion of hose inernaional firms. We include he variable T, because we wan o conrol for rading of counry c s c equiies on inernaional exchanges. nformaion abou a counry s poliical and economic condiions may induce rading of ha counry s socks in boh inernaional and domesic markes. This effec would be capured by a posiive coefficien on T,. To assess he c independen impac of he share of firms in a counry ha are inernaional on domesic liquidiy, we seek o absrac from ime-varying counry specific facors influencing rading. Hence, we include he rading of counry c s socks in inernaional markes in regression (1). M is a marix of macroeconomic and counry-specific conrol variables. We include gross domesic produc (GDP) per capia since he level of economic developmen may influence 12 Since firms can lis abroad wihou lising in he domesic markes, his raio could, in heory, be larger han one. 13

15 financial markes developmen (Levine, 2003). We also include an index of he law and order radiion of he economy since he operaion of legal sysems may influence equiy marke developmen (Beck, Demirguc-Kun, and Levine, 2003; La Pora, Lopez-de-Silanes, Shleifer, and Vishny, 1998). Furhermore, we conrol for he openness of he capial accoun o inernaional capial flows (using daa from he nernaional Moneary Fund) since inernaional financial inegraion may influence he liquidiy of domesic equiy markes (Bekaer, Harvey, and Lundblad, 2001, 2002). We incorporae he macroeconomic and counry-specific conrol variables because we wan o assess he independen impac of inernaionalizaion on domesic liquidiy. Toward his end, we examined a variey of addiional counry-specific facors in robusness checks as discussed below. F includes firm-specific characerisics in counry c during year. We conrol for j, company level rais o assess he independen impac of inernaionalizaion on he rading of firms in he domesic marke. n he ables, we include he logarihm of he oal asses in U.S. dollars. n robusness checks, we conrol for many oher firm characerisics. 2. Resuls on he direc effec Conrary o a variey of heoreical models discussed in he nroducion, he Table 1 resuls indicae ha inernaionalizaion is negaively associaed wih he liquidiy of domesic firms. n paricular, he coefficien on he share of inernaional firms in counry c a ime, γ 1, is negaive and significan a he one-percen level across all of he specificaions ha conrol for differen combinaions of regressors. n erms of he oher regressors, we do no find a srong link beween he rading of inernaional firms in inernaional markes and he liquidiy of domesic socks. Pu differenly, rading of counry c s inernaional socks on inernaional exchanges ( T, ) is no robusly relaed wih he liquidiy of domesic socks. Also, rich c 14

16 counries and counries wih a srong law and order radiion end o have domesic firms wih greaer liquidiy. Finally, we see ha he variable, oal asses, eners wih a negaive coefficien. The reason for he negaive coefficien is ha oal asses is closely linked wih marke capializaion, which is he denominaor of he dependen variable. As we will see below however, when we compare he rading of socks wihin a counry, he equiies of bigger companies rade more han hose of smaller companies. n sum, as he share of inernaional firms in an economy rises i.e., as he fracion of firms in an economy ha issue deposiary receips, cross-lis, or raise capial abroad rises, he liquidiy of remaining firms falls. The adverse impac of inernaionalizaion on he liquidiy of domesic firms is no only saisically significan; i is economically relevan. For insance, consider he las regression coefficien based on he regression wih all of he regressors included (-2.2). This esimae implies ha a wo-sandard deviaion increase in he share of inernaional firms (0.086) will cause he liquidiy of domesic firms o fall by This is subsanial given ha he mean value of he liquidiy of domesic firms ( D T j c,, ) is Some cauion, however, is needed in inerpreing hese iniial resuls. Some may argue ha he resuls simply reflec he possibiliy ha firms ha inernaionalize are good firms and firms ha do no inernaionalize are comparaively poor. While poenially rue, his would no negae he value of he Table 1 resuls. Firs, some heories discussed in he nroducion sugges ha inernaionalizaion booss domesic liquidiy by making markes more inegraed. We find no evidence for his. Second, we confirm he Table 1 resuls when conrolling for many firmspecific rais (as discussed below). Thus, even when conrolling for firm qualiy, we ge he same resul. Third, he argumen ha bad firms remain domesic does no necessarily predic 13 Of course, his ype of experimen is only for illusraive purposes. Two sandard deviaions is no a marginal change and we do no specify wha drives he change in inernaionalizaion. 15

17 ha rading in hose firms will diminish as good firms become inernaional, which is wha we find in Table 1. Fourh, we obain he same resuls even when we resric he sample o firms ha rade for he enire sample period. Thus, uncompeiive firms ha lose liquidiy and drop ou of he sample do no drive he resuls. Fifh, as we show below, he resuls indicae ha he liquidiy of inernaional firms in he domesic marke falls wih inernaionalizaion, which is inconsisen wih a simple sory ha inernaional firm liquidiy hrives while domesic firm liquidiy falls. An addiional weakness wih he resuls hus far is ha we do no provide informaion on he mechanisms linking inernaionalizaion o domesic firm liquidiy. Alhough regression (1) provides informaion on he direc impac of inernaionalizaion on he liquidiy of domesic firms, i does no provide informaion on he channels hrough which inernaionalizaion affecs he liquidiy of domesic firms. We urn o his now. B. Migraion and Liquidiy Spillover Channel The migraion and liquidiy spillover view predics a wo-sage channel hrough which inernaionalizaion may influence he liquidiy of domesic socks. Firs, inernaionalizaion may reduce he domesic rading of inernaional firms as he rading of inernaional firms migraes o more liquid, lower cos inernaional markes. Second, he reducion in rading of inernaional firms in domesic markes because of migraion may hur he liquidiy of domesic firms because of liquidiy spillovers. Taken ogeher, migraion and liquidiy spillovers provide a heory of how inernaionalizaion migh reduce he liquidiy of domesic firms. As discussed in he nroducion, heoreical debae exiss on each of hese wo mechanisms ha define he migraion and spillover channel. We assess empirically each of hese channels. 16

18 1. The migraion par of he migraion and liquidiy spillover channel To examine he migraion componen of he migraion and liquidiy spillover channel we use hree differen regression specificaions. Consider firs he simple specificaion ha assesses he impac of inernaionalizaion on he domesic liquidiy of inernaional firms. T j, = γ 1 S + γ 2 Tj, + θ ' M + λ1 Fj, + δ1 nc + δ 2 τ + ε j,. (2) T j c,, is he urnover raio of inernaional firm j in counry c in year. The superscrip designaes ha i is an inernaional firm, which is a firm ha has eiher issued a deposiary receip, cross-lised, or raised capial abroad a some poin in he sample. Thus, he definiion of an inernaional firm in equaion (2) is consisen wih he definiion of domesic firms in equaion (1). n hese firs analyses, we simply spli he sample beween firms ha never inernaionalize and firms ha become inernaional a some poin in he sample. Below, we will assess he impac of an individual firm s decision o inernaionalize on is liquidiy wihin he domesic marke. T j, c, is he aggregae urnover raio of counry c s inernaional firms in inernaional equiy markes a ime, excluding he rading of company j. The oher variables are he same as hose in equaion (1). Table 2 provides srong evidence ha inernaionalizaion exers a negaive impac on he domesic liquidiy of inernaional firms. The coefficien on S always eners significanly and negaively. As in Table 1, we conrol for he inernaional rading of inernaional firms ( T j, c, ). We do his o conrol for oher facors influencing he rading of ha counry s equiies. T j, c, eners posiively, hough in some specificaions only a he en-percen level, which indicaes a posiive link beween he rading of a counry s socks abroad and he rading of hose 17

19 inernaional firms in he local marke. n sum, afer conrolling for many facors, we find ha as a counry s firms inernaionalize his negaively influences he domesic liquidiy of inernaional firms. The second regression we use o examine he migraion componen of he migraion and liquidiy spillover channel conrols for he domesic liquidiy of inernaional firms in addiion o he inernaional liquidiy of inernaional firms. Thus, o assess he independen impac of he share of inernaional firms in a counry on he domesic liquidiy of individual inernaional firms we now conrol for he aggregae liquidiy of inernaional firms in boh inernaional and domesic markes. Specifically, we esimae equaion (3). T j, = γ 1 S + γ 2 Tj, + β Tj, + θ ' M + λ1 Fj, + δ1 nc + δ 2 τ + ε j,. (3) T j c,, is he aggregae domesic urnover raio of inernaional firms, respecively, excluding he rading of company j. Table 3 shows ha inernaionalizaion lowers he domesic liquidiy of inernaional firms, i.e., here is a negaive and significan coefficien on S. Thus, even when conrolling for many facors, he domesic liquidiy of inernaional firms falls as he share of firms in he economy wih inernaional equiy marke operaions rises. The Table 3 resuls also provide some preliminary evidence on spillovers. The coefficien on T j c,, eners posiively and significanly. Thus, aggregae rading of inernaional firms in he local marke posiively influences he rading of individual inernaional firms in he local marke. We examine liquidiy spillovers in greaer deph below. 18

20 The hird regression we employ o es for migraion examines he relaive rading of an inernaional firm in inernaional and domesic markes. Thus, we examine wheher he fracion of rading of an inernaional firm shifs from domesic o inernaional markes as more firms inernaionalize. So far, we have examined he impac of inernaionalizaion on he level of he domesic rading of inernaional firms. Bu he domesic liquidiy of inernaional firms can be influenced by several facors, including how aracive an inernaional company is relaive o oher companies. Therefore, a more direc mehod for sudying migraion is o analyze he share of he company s liquidiy in he domesic marke relaive o is oal liquidiy. Thus, we esimae he following regression for inernaional firms. T j, T j, + T j, = γ S + γ T + β T + θ ' M + λ F + δ n + δ τ + ε 1 2 j, j, 1 j, 1 c 2 j,. (4) The dependen variable in his equaion measures he level of domesic liquidiy of firm j relaive o firm j s oal liquidiy, which includes he domesic liquidiy of firm j and he inernaional liquidiy of firm j. Since he marke capializaion is he same in he numeraor and denominaor, his measure is equivalen o using he raio of value raded in he domesic marke o oal value raded. mporanly, we conrol for he aggregae liquidiy of counry c s inernaional firms, excluding firm j ( T j, ). Thus, we conrol for he aggregae liquidiy of firm j s markes when assessing he impac of inernaionalizaion on wheher he rading of firm j shifs abroad. Table 4 presens regressions ha are consisen wih migraion. There is a negaive and significan coefficien on S. This indicaes ha inernaionalizaion (an increase in he proporion of inernaional firms in he domesic marke) reduces he proporion of rading of inernaional firms in domesic markes. As above, we conrol for many facors, including he 19

21 liquidiy of counry c s socks ( T j, c, ) in inernaional markes and also he domesic liquidiy of counry c s inernaional firms ( T ). j, Table 4 also provides evidence consisen wih he exisence of liquidiy spillovers. Noe ha T,, has a posiive and significan coefficien. Also, noe ha his holds while conrolling j c for he liquidiy of counry c s inernaional socks in inernaional markes ( T j, c, ). Thus, proporion of rading of firm j ha occurs in he domesic marke is posiively affeced by he aggregae liquidiy of he domesic marke (excluding firm j), i.e., aggregae liquidiy influences he liquidiy of individual socks. 2. The liquidiy spillover par of he migraion and liquidiy spillover channel Nex, we furher examine liquidiy spillovers. Does aggregae rading in a marke influence he liquidiy of individual domesic socks? f here is migraion if inernaionalizaion induces a shif in he rading of inernaional firms from domesic o inernaional markes and if here are liquidiy spillovers, hen his represens a wo-par channel hrough which inernaionalizaion affecs he liquidiy of domesic firms. Besides he evidence on liquidiy discussed above ha focuses on wheher aggregae liquidiy influences he rading of inernaional firms in he local marke, we esimae an exension of equaion (1) ha focuses on he liquidiy of domesic firms. T D j, = γ 1 S + γ 2 Tc, + β Tc, + θ ' M + λ1 Fj, + δ1 nc + δ 2 τ + ε j,. (5) The difference beween equaion (1) and equaion (5) is ha equaion (5) conrols for he aggregae liquidiy of inernaional firms in he domesic marke. Specifically, domesic urnover of inernaional firms in counry c a ime. T equals he 20

22 Table 5 provides posiive evidence of liquidiy spillovers. As shown, here is a posiive and significan coefficien on T in all of he specificaions. The aggregae liquidiy of inernaional firms in he domesic marke posiively influences he liquidiy of individual domesic firms above and beyond (i) he aggregae liquidiy of inernaional firms in inernaional markes ( T, ), (ii) he degree of inernaionalizaion ( c S ), (iii) macroeconomic and counry-specific conrols ( M ), (iv) firm-specific rais ( F j, ), and (v) counry and ime effecs ( n c and τ respecively). Thus, he posiive coefficien on T presens evidence of posiive liquidiy spillovers. The regression resuls presened in Tables 2-5 are consisen wih he migraion and liquidiy spillover channel. We find ha (a) inernaionalizaion reduces he domesic liquidiy of inernaional firms and (b) he domesic liquidiy of inernaional firms exers a posiive impac on he liquidiy of domesic firms. Taken ogeher, hese resuls imply ha inernaionalizaion hurs he liquidiy of domesic firms hrough he migraion and liquidiy spillover channel. Noe, however, ha he migraion and liquidiy spillover channel is no he whole sory. n Table 5 when we conrol for he liquidiy of inernaional firms in he domesic marke, S sill eners negaively and significanly. Thus, he liquidiy of domesic firms is negaively influenced by he share of inernaional firms in a marke beyond he aggregae rading of inernaional firms in he domesic economy ( T ) and in inernaional markes ( T, ) and afer c conrolling for counry-specific and firm-specific facors. f migraion and liquidiy spillovers were he only channel hrough which inernaionalizaion affeced he liquidiy of domesic socks, hen S should ener insignificanly afer conrolling for he liquidiy spillover channel. 21

23 The fac ha S remains significan suggess ha inernaionalizaion is influencing domesic liquidiy hrough an addiional mechanism. C. The Trade Diversion Channel 1. Mehod Trade diversion is an addiional channel hrough which inernaionalizaion can influence domesic sock liquidiy. We assess wheher inernaionalizaion induces a composiional shif in he domesic marke from he rading of domesic socks o he rading of inernaional socks. More specifically, does he proporion of he overall liquidiy of he domesic sock marke accouned for by a paricular firm rise simply because i becomes an inernaional firm? To sudy he rade diversion channel, we esimae he following equaion: S j, = φ 1 j, + φ2 Tj, + θ ' M + κ MCap j, + λ1 Fj, + δ1 nc + δ 2 τ + ε j,. (6) T, is firm j s share of urnover in counry c in year relaive o he oal urnover of j, S j = D+ Tc, counry c s domesic sock marke in year, where oal urnover includes he domesic rading of boh domesic and inernaional firms. We also used value raded insead of he urnover raio and obained similar resuls. j, is a dummy variable ha equals one if he company is inernaional and zero oherwise. Noe, ha his dummy urns from zero o one when a firm inernaionalizes. T j, c, is he inernaional rading of company j and equals zero for domesic firms. 22

24 MCap j, c, is he marke capializaion of firm j. We include his variable o conrol for he fac ha he share of urnover in firm j migh end o rise when he price of he sock rises or when he number of shares ousanding increase. 14 Finally, we coninue o conrol for he rading of inernaional firms in inernaional markes. We do his o conrol for as many firm- and counry-specific facors as possible and focus on he marginal impac of inernaionalizaion of he proporion of domesic liquidiy accouned for by inernaional firms. We conrol for firm-specific facors, macroeconomic rais, year dummies, and counry dummies. 2. Resuls on he rade diversion channel The Table 6 resuls indicae ha inernaionalizaion reduces he proporion of liquidiy of domesic firms in he local marke hrough he rade diversion channel. The coefficien, φ 1, on j, eners wih a posiive coefficien in all of he Table 6 specificaions. Thus, he proporion of he overall liquidiy of he domesic sock marke accouned for by a paricular firm rises simply because i becomes inernaional. Furhermore, noe ha he size of a company (oal asses) is posiively associaed wih he share of liquidiy of ha company in he local marke. n sum, he resuls are consisen wih he view ha inernaionalizaion induces a composiional shif in he local marke oward comparaively less rading of domesic sock and greaer liquidiy of inernaional socks. As noed in he nroducion, alernaive heories predic rade inensificaion, no rade diversion. These alernaive views hold ha inernaionalizaion will induce more acive rading of domesic socks, no less. n conras, our resuls suppor he view ha inernaionalizaion 14 n he previous specificaions, we do no include marke capializaion among he independen variables because he dependen variables are already scaled by marke capializaion. 23

25 induces rade diversion. As firms inernaionalize, he domesic marke becomes more focused on rading hose inernaional companies. D. Robusness ssues Firs, here may be concerns ha he enry and exi of domesic and inernaional firms will affec he resuls. Thus, esimaed all regressions holding consan he number of firms in he sample. We obained he same resuls wih he conrol sample. Second, we incorporaed addiional macroeconomic and counry-specific conrol variables o evaluae he independen impac of inernaionalizaion on domesic liquidiy. For insance, we included he inflaion rae since inflaion may inerfere wih rading and reduce marke liquidiy (Boyd, Levine, and Smih, 2001). We also conrolled for economic growh since business-cycle phenomenon may influence marke aciviy. We examined erms of rade changes since shocks may imporanly influence equiy marke ransacions. n oher specificaions, we included he real ineres rae, a broad index of financial liberalizaion developed by Kaminsky and Schmukler (2002), and a ime rend. ncluding hese addiional macroeconomic conrols did no change he resuls on he impac of inernaionalizaion on he liquidiy of domesic firms. Third, we included an assormen of microeconomic regressors o conrol for firmspecific and indusry-specific facors influencing sock liquidiy. This is imporan since firmspecific rais may lead high-performing firms o inernaionalize and poorly performing firms o remain domesic. Thus, we included indusry dummy variables and informaion on firm sales and profis. Conrolling for hese addiional microeconomic facors did no change he findings. Moreover, even when including array of firm-specific variables, macroeconomic conrols, 24

26 indusry dummy variables, year dummies, and counry dummy variables, we coninued o confirm he papers findings. While we are unable o rule ou he possibiliy ha some hird facor is driving he resuls, he findings remained robus o many conrols. Fourh, o measure spillover effecs in a differen way, we esimaed equaions (3), (4), and (5) including he aggregae domesic liquidiy of boh domesic and inernaional firms, insead of he liquidiy of only inernaional firms. We confirmed his paper s conclusions. Fifh, our measure of inernaionalizaion is based on he number of firms becoming inernaional. may be appropriae o weigh inernaionalizaion by he size and aciviy of he firm ha is cross-lising, issuing deposiary receips, or raising capial abroad. Thus, we compued an inernaionalizaion measure based on he value raded of he inernaionalizing firm. We again confirmed his paper s findings. Sixh, we re-defined inernaionalizaion by excluding he cases in which firms raise privae capial in inernaional markes and, a he same ime, do no issue a deposiary receips or cross-lis. These cases are only a small proporion (less han 10 percen) of he inernaionalizaion episodes. Excluding hem did no aler he resuls of he paper. Sevenh, we also experimened wih ineracion erms. We examined wheher inernaionalizaion has a differen impac on domesic firms depending on heir size or oher characerisics. Thus, we assessed wheher he liquidiy of big firms ha do no inernaionalizaion falls more or less han smaller firms ha do no inernaionalize. We also examined firm profiabiliy, sales, ec. We found no evidence of hese ineracion erms enering significanly. 25

27 Eighh, in our sample, 19 ou of 55 counries have zero or only one inernaional firm. Thus, we re-did he analyses eliminaing all 19 of hese counries. We go he same resuls wih his alernaive sample. V. Conclusions This paper finds ha he inernaionalizaion of sock markes has a negaive effec on he sock marke liquidiy of domesic firms. We sudied in deail how his effec akes place. Liquidiy migraes o inernaional financial markes, having negaive spillover effecs on he liquidiy of domesic firms in domesic markes. Furhermore, here is rade diversion in domesic markes as rading shifs from domesic o inernaional socks wihin he local marke. As a resul, we were able o idenify wo channels hrough which inernaionalizaion hurs domesic firms. The findings in his paper have opened several avenues for fuure research. Firs, a heoreical model ha more comprehensively specifies he mechanisms influencing he impac of inernaionalizaion on domesic markes would subsanively sharpen he inerpreaion of his paper s resuls and shape fuure empirical work. Second, alhough his paper finds srong evidence of liquidiy spillovers, we do no idenify he source of hese spillovers. To beer undersand he operaion of financial markes, fuure research migh usefully dissec he sources of liquidiy spillovers. Third, i would be ineresing o undersand he ne effec of inernaionalizaion. Some papers have argued ha inernaionalizaion has posiive effecs on he firms ha inernaionalize. This paper has shown ha inernaionalizaion hurs he liquidiy of domesic firms. Wha is he ne effec for he economy? Wha is he fuure for domesic 26

28 markes and companies ha are unable o inernaionalize? We believe hese quesions represen fruiful areas for fuure research. 27

29 References Ahearne, A., Griever, W., and Warnock, F., nformaion Coss and Home Bias: AN Analysis of U.S. Holdings of Foreign Equiies. Journal of nernaional Economics, forhcoming. Alexander, G., Eun, C., and Janakiramanan, S., Asse Pricing and Dual Lising on Foreign Capial Markes: A Noe. Journal of Finance Vol. 42(1), pp Alexander, G., Eun, C., and Janakiramanan, S., nernaional Lisings and Sock Reurns: Some Empirical Evidence. Journal of Financial and Quaniaive Analysis Vol. 23(2), pp Amihud, Y., and Mendelson, H., Asse Pricing and he Bid-Ask Spread. Journal of Financial Economics Vol. 17, pp Bailey, W., Karolyi, A., and Salva, C., The Economic Consequences of ncreased Disclosure: Evidence from nernaional Cross-Lisings. Ohio Sae and Cornell Universiy working papers. Baker, H. K., Nofsinger, J. R., and Weaver, D. G., nernaional Cross-Lising and Visibiliy. Journal of Financial and Quaniaive Analysis Vol. 37(3), pp Beck, T. and Levine, R Sock Markes, Banks, and Economic Growh: Panel Evidence. Journal of Banking and Finance, forhcoming. Beck, T., Demirguc-Kun, A., and Levine, R., Law, Endowmens, and Finance. Journal of Financial Economics, forhcoming. Bekaer, G., and Harvey, C. R., Time-Varying World Marke negraion. Journal of Finance Vol. 50(2), pp Bekaer, G., and Harvey, C. R., Foreign Speculaors and Emerging Equiy Markes, Journal of Finance Vol. 55(2), pp Bekaer, G., Harvey, C. R., and Lundblad, C., Emerging Equiy Markes and Economic Developmen. Journal of Developmen Economics Vol. 66(2), pp Bekaer, G., Harvey, C. R., and Lundblad, C., Does Financial Liberalizaion Spur Growh? NBER working paper Bovespa, Nova York Aaca e os Mercados Reagem. Revisa Bovespa, May Boyd, J. H., Levine, R., and Smih, B. D., The mpac of nflaion on Financial Secor Performance. Journal of Moneary Economics Vol. 47(2), pp

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