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Publisher : Elsevier - Science Direct (الزویر - ساینس دایرکت)
Journal : Journal of Corporate Finance, Volume 12, Issue 3, June 2006, Pages 560–593
This paper examines the link between capital market governance (CMG) and several key measures of market performance. Using detailed data from individual stock exchanges, we develop a composite CMG index that captures three dimensions of security laws: the degree of earnings opacity, the enforcement of insider laws, and the effect of removing short-selling restrictions. We find that improvements in the CMG index are associated with decreases in the cost-of-equity capital (both implied and realized), increases in market liquidity (trading volume, market depth, and U.S. foreign investments), and increases in market pricing efficiency (reduced price synchronicity and IPO underpricing). The results are quite consistent across individual components of CMG and over alternative market performance measures.
In an increasingly integrated global economy, interest in (and awareness of) good capital market regulation is on the rise. While presumption of the damaging effects of bad market governance is widespread, direct evidence on its economic consequences has been more difficult to document. Contributing to this problem is the elusive nature of governance. Because the quality of capital market governance can be associated with a number of other country-level phenomena, its direct impact on the performance of stock markets may be difficult to isolate. In this paper, we examine how capital market regulations and their enforcement might affect a wide range of market performance measures. We focus on exchange-based (or market-related) regulations, and coin the term capital market governance (CMG) to describe this aspect of a country's regulatory environment. Using detailed data collected from individual exchanges for the period 1969–1998, we construct a composite CMG index that varies over time, thus reflecting inter-temporal variations in the quality of market governance in each country. We then examine the relation between changes in the CMG index and changes in market performance across countries. Our study consists of two stages. In the first stage, we use a unique data set gleaned from market regulators, exchange officials, and industry contacts, to construct a broad index of capital market governance. Specifically, we exploit innovations developed in several recent studies to measure three dimensions of capital market governance: (1) a composite earnings opacity measure, (2) insider trading laws and their enforcement, and (3) relaxation of short-selling restrictions. Fig. 1 provides an overview of these market governance variables. Full-size image (46 K) Fig. 1. Capital market governance measures. Figure options In the second stage, we evaluate the impact of CMG on key dimensions of market performance. Specifically, we use seven empirical proxies to capture three aspects of market performance: (1) Cost-of-capital (both implied and realized); (2) Market liquidity (including trading volume, market depth, and foreign ownership by U.S. investors); and Pricing efficiency (including price synchronicity and IPO underpricing). Fig. 2 offers an overview of these performance measures and our empirical proxies. Full-size image (57 K) Fig. 2. Market performance measures and their empirical proxies. Figure options Our goal is to gain an overarching perspective on how changes in security laws can affect the returns shareholders demand, their willingness to trade, and the efficiency with which prices incorporate information. Securities laws cover a wide spectrum of areas, including the distribution of securities, takeovers, stock market manipulations, insider trading, stock exchanges, and the activities of financial intermediaries. We focus on three aspects of these regulations: earnings opacity, insider laws, and short-selling restrictions. We examine how these laws individually affect a wide set of market performance metrics, and we evaluate their combined effect using a CMG index. A distinguishing feature of this study is the range of market performance measures we examine. Prior studies have typically focused on the effect of individual laws on one or two aspects of market performance—e.g., the role of accounting disclosure laws on the cost-of-capital. However, regulatory decisions can hinge on potential trade-offs across different market performance metrics (e.g., the trade-off between pricing efficiency and market liquidity in the insider trading law debates). From a policy perspective, it is important to know how regulatory changes might affect multiple aspects of market performance.1 Our strategy is to examine several key dimensions of market performance, using multiple empirical proxies for each. For example, in estimating changes in the cost-of-capital, we use both an implied approach based on discounted cash flow models (Bekaert and Harvey, 2000 and Lee et al., 2003), and a more traditional international asset pricing approach based on realized returns. In measuring market liquidity, we examine changes in trading volume, market depth (volume scaled by volatility), as well as U.S. foreign investment. Finally, in examining pricing efficiency, we use both a Morck et al. (2000) synchronicity measure, and a measure of the degree of underpricing in IPO offerings. While none of these individual proxies might fully capture the underlying economic construct, the consistency of our results across multiple methods adds to their interpretability. To deal with the empirical challenge posed by country-level correlated omitted variables, we designed our tests to capture inter-temporal changes in a country's securities laws. By estimating most of our models with fixed-country effects, we use each country as its own control. We are thus able to isolate inter-temporal fluctuations in the CMG index, and evaluate the effect of changes in a country's CMG index on changes in its cost-of-equity, market liquidity and pricing efficiency over time. 2 We find that after controlling for other factors, improvements in the CMG index are associated with economically significant decreases in the cost-of-equity capital. The estimated economic magnitude of the effect is similar across the two cost-of-capital measures—using the implied estimation method, the cost of equity decreases by 2.6% per standard deviation increase in CMG; using the average realized returns from an international asset pricing model, the effect is 2.9% per standard deviation increase in CMG. While not all three components of the CMG index are individually significant in every regression specification, the directional inferences are always the same: improvements in earnings opacity, insider trading, and short-selling laws result in lower costs of capital. In addition, we find that improvements in the CMG index are positively correlated with three measures of market liquidity. Specifically, improved CMG is associated with increases in trading volume, market depth (i.e., volume divided by volatility), as well as the level of U.S. stockholdings (suggesting that countries with improving governance laws attract more U.S. investors). Once again, all three components of the CMG index contribute to these overall results. The directional inferences are consistent for the earnings opacity, insider trading, and short-selling variables, even when each is individually included in the same regression. Finally, we find that the CMG index is negatively correlated with pricing synchronicity (Morck et al., 2000) and the amount of IPO underpricing, after controlling for a host of other factors. These results suggest that improved CMG increases pricing efficiency. Detailed analysis indicates that the pricing efficiency results are driven primarily by the insider trading and short-selling variables, with earnings opacity playing a lesser role. Overall, our findings support the view that improved capital market governance is associated with lower costs-of-equity capital, increased market liquidity, improved price efficiency, and increased stock ownership by U.S. investors. We find little evidence that the improvements in each of the three market performance attributes come at the expense of the other two. To the extent that market regulators find the directional changes we document desirable, the prescriptive implications are unambiguous.
نتیجه گیری انگلیسی
This paper explores the link between capital market governance (CMG) and market performance in a broad cross-section of countries. We use variables related to three dimensions of capital market governance-earning opacity, enforcement of insider trading laws, and short-selling. We combine these three dimensions to obtain an overall capital market governance time-series measure per country. We then examine the association between changes in CMG and changes in: (1) the cost of capital (both realized and implied); (2) market liquidity (i.e., trading volume and market depth), and U.S. foreign stockownership); and (3) pricing efficiency (i.e., stock price synchronicity and IPO underpricing). We document in our tests that, after controlling for other influences, an increase in overall capital market governance in a country is linked to a decrease in the cost of equity, an increase in market liquidity, and an increase in pricing efficiency. Specifically, improved security laws are associated with decreased cost of capital, higher trading volume, greater market depth, increased U.S. ownership, lower price synchronicity, and reduced IPO underpricing. These results hold for the overall CMG index, and are directionally consistent for each of the three individual CMG components. We believe our analyses have important implications for investors, securities regulators and financial academics. Collectively, our evidence points to the importance of security laws to the proper functioning of stock markets. Specifically, our results indicate that increased enforcement of insider trading laws, improved accounting standards (through more stringent auditing and disclosure standards) and a relaxation of short-selling constraints are all associated with market performance. Specifically, improvements in these CMG variables lead to decreases in the cost of capital, increases in market liquidity, and increases in market pricing efficiency. In general, the magnitude of these relations suggests they are economically and statistically important. These findings are consistent with the view that investors associate bad capital market governance with increased risk. Specifically, our findings suggest heightened investor concerns over capital market governance can prompt investors to reduce their trading activity and demand greater premiums for holding equity securities. Interestingly, we also find that bad security laws result in lower market pricing efficiency. To the extent that regulators prefer lower costs of capital, greater market liquidity, and improved pricing efficiency, the prescriptive implications of our results are unambiguous.