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Execution costs, investability, and actual foreign investment in emerging markets

Hee-Joon Ahn (SKK Business School, Sungkyunkwan University, Seoul, The Republic of Korea)
Jun Cai (Department of Economics and Finance, City University of Hong Kong, Kowloon, Hong Kong)
Yan-Leung Cheung (Department of Social Sciences, The Education University of Hong Kong, Tai Po, Hong Kong)

China Finance Review International

ISSN: 2044-1398

Article publication date: 1 March 2019

Issue publication date: 23 March 2020

324

Abstract

Purpose

This paper focuses on execution costs as liquidity measure. Execution costs are related to volatility and are an important component of a firm’s cost of capital. The purpose of this paper is to examine whether emerging market firms have lower execution costs when they face less restrictions on foreign investment and when they have more foreign shareholders.

Design/methodology/approach

The authors begin by documenting the cross-sectional behavior of execution costs. The authors then obtain preliminary evidence on the interaction between execution costs, the investability index and actual foreign investment. These results foreshadow those the authors obtain with the regression analysis. The ordinary least square results show that more investable firms have lower execution costs after the authors control for firm size, stock price, return volatility, industry effects and country effects. This evidence is very robust and highly significant. Direct foreign ownership (FO) in emerging market firms also appear to be associated with lower execution costs. The economic benefit from lowering the investability index on trade execution costs is highly significant.

Findings

Using a large cross-sectional sample from 23 emerging markets, the authors show that firms with more ex ante restrictions on FO, measured by the investability index, have lower execution costs, such as quoted spreads (QS) and effective spreads (ES), after the authors control for firm size, stock price, return volatility, industry factors and country effects. In addition, direct FO in emerging market firms appears to be associated with lower execution costs. However, ex ante restrictions on FO dominate the influence of direct FO. For a 0.5 increase in the investability index in the range of 0–1, the QS will be reduced by 17 percent of the mean QS, and the ES will be reduced by 12 percent of the mean ES from the sample stocks.

Originality/value

There are important differences between the approach and most of the financial liberalization studies. First, whereas most of the earlier studies are conducted at the level of country or market analysis, the investigation is at the level of individual stocks. Second, the authors focus on a cross-sectional association that avoids a criticism leveled at time series analyses. Over-time studies often use specific time points to represent financial liberalization watersheds. This approach can be misleading when financial liberalizations are viewed as processes that unfold over time. Third, the proxies for financial openness are available not only for individual firms across markets, but the authors also make a distinction between potential and actual foreign investment. The authors further categorize actual foreign investment into direct and indirect FO.

Keywords

Acknowledgements

The authors would like to thank Wenfeng Wu, Michael McAleer, Wong Wing-Keung, Lu Huixia, two anonymous referees, and seminar participants at Fudan University, Shanghai University of Finance and Economics, Seoul National University, and 2007 AMF/SEC Conference in Paris, France for helpful comments and suggestions. The authors gratefully acknowledge financial support from the Hong Kong Research Grants Committee GRF Project 140410 and City University of Hong Kong Strategic Grant (SRG 7008142). All errors remain the authors’ own responsibility.

Citation

Ahn, H.-J., Cai, J. and Cheung, Y.-L. (2020), "Execution costs, investability, and actual foreign investment in emerging markets", China Finance Review International, Vol. 10 No. 2, pp. 143-167. https://doi.org/10.1108/CFRI-04-2018-0030

Publisher

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Emerald Publishing Limited

Copyright © 2019, Emerald Publishing Limited

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