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

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1 Migraion, Spillovers, and Trade Diversion: The mpac of nernaionalizaion on Domesic Sock Marke Aciviy Ross Levine and Sergio L. Schmukler Firs Draf: February 10, 003 This draf: April 8, 004 Absrac Wha is he impac of firms ha cross-lis, issue deposiary receips, or raise capial in inernaional sock markes on he rading aciviy and liquidiy of remaining firms in domesic markes? Using a panel of 3,000 firms from 55 counries during , we find ha inernaionalizaion reduces he rading aciviy and liquidiy of domesic firms hrough wo channels. Firs, he rading of inernaional firms migraes from domesic o inernaional markes and his migraion along wih he reducion in domesic rading of inernaional firms has negaive spillover effecs on domesic firm rading aciviy and liquidiy. Second, here is rade diversion wihin domesic markes as rading aciviy shifs ou of domesic firms and ino inernaional firms. JEL classificaion codes: G15, F36, F0 Keywords: inernaional finance; equiy markes; rading, liquidiy; cross-lising; deposiary receips; ADRs; GDRs Levine: Universiy of Minnesoa and he NBER Schmukler: World Bank We hank Taiana Didier and Juan Carlos Gozzi Valdez for ruly ousanding research assisance. We received very helpful commens from Gordon Alexander, Luca Benzoni, Sijn Claessens, Valery Polknichenko, Helene Rey, Michael Schill, Frank Warnock, and seminar paricipans a he Universiy of Minnesoa and he Universiy of Zurich. For help wih he daa, we hank Pamela Doin, Monica Erpen, Dori Flanagan, Marina Hala 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 ample 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 rading aciviy and liquidiy of he remaining firms in he domesic marke? As reviewed below, 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 Janakiramanan, 1987). We, insead, focus 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 rading aciviy and liquidiy of domesic firms. Consider firs he migraion and spillovers argumen. According o he migraion view, inernaionalizaion will induce a shif in he rading of inernaional firms ou of he domesic marke and ino major inernaional financial markes. This may occur because major inernaional markes have lower informaion and ransacion coss (Lang, Lins, and Miller, 003, 004; Chowdhry and Nanda, 1991). Spillovers mean ha a drop in he domesic rading of inernaional firms hurs he rading and liquidiy of domesic firms. ndeed, using daa from he Unied Saes, Chordia, Roll, and Subrahmanyam (000) find ha liquidiy is no simply an asse specific aribue; raher, individual asse liquidiy ends o co-move wih aggregae marke liquidiy. Spillovers could occur because of fixed coss associaed wih operaing a marke, running brokerage firms, clearing and seling ransacions, among oher hings. Thus, a drop in he domesic rading of inernaional socks could increase he per-rade cos of domesic sock ransacions and reduce he rading and liquidiy of domesic firms. 1 This involves a shif ou of rading on domesic exchanges and ino rading inernaionalized socks on inernaional exchanges. Combined, migraion and spillovers imply ha inernaionalizaion reduces he rading aciviy and liquidiy of domesic firms. 1

3 Some disagree wih he migraion and spillovers view and insead argue ha inernaionalizaion improves he domesic marke. n conras o he migraion view, Hargis (000) argues ha cross-lising can ransform a segmened equiy marke wih low liquidiy ino an inegraed marke wih high rading aciviy and 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 (Hargis and Ramanlal, 1998). Oher skepics of he migraion-spillovers view could quesion he exisence and magniude of spillovers. Thus, i is an empirical quesion as o wheher inernaionalizaion induces migraion and spillovers, or wheher inernaionalizaion booss he rading aciviy and 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 raders in he domesic marke if inernaionalizaion induces improvemens in repuaion, disclosure sandards, analys coverage, and he shareholder base. 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. Some heories, however, 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, 000). This could occur because inegraion increases he liquidiy of all firms in he local markes. Moreover, inegraion may induce a

4 composiional shif in domesic rading 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, which in urn moivaes his paper s empirical inquiry. To sudy he effecs of inernaionalizaion, his paper assembles rading and liquidiy informaion on over 3,000 firms across 55 emerging marke counries during he years 1989 o 000. To measure rading aciviy, we use urnover, which equals he value of a firm s ransacions in a marke divided by he firm s marke capializaion. Turnover, and similar rade-based indicaors, are frequenly used o proxy for liquidiy since (i) heory and evidence sugges a close associaion beween urnover and bid-ask spreads, (ii) many counries do no have bid-ask spread informaion (especially ime series daa) and (iii) some research finds ha urnover can be a beer proxy for liquidiy han bid-ask spreads due o problems wih measuring spreads. 4 Moreover, i is crucial o examine urnover since heory and evidence idenify a srong link beween urnover and firm performance, indusrial expansion, and naional growh. 5 Neverheless, since urnover does no direcly measure rading coss or he price impac of ransacions, we inerpre urnover as a general index of rading aciviy raher han as a precise measure of liquidiy. We also examine liquidiy more direcly. Because bid-ask spreads and oher ransacion cos based indicaors are unavailable for our counries, we compue a price-impac liquidiy measure. Specifically, we use Amihud s (00) illiquidiy index, which equals he raio of a sock s absolue reurns o is value raded. Hasbrouck (00) finds ha, wihin he class of price-impac liquidiy esimaes, Amihud s (00) illiquidiy index is he mos reliable proxy of rading coss. mporanly, we obain consisen resuls using he urnover and illiquidiy indexes. Neverheless, we inerpre he illiquidiy resuls cauiously. The illiquidiy index, as defined by Amihud (00), is frequenly 3

5 consruced from daily series, bu daa limiaions consrain us o monhly observaions. Thus, we primarily discuss he resuls wihin he conex of he urnover measure. The paper firs examines he direc impac of inernaionalizaion on he urnover of domesic firms. The daa indicae ha as more firms become inernaional, his lowers he urnover of domesic firms. While we canno eliminae he possibiliy ha an omied facor is driving he resuls, his resul is robus o conrolling for firm characerisics (such as firm size, sales, profis, and he firm s indusry) and various counry facors (e.g., rading of ha counry s shares on inernaional exchanges, economic developmen, legal sysem efficiency, inernaional capial flow openness, and inflaion). These iniial resuls, however, do no shed ligh on he mechanisms hrough which inernaionalizaion hurs he urnover of domesic firms. Nex, he paper sudies he channels hrough which inernaional firms affec he urnover of domesic firms. There is evidence of migraion: as he fracion of inernaional firms rises, he rading of inernaional firms shifs from domesic markes o inernaional markes. Furhermore, we find evidence of spillovers: he domesic rading of inernaional shares is srongly, posiively relaed o he urnover of domesic firms. Hence, he daa are consisen wih he migraion and spillovers view: as he urnover of inernaional firms in he domesic marke dries up because of migraion, he urnover of domesic firms diminishes because of spillovers. The migraion and spillovers channel, however, is no he only mechanism linking inernaionalizaion and he urnover of domesic firms. nernaionalizaion is negaively associaed wih he urnover of domesic firms even afer conrolling for he migraion and spillovers channel. Thus, we nex 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 4

6 above: inernaionalizaion reduces he domesic urnover of inernaional shares. The rade diversion resul is consisen wih, albei no an unambiguous proof of, 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 urnover of firms ha do no inernaionalize. Finally, we examine he connecion beween inernaionalizaion and he illiquidiy index. Consisen wih he urnover resuls, he liquidiy of domesic firms falls as inernaionalizaion rises. Furhermore, we confirm he migraion and spillovers channel. As he fracion of inernaional firms rises, he domesic liquidiy of inernaional firms falls and his drop in he domesic liquidiy of inernaional firms reduces he liquidiy of domesic firms. 6 This paper s assessmen of he impac of inernaionalizaion on he urnover and liquidiy of domesic firms is relaed o a large lieraure on inernaionalizaion. Firs, research analyzes he impac of marke inegraion on economic growh, invesmen, and asse pricing. 7 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 inernaionalize on he rading aciviy and liquidiy of hose firms ha do no inernaionalize. 8 Second, an exensive lieraure sudies he effecs of inernaionalizaion on inernaional firms. 9 Alhough we assess he impac of (i) inernaionalizaion decisions and (ii) he inernaional rading aciviy of inernaional firms on he domesic rading of hose inernaional firms, he focus of our research is differen. We concenrae on examining he impac of inernaionalizaion on domesic firms. Only wo oher sudies examine specifically he effecs of inernaionalizaion on domesic firm rading aciviy. Moel (001) and Karolyi (004) find a negaive associaion beween he 5

7 fracion of a counry s socks ha issue American deposiary receips (ADRs) and domesic marke urnover. Our research conribues o hese wo papers along seven dimensions. Firs, his is he firs paper o dissec he channels hrough which inernaionalizaion influences domesic socks. Thus, we evaluae he imporance of he migraion-spillovers channel and he rade diversion channel. Second, we subsanially expand he sample size. Our daa cover 55 counries, while Karolyi (004) and Moel (001) sudy 1 counries and 8 counries respecively. Third, we confirm our resuls using a direc measure of liquidiy, i.e., he illiquidiy index. Fourh, we measure he main explanaory variable classifying companies as inernaional or domesic more broadly han earlier sudies, by moving beyond he ADR marke in New York o include global deposiary receips, cross-lisings, and privae placemens in New York and oher financial ceners. Fifh, we collec and incorporae ime-varying daa on he inernaional rading aciviies of inernaional firms. This allows us o esimae more precisely he impac of inernaionalizaion on domesic equiies because we conrol for counry-specific news ha influences global rading of ha counry s shares, while also obaining separae esimaes of inernaional rading on he domesic marke. Sixh, o furher isolae he marginal impac of inernaionalizaion, we conrol for firm specific characerisics, including firm size, which exising sudies do no. Sevenh, 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 examining he effecs of inernaionalizaion on domesic firms, we also use our new daabase o augmen he more esablished lieraure on inernaional firms. The res of he paper is organized as follows. Secion discusses he daa. Secion discusses he economeric mehodology and presens he resuls. Secion V concludes. 6

8 . Daa To assess he impac of inernaionalizaion on domesic socks, we need he following daa: 1. Firm-level daa on he inernaional equiy aciviies of firms, including a. Daes of capial raisings, cross-lising, and deposiary receips, b. nernaional rading daa,. 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, he London Sock Exchange (LSE), NASDAQ, and he New York Sock Exchange (NYSE). Euromoney provides he daes when firms raise equiy capial in inernaional markes, including cross-lisings and issuance of global deposiary receips. Thus, he Euromoney daa subsanively enhance he idenificaion of inernaional firms. The Euromoney daabase covers 8,795 cross-border equiy issuance and cross-lising operaions from 5,665 firms in 86 counries over he period January April 001. LSE, NASDAQ, and NYSE provide informaion on lising daes by foreign corporaions. 7

9 n erms of rading abroad, we focus on rading in ADRs. The daase on ADR value raded also comes from Bank of New York and covers he period , providing he value raded in U.S. dollars. Companies ha are no shown o be rading according o Bank of New York are assigned a zero. We also have daa from he LSE and he Frankfur Sock Exchange (FSE) on he rading of deposiary receips and cross-lised firms. However, LSE rading daa for hese firms do no begin unil 1997 and he daa from 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 (00) 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, () 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 crosslising 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. 8

10 The firm-level domesic sock marke rading and reurn 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 is inconsisen over ime. Thus, unlike 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 (i.e., 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, 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. Some counries do no have any inernaional firms. We keep hese in he sample as a conrol group, bu emphasize ha his paper s resuls hold when we exclude counries wih zero or only one 9

11 inernaional firm. n oal, we have over 16,000 firm-year observaions. Appendix Table provides addiional informaion on daa sources. For robusness, we conrol for ime-varying counry-specific informaion and counry dummy variables. 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 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.. Mehodology and Resuls This secion examines he impac of firms ha inernaionalize (firms ha issue deposiary receips, cross-lis, or raise new capial abroad) on domesic firms (firms ha do no inernaionalize). To do his, we firs examine wheher inernaionalizaion has a direc effec on he urnover of domesic firms. Second, we examine wheher inernaionalizaion affecs domesic urnover hrough he migraion and spillovers channel. Third, we es wheher inernaionalizaion induces rade diversion, i.e., does inernaionalizaion diver he composiion of rading in he local marke ou of domesic firms and ino inernaional firms? Fourh, we assess wheher inernaionalizaion influences he liquidiy of domesic firms using Amihud s (00) illiquidiy index. 10

12 A. Direc Effec on Turnover 1. Mehod To examine wheher inernaionalizaion is direcly relaed o he urnover of domesic equiies, we esimae he following regression using feasible generalized leas squares wih sandard errors ha are robus o heeroskedasiciy. T D γ 1 S + γ Tc, + θ ' M + λ1 F + δ1 nc + δ τ + ε =. (1) D T j c,, is he logarihm of one plus he urnover raio of domesic firm j in counry c in year, where he urnover raio equals he oal value of rades of firm j s sock during year divided by firm j s marke capializaion. 10 For breviy in he ex, we refer o D T j, c, as he urnover of domesic firms. 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 urnover changes as oher firms inernaionalize. n all regressions, we conrol for counry and ime effecs ( n c and τ respecively), bu do no repor hese in he ables o save space. S is he share of inernaional firms in counry c a ime. Thus, is he number of S 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 S numeraor of falls by one

13 T, is he aggregae urnover raio of counry c s inernaional firms in inernaional equiy c markes a ime. Thus, T c, equals he aggregae value raded of all of counry c s inernaional firms in inernaional markes divided by he marke capializaion of hose inernaional firms. We include he variable T, c because we wan o conrol for rading of counry c s 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, c. To assess he independen impac of he share of firms in a counry ha are inernaional on domesic urnover, we seek o absrac from imevarying 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 financial markes developmen (Levine, 003). 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, 003; 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, 00, 003). We incorporae he macroeconomic and counry-specific conrol variables because we wan o assess he independen impac of inernaionalizaion on domesic urnover. Toward his end, we examined a variey of addiional counry-specific facors in robusness checks as discussed below. 1

14 F includes firm-specific characerisics in counry c during year. We conrol for 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 discussed below, we conrol for many oher firm characerisics.. 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 urnover 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 find a srong link beween he rading of inernaional firms in inernaional markes and he urnover of domesic socks. Pu differenly, rading of counry c s inernaional socks on inernaional exchanges ( T, c ) is robusly relaed wih he urnover of domesic socks. Also, rich counries and counries wih a srong law and order radiion end o have domesic firms wih greaer urnover. 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 urnover of remaining firms falls. The adverse impac of inernaionalizaion on he urnover 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 (-.6). This esimae implies 13

15 ha a one-sandard deviaion increase in he share of inernaional firms (0.05) will cause he urnover of domesic firms (measured as he log of one plus urnover) o fall by This is subsanial given ha he mean of he urnover of domesic firms ( ) is 0.51, so ha a onesandard deviaion increase in inernaionalizaion reduces domesic firm urnover by 5 percen of he sample mean. 1 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 urnover by making markes more inegraed. We find no evidence for his. Second, we confirm he Table 1 resuls when conrolling for many firm-specific 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 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 become inacive and drop ou of he sample do no drive he resuls. Fifh, as we show below, he resuls indicae ha he urnover of inernaional firms in he domesic marke falls wih inernaionalizaion, which is inconsisen wih a simple sory ha inernaional firm urnover hrives while domesic firm urnover falls. An addiional weakness wih he resuls hus far is ha we do no provide informaion on he mechanisms linking inernaionalizaion o domesic firm urnover. Alhough regression (1) provides informaion on he direc impac of inernaionalizaion on he urnover of domesic firms, i does no provide D T j, c, 14

16 informaion on he channels hrough which inernaionalizaion affecs he urnover of domesic firms. We urn o his now. B. Turnover and he Migraion and Spillovers Channel The migraion and spillovers view predics a wo-sage channel hrough which inernaionalizaion may influence he urnover 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, migraion and he reducion in rading of inernaional firms in domesic markes may hur he urnover of domesic firms because of spillovers. Taken ogeher, migraion and spillovers provide an explanaion of how inernaionalizaion migh reduce he urnover of domesic firms. As discussed in he nroducion, heoreical debae exiss on each of hese wo mechanisms ha define he migraion and spillovers channel. We assess empirically each of hese channels. 1. The migraion par of he migraion-spillovers channel To examine he migraion componen of he migraion and spillovers channel we use hree differen regression specificaions. Consider firs he simple specificaion ha assesses he impac of inernaionalizaion on he domesic urnover of inernaional firms. T = γ 1 S + γ T + θ ' M + λ1 F + δ1 nc + δ τ + ε. () T j c,, is he logarihm of one plus 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. For breviy in he ex, we refer o T j, c, as he domesic urnover of inernaional firms. Thus, he definiion of an inernaional firm in equaion () is consisen wih he definiion of domesic firms 15

17 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 rading aciviy 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 provides srong evidence ha inernaionalizaion exers a negaive impac on he domesic urnover 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, which indicaes a posiive link beween he rading of a counry s socks abroad and he rading of hose 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 urnover of inernaional firms. Again he resuls sugges an economically large impac. A one-sandard deviaion increase in inernaionalizaion reduces he domesic urnover of inernaional firms (measured as he log of one plus urnover) by abou 0.1 (.4*0.05). This ranslaes ino a reducion of he domesic urnover of inernaional firms of 9 percen of he sample mean. Thus, migraion of inernaional firms is subsanial. The second regression we use o examine he migraion componen of he migraion and spillovers channel conrols for he domesic urnover of inernaional firms in addiion o he inernaional urnover of inernaional firms. Thus, o assess he independen impac of he share of 16

18 inernaional firms in a counry on he domesic urnover of individual inernaional firms we now conrol for he aggregae urnover of inernaional firms in boh inernaional and domesic markes. Specifically, we esimae equaion (3). T = γ 1 S + γ T + β T + θ ' M + λ1 F + δ1 nc + δ τ + ε. (3) T j c,, is he aggregae domesic urnover raio of inernaional firms, excluding he rading of company j. Table 3 shows ha inernaionalizaion lowers he domesic urnover of inernaional firms, i.e., here is a negaive and significan coefficien on S. Thus, even when conrolling for many facors, he domesic urnover 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 spillovers in greaer deph below. 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 urnover 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 urnover in he domesic marke relaive o is oal urnover. 17

19 Thus, we esimae he following regression for inernaional firms. T T + T = γ S + γ T + β T + θ ' M + λ F + δ n + δ τ + ε c. (4) The dependen variable in his equaion measures he level of domesic urnover of firm j relaive o firm j s oal urnover, which includes he domesic urnover of firm j and he inernaional urnover 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 urnover of counry c s inernaional firms, excluding firm j. Thus, we conrol for he aggregae urnover 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 share of inernaional firms in he domesic marke) reduces he proporion of rading of inernaional firms in domesic markes. Economically, he effec is no inconsequenial. According o he coefficien esimaes, a one sandard deviaion increase in inernaionalizaion (0.05) reduces he proporion of rading of inernaional firms in domesic markes (measured as he log of one plus he proporion of rading) by abou eigh percen of he sample mean (([-0.998*0.05]/0.65)*100). As above, we conrol for many facors, including he urnover of counry c s socks ( T j, c, ) in inernaional markes and also he domesic urnover of counry c s inernaional firms ( T ). Table 4 also provides evidence consisen wih he exisence of spillovers. Noe ha T has a posiive and significan coefficien. Also, noe ha his holds while conrolling for he urnover of counry c s inernaional socks in inernaional markes ( T j, c, ). Thus, he proporion of 18

20 rading of firm j ha occurs in he domesic marke is posiively affeced by he aggregae urnover of inernaional firms in he domesic marke (excluding firm j), i.e., aggregae urnover influences he urnover of individual socks.. The spillover par of he migraion and spillovers channel Nex, we furher examine spillovers. Does aggregae rading in a marke influence he urnover 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 spillovers, hen his represens a wo-par channel hrough which inernaionalizaion affecs he rading aciviy of domesic firms. Besides he evidence discussed above on wheher aggregae urnover influences he rading of inernaional firms in he local marke, we esimae an exension of equaion (1) ha focuses on he urnover of domesic firms. T D = γ 1 S + γ Tc, + β Tc, + θ ' M + λ1 F + δ1 nc + δ τ + ε. (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, T equals he domesic urnover of inernaional firms in counry c a ime. Table 5 provides posiive evidence of spillovers. As shown, here is a posiive and significan coefficien on T in all of he specificaions. The aggregae urnover of inernaional firms in he domesic marke posiively influences he urnover of individual domesic firms above and beyond (i) he aggregae urnover of inernaional firms in inernaional markes ( T, c ), (ii) he degree of inernaionalizaion ( S ), (iii) macroeconomic and counry-specific conrols ( ), (iv) firm-specific rais ( F ), and (v) counry and ime effecs ( n c and τ respecively). M 19

21 Thus, he posiive coefficien on T presens evidence of posiive spillovers, and he impac is economically large. A one sandard deviaion decrease in he domesic urnover of inernaional firms (0.46) ranslaes ino a reducion of 0.13 in domesic firm urnover (-0.46*0.9). Since he sample mean value of urnover of domesic firms is 0.51, his implies ha a one-sandard deviaion drop in inernaional firm urnover in he domesic marke lowers domesic firm urnover by 6 percen of he sample mean. These spillover resuls confirm and exend research from U.S. markes (Chordia, Roll, and Subrahmanyam, 000). Across 55 markes during he years , we find ha an individual equiy s urnover reflecs he marke s overall level of aciviy afer conrolling for firm-specific and counry-specific facors. The regression resuls presened in Tables -5 are consisen wih he migraion and spillovers channel. We find ha (a) inernaionalizaion reduces he domesic urnover of inernaional firms and (b) he domesic urnover of inernaional firms exers a posiive impac on he urnover of domesic firms. Taken ogeher, hese resuls imply ha inernaionalizaion hurs he urnover of domesic firms hrough he migraion and spillovers channel. Noe, however, ha he migraion and spillovers channel is no he whole sory. n Table 5 when we conrol for he urnover of inernaional firms in he domesic marke, S sill eners negaively and significanly. Thus, he urnover of domesic firms is negaively influenced by he share of inernaional firms in a marke, beyond he effecs of he aggregae rading of inernaional firms in he domesic economy ( T ) and in inernaional markes ( T c, ), and afer conrolling for counry-specific and firm-specific facors. f he migraion-spillovers channel were he only channel hrough which inernaionalizaion affeced he urnover of domesic socks, hen S should ener insignificanly afer conrolling for he spillovers channel. The fac ha S remains significan 0

22 suggess ha inernaionalizaion is influencing domesic urnover hrough an addiional mechanism. C. The Trade Diversion Channel 1. Mehod Trade diversion is an addiional channel hrough which inernaionalizaion can influence he rading aciviy of domesic socks. We assess wheher inernaionalizaion induces a composiional shif in he domesic marke ou of he rading of domesic socks and ino he rading of inernaional socks. More specifically, does he proporion of he overall urnover 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 = φ 1 + φ T + θ ' M + κ MCap + λ1 F + δ1 nc + δ τ + ε. (6) T, is firm j s share of urnover in counry c in year relaive o he oal urnover of 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. 1

23 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 increases. 13 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 on he proporion of domesic urnover accouned for by inernaional firms. We conrol for firm-specific facors, macroeconomic rais, year dummies, and counry dummies.. Resuls on he rade diversion channel The Table 6 resuls indicae ha inernaionalizaion reduces he proporion of urnover of domesic firms in he local marke hrough he rade diversion channel. The coefficien, φ 1, on eners wih a posiive coefficien in all of he Table 6 specificaions. Thus, he proporion of he overall urnover of he domesic sock marke accouned for by a paricular firm rises simply because i becomes inernaional. ndeed, he coefficiens indicae ha inernaionalizaion raises an individual firm s share of domesic urnover by a leas 10 percen of he average firm s share of domesic urnover. Furhermore, noe ha he size of a company (oal asses) is posiively associaed wih he share of urnover 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 urnover 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 induces

24 rade diversion. As firms inernaionalize, he domesic marke becomes more focused on rading hose inernaional companies. D. Robusness ssues on he Turnover Resuls We subjeced hese resuls o six caegories of sensiiviy checks. Firs, we experimened wih hree differen approaches o defining inernaionalizaion. Firs, insead of basing he S indicaor on he number of firms becoming inernaional, we compued an inernaionalizaion measure based on he value raded of he inernaional firms. We confirmed his paper s findings. The nex approach o defining inernaionalizaion assesses he paricular mechanisms hrough which a company inernaionalized. Thus, we examined separaely (i) firms ha inernaionalized hrough a public offering and (ii) firms ha inernaionalized hrough a privae placemen. f a company firs does a privae placemen and hen a public placemen, i is considered public afer he public placemen. Noe ha while public placemens clearly involve ongoing rading of domesic socks in foreign counries, raising capial hrough privae placemens is differen because he new shares are no necessarily raded abroad. Thus, public offerings abroad may involve migraion/spillovers and rade diversion. Raising capial abroad in he absence of crosslising, however, will only poenially involve rade diversion in he domesic marke since simply raising capial abroad canno induce migraion of rading abroad. We confirm all of his paper s resuls for public placemens and he resuls on rade diversion for privae placemens. Furhermore, we examined he differen ypes of ADR programs. This is problemai however. One of his paper s conribuions is o obain more precise indicaors of inernaionalizaion ha exend beyond he ADR marke. Thus, when we use hese subcaegories we 3

25 are no using a comprehensive definiion of inernaionalizaion. We confirm all his paper s findings for he Level programs (deposiary receips raded in he over-he-couner, OTC public markes) and Level and programs (deposiary receips lised on a U.S. exchange and hose sold in a public offering, respecively). When using he Regulaion 144A privae placemens in he U.S., since hese shares are sold o qualified insiuional buyers and rade on he PORTAL sysem wih very limied liquidiy, we can only assess he rade diversion effec. n sum, when we define inernaionalizaion only as public placemens, we confirm his paper s resuls; when we define inernaionalizaion only as privae placemens, we confirm his paper s resuls on rade diversion; when we define inernaionalizaion only as Level ADR programs, we confirm his paper s resuls; when we define inernaionalizaion as only Level and ADR programs, we confirm his paper s resuls; and, when we define inernaionalizaion only as 144A privae placemens, we confirm his paper s resuls on rade diversion. The las approach o re-defining inernaionalizaion excludes firms ha 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 a all. Second, we incorporaed addiional ime-varying macroeconomic and counry-specific conrol variables o evaluae he independen impac of inernaionalizaion on domesic urnover. 14 For insance, we included he inflaion rae since inflaion may inerfere wih rading and reduce marke urnover (Boyd, Levine, and Smih, 001). We 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 4

26 Schmukler (003), and a ime rend. ncluding hese addiional macroeconomic conrols did no change he resuls on he impac of inernaionalizaion on he urnover of domesic firms. Third, we conrolled for addiional firm-specific and indusry-specific characerisics. This is imporan since firm-specific 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. This did no change he findings. While we are unable o rule ou he possibiliy ha some hird facor is driving he resuls, he findings remain robus o many conrols. Fourh, o measure spillover effecs in a differen way, we esimaed equaions (3), (4), and (5) including he aggregae domesic urnover of boh domesic and inernaional firms, insead of he urnover of only inernaional firms. We confirmed his paper s conclusions. Fifh, we experimened wih differen samples. n paricular, here may be concerns abou he enry and exi of firms. Thus, we re-did he analyses using only a sample of firms ha exis for he enire period and obained he same conclusions. Also, 18 ou of 55 counries have zero or only one inernaional firm. Thus, we re-did he analyses eliminaing all 18 of hese counries and go he same resuls. Sixh, 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 urnover of big firms ha do no inernaionalize falls more or less han smaller firms ha do no inernaionalize. We addiionally examined firm profiabiliy and sales. We found no robus evidence of hese ineracion erms enering significanly. 5

27 E. Liquidiy Nex, we examine he impac of inernaionalizaion on he liquidiy of domesic equiies as measured by Amihud s (00) illiquidiy index. Liquidiy is a complex concep ha is no observed direcly. While many auhors use urnover as a proxy for liquidiy, urnover does no direcly measure rading coss or he price impac of ransacions. Consequenly, we augmen our sudy of urnover wih a more direc measure of liquidiy. Bid-ask spread measures of rading coss do no exis for he bulk of our sample, so we compue a price-impac measure. Since Hasbrouck (00) finds ha, wihin he class of price-impac liquidiy esimaes, Amihud s (00) illiquidiy index is he mos reliable proxy of rading coss, we use his illiquidiy index in our sudy. Amihud s (00) illiquidiy index is defined as he average raio of absolue reurn o rading value. Due o daa limiaions we are consrained o monhly daa, so he illiquidiy raio is defined as follows 1 = M M j, P V m, m= 1 m,. (7) P m, Where is he illiquidiy raio of firm j from counry c in year, in he sock price of firm j in monh m of year, V m, is he percen change is he value raded of firms j sock in monh m of year, and M j, c, is he number of monhs for which he raio can be calculaed for firm j in year. 15 The illiquidiy index relaes he absolue value of price movemen o he value of equiy ransacions. Thus, for a dollar denominaed equiy, he illiquidiy index is inerpreed as he percen price response o one dollar worh of rading, so ha higher values signify less liquidiy. We re-do he urnover analyses using he illiquidiy index insead of urnover. We examine he impac of inernaionalizaion on he illiquidiy index. Specifically, we esimae he following regressions and presen he resuls in Table 7 s panel A and B respecively. 6

28 D = γ 1 S + γ A + θ ' M + λ1 F + δ1 nc + δ τ + ε = γ 1 S + γ A + θ ' M + λ1 F + δ1 nc + δ τ + ε. (8). (9) D Where is he illiquidiy index of domesic firm j from counry c in year, is he illiquidiy index of inernaional firm j from counry c in year, and inernaional firms from counry c in year. 16 A, c is he average illiquidiy raio of he The illiquidiy resuls are consisen wih he earlier findings on migraion and spillovers. Firs, Table 7 Panel A indicaes ha here is a direc posiive impac of inernaionalizaion on a domesic firm s illiquidiy. Pu succincly, inernaionalizaion lowers he liquidiy of domesic firms. Second, Table 7 Panel B provides evidence of liquidiy migraion. nernaionalizaion increases he illiquidiy of inernaional firms in he domesic marke. Pu differenly, inernaionalizaion reduces he liquidiy of inernaional firms. Finally, here is evidence of spillovers. Table 7 Panel A indicaes ha greaer illiquidiy of inernaional firms in he domesic marke is associaed wih greaer illiquidiy of domesic firms. Thus, if he domesic liquidiy of inernaional firms falls, his will lower he liquidiy of domesic firms. Puing hese ogeher, he evidence is consisen wih he view ha an increase in inernaionalizaion reduces he liquidiy of inernaional firms in he domesic marke and his hurs he liquidiy of domesic firms. While he resuls using he illiquidiy index confirm he findings using urnover, we reierae our cauious inerpreaion of hese resuls. Users of price-impac measures of liquidiy frequenly rely on daily or even inra-daily observaions (e.g., Brennan and Subrahmanyam, 1996; Amihud, 00; Hasbrouck, 00). Given daa availabiliy in he EMDB, we are resriced o monhly daa. This may confound he inerpreaion of he illiquidiy index as a precise measure of how much prices change for a given amoun of rading. Neverheless, he consisen findings across he urnover and liquidiy measures ends o suppor he view ha inernaionalizaion reduces he 7

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