sJY?o 0 POLICY RESEARCH WORKING PAPER 3 046 Migration, Spillovers, and Trade Diversion The Impact of Internationalization on Stock Market Liquidity Ross Levine Sergic L. Schmukler The Wor'd Bank :Development Research Group U Macroeconomnics and Growth .Vay 2003 POLICY RESEARCH WORKING PAPER 3046 Abstract What is the impact of firms that cross-list, issue international firms migrates from domestic to depositary receipts, or raise capital in international stock international markets and the reduction in domestic markets on the liquidity of remaini ig firms in domes:ic liq uidity of 'nternational firms has negative spillover markets? Using a panel of over 3,200 firmrs from 55 eff:cts on do nesric firm liquidity. Second, there is trade countries during 1989-2000, Levine and Schmukler find diversion wit lin domestic markets as liquidity shifts out that internationalization reduces th 'liquidity of domestic of domestic firms and into international firms. firms through two channels. First, the trading of This paper-a product of Macroeconomics and Growth, Devclopment Rescarch Group-is part of a larger effort in the group to understand the effects of financial globalization. Copies o the paper are available free from the World Bank, 1818 H Street NW, Washington, DC 20433. Please contact Emi y Kline, room 0C3-301, telephone 202-473-7471, fax 202- 522-3518, email address kkhine(cfworldbank.org. Policy Rescarc1 Working Papers are also posted on the Web at http:// econ,worldbank.org. The authors may be contactcd at -lcvineCoicso n.u nn.edu or sschmukler@cbworldbank.org. ,May 2003. (40 pages) The Policy Research Working Paper Series disse;,iinates the findings of work in prvXress to encoturage the exchange of ideas abovt development issues. An objective of the series is to get the fadings out qtnckly, even if t 'e presentations are less than fully polished. The papers carry the names of the authors and should be cited accordingly. Tr,he findings, ii terpretations, and conclusions expressed ir this paper are entirely those of the autthors. They do not necessarily represent the hiew of the WVorld Bank, its Exectutive Directors, or the countries they represent. Producud by the Rcs2arch Ad"isory Staff Migration, Spillovers, and Trade Diversion: The Impact of Internationalization on Stock Market Liquidity Ross Levine and Sergio L. Schmulcer JEL classification codes: G15, F36, F20 Keywords: international finance; internationalization; stock markets; liquidity; cross-listing; depositary receipts; ADRs; GDRs Levine: University of Minnesota and the NBER (rlevine@csom.umn.edu). Schmukler: World Bank (sschmukler@worldbank.org). We thank Tatiana Didier for truly outstanding research assistance. We received very helpful comments from Gordon Alexander, Luca Benzoni, Stijn Claessens, Valery Polknichenko, Helene Rey, and Frank Warnock. For help with the data, we are grateful to Pamela Dottin, Monica Erpen, Dori Flanagan, Angela Marshall, Richard Webster-Smith, and Cheryl Workman. Levine is grateful for generous financial support from the BSI Gamma Foundation. Schmukler thanks the World Bank Latin American Regional Studies Program and Research Support Budget for financial support. I. Introduction This paper assesses the question: what is the impact of firms that participate in international stock markets on the liquidity of the remaining firms in the domestic stock market? An extensive literature examines "intemational firms," the firms that participate in international markets by issuing depositary receipts, cross-listing, or raising new capital (e.g., Alexander, Eun, and Janakirananan, 1987, 1988; Foerster and Karolyi, 1998, 1999, 2000; Miller, 1999; Doidge, Karolyi, and Stulz, 2002; and the review by Karolyi, 1998). This paper, instead, focuses on the impact of internationalization on "domestic firms," the firms that do not internationalize. Theory provides conflicting predictions about the impact of internationalization on the liquidity of domestic firms. Consider first the "migration and spillover" argument. According to the migration view, internationalization will induce a shift in the trading of international firms out of the domestic market and into international markets. This may occur because foreign markets have lower transaction costs and are more liquid (Chowdhry and Nanda, 1991). "Spillovers" means that a drop in the domestic trading of international firms hurts the liquidity of domestic firms.' This could occur because of fixed costs associated with operating a market, running brokerage firms, clearing and settling transactions, etc. Thus, a drop in the domestic trading of intemational stocks increases the per trade cost of domestic stock transactions. Liquidity spillovers could also occur if investors shift their trading to international markets. For example, investors may seek to diversify country-specific risk. Thus, when some firms cross-list or issue depositary receipts in international markets, investors may attain country-specific diversification through these liquid international markets and therefore reduce their trading in Chordia, Roll, and Subrahmanyam (2000) argue that liquidity is more than an attribute of a single security. Individual liquidity tends to co-move with market liquidity. 1 domestic markets.2 This involves a shift out of trading domestic stocks on domestic exchanges and into trading internationalized stocks on international exchanges. Combined, migration and spillovers imply that internationalization reduces the domestic liquidity of international firms due to migration, and the resultant drop in aggregate domestic liquidity reduces the liquidity of domestic firms due to spillovers. Some disagree with the migration and liquidity spIlover view and instead argue that internationalization improves domestic market liquidity. In contrast to the migration view, Hargis (2000) argues that cross-listing can transform a segmented equity market with low liquidity into an integrated market with high liquidity. Similarly, Alexander, Eun, and Janakiramanan (1987) and Domowitz, Glen, and IvIadhavan (1998) hold that internationalization may actually stimulate domestic trading of international firmis due to the increased integration of markets. Also, if internationalization increases transparency, this could increase the domestic trading of international firms with positive spillover effects for the rest of the domestic market. Other skeptics of the migration spillover view could question the existence of liquidity spillovers, or doubt the economic importance of the impact of aggregate trading on the liquidity of domestic firms. Thus, it is an empirical question as to whether internationalization induces migration and spillovers, or whether intemnationalization boosts the liquidity of domestic firms. Second, consider the "domestic trade diversion" view, which argues that internationalization induces a compositional shift in dornestic market trading. Firms that internationalize may become more attractive to those trading in domestic markets because of improvements in reputation, higher disclosure staLndards, the availability of more analysts that generate more information, and the expansion of the shareholder base in the context of 2 Ahearne, Griever, and Warnock (2003) and Edison and rnamock (2003) show that U.S. investors focus on firms that have intemationalized. 2 segmented markets.3 Thus, traders in the domestic market may shift their trading out of domestic firms and into the domestic trading of intemational firms. All else equal, this domestic trade diversion implies less trading of domestic firms and greater trading of intemational firms in the domestic market. However, some theories conflict with the trade diversion view and instead argue that intemationalization may enhance integration and thereby boost liquidity of domestic firms (e.g., Alexander, et al., 1987; Domowitz, et al., 1998; Hargis, 2000). This could occur because integration increases the liquidity of all firms in the local markets. Moreover, integration may induce a compositional shift in domestic market liquidity toward domestic firms as the trading of intemational firms migrates abroad. Again, theory provides conflicting predictions about the impact of firms that choose to intemationalize on domestic firms. To study the effects of intemationalization on domestic liquidity, this paper uses information on 3,253 domestic firms and 640 intemational firms across 55 emerging market countries during the years 1989 to 2000. To measure liquidity, we use the turnover ratio, which equals the value of a firm's transactions in a market divided by the market capitalization of the firm in the domestic market. We use transactions data because bid-ask spreads are unavailable for our large panel of countries. The paper first examines the direct impact of intemationalization on the liquidity of domestic firms. Using annual, firm-level data, we regress the liquidity of domestic firms on the share of intemational firms in the domestic market as well as country and year dummy variables. While we cannot eliminate the possibility that an omitted factor is driving the results, we can control for an array of firm-specific and country specific traits. We do a variety of robustness checks controlling for firm-specific characteristics (such as finn size, sales, firm profits, the 3 See, Baker, Nofsinger, and Weaver (2002), Coffee (1999), Lang, Lins, and Miller (2002), Merton (1987), Portes and Rey (1999), and Reese and Weisbach (2001). Also, Bailey, Karolyi, and Salva (2002) find that eamings releases impact the price and volume of intemational firms significantly more than domestics firms. 3 firm's industry etc.) and various country-specific factors (e.g., trading of that country's shar,zs on international exchanges, economic development, legal system efficiency, international capital flow openness, inflation, etc.). The results are consistent across numerous specifications. The data indicate that as more firms become international, this lowers the liquidity of domestic firms. This result is robust to controlling for numerous firm-specific and coumtry- specific traits. These initial results, however, do not shed light on the mechanisms through which internationalization hurts the liquidity of domestic firms. Next, the paper studies the channels through which international firms affect the liquidity of domestic firms. We study both the (1) migration and liquidity spillover channel and (2) the domestic trade diversion channel. Thus, we seek to explain the mechanisms through which internationalization influences the liquidity of domestic firms. To study the migration and liquidity spillover channel, we (a) assess whether the trading of international firms migrates from domestic to international markets and (b) test whether the domestic trading of international firms influences the liquLidity of domestic firms. We, find evidence of migration: as the fraction of international fimis rises, the trading of international firms shifts from domestic markets to international markets. That is, as more firms internationalize, domestic liquidity of international firms falls. Furthermore, we find evidence of liquidity spillovers. The domestic trading of international shtares is strongly, positively related to the liquidity of domestic firms. Thus, the data are consistent with migration and spillover view: as the liquidity of international firms in the domestic market dries up because of migration, the liquidity of domestic firms diminishes because of spillovers. The migration and liquidity spillover channel, however, is not the only mechanism through which internationalization hurts the liquidity of domestic firms. In particular, we find 4 that internationalization is negatively associated with the liquidity of domestic firms even after controlling for the migration and spillover channel. Thus, we need to look beyond migration and spillovers to understand fully the impact of internationalization on the domestic market. Finally, we examine the domestic trade diversion channel. The data suggest that as firms internationalize, the domestic market intensifies its trading of those international shares, while trading of firms that do not internationalize wanes. This does not overturn the result mentioned above: internationalization reduces the domestic liquidity of international shares. This result is consistent with theories that emphasize that when a firm internationalizes this enhances its reputation, transparency, and shareholder base in ways that make it more attractive relative to domestic firms. In sum, domestic trade diversion is another mechanism through which internationalization reduces the liquidity firms that do not internationalize. This paper's assessment of the impact of internationalization on the liquidity of domestic firms is related to, though distinct from, a large literature on internationalization. First, some research analyzes the impact of market integration on economic growth, investment, and asset pricing.4 In this paper, we do not focus on financial integration broadly defined. Rather, we examine the impact of the decision of one set of firms to cross-list, issue depositary receipts, or raise capital abroad on the liquidity of the domestic firms that do not internationalize.5 Second, an extensive literature studies the effects of internationalization on international firms. Some papers examine the volume and liquidity of international firms in local markets after firms cross- list or issue depositary receipts.6 Other researchers study the impact of intemationalization on 4 See Bekaert and Harvey (1995, 2000), Bekaert, Harvey, and Lundblad (2001, 2002), Henry (2000), Levine and Zervos (1 998a,b), and Martin and Rey (2000). 5 Various publications voice concerns of markets becotming illiquid (e.g., Bovespa, 1996; Financial Times, 1998; and Latin Finance, 1999; The Economist, 2000; and the Federation des Bourses de Valeurs, 2000). 6 See Foerster and Karolyi (1998, 2000), Hargis (1998), Noronha, Sarin, and Saudagaran (1996), and Pulatkonak and Sofianos (1999). 5 stock prices, the cost of capital, and growth opportunities.7 A related line of research analyzes the effect of internationalization on asset size, growth, fnancing constraints, and the financial structure of firms that issue depositary receipts or cross-list.8 Although in the course of our research we assess the impact of the liquidity of international firms on the domestic liquidity of those intemational fimns, the focus of our researchl is different. We concentrate on examining the impact of internationalization on the liquic[ity of domestic firmns. Only two previous studies examine specifically th. effects of intemationalization on domestic firms. Moel (2001) finds a negative association between the fraction of a country's stocks that issue American depositary receipts (ADRs) and domestic market liquidity. Karolyi (2003) also finds a negative link between ADRs and domestic market size and liquidity. This paper contributes to the literature on internationalization and the liquidity of domestic stocks in a number of ways. First, this is the first paper to dissect the channels through which intemationalization influences the liquidity of domestic stocks. Thus, we evaluate the importance of the migration/spillover channel and the trade diversion channel. Second, in examining the potential channels through which internationalization influences domestic stock liquidity, we examine the impact of firms that internationalize on both (a) the trading of international firms in the domestic market and (b) the liquidity of domestic firms. Thus, besides contributing to the recent literature on the effects of internationalization on domestic firms, we also use our new database to augment the more established literature on international firms. Third, we substantially expand the sample size. Our data cover 55 countries, which almost doubles the number of countries used in previous studies (e.g., Moel, 2001, examines 28 7 See Alexander, Eun, and Janakiramanan (1988), Demirguc-Kunt and Maksimovic (1998), Ernunza aned Miller (2000), Foerster and Karolyi (1993, 1999), Miller (1999) and Stulz (1999). 8 See Claessens, Klingebiel, and Schtnukler (2002a), Pagano, Roell, and Zechner (2002), and Schmukler and Vesperoni (2001). 6 countries and Karolyi, 2003, studies 12). Fourth, we extend the coverage of the internationalization process by moving beyond the ADR market in New York. Specifically, we compile data on capital raisings that include global depositary receipts, cross-listings, and private placements in other international markets. Thus, we can more precisely classify companies as international or domestic. Fifth, we collect information on the international trading activities of international firms. That is, we do not simply examine whether a firm is listed abroad or not; we incorporate time-vary trading data. This has two advantages: (a) we control for country-specific news that influences global trading of that country's shares and (b) we assess how the time- varying extent of internationalization impacts domestic markets. Sixth, we control for firm specific characteristics, including firm size and other traits, to isolate the marginal impact of intemationalization on firm liquidity while holding firm-specific factors constant. Finally, we stress a limitation of this paper's analyses. We find that internationalization reduces the liquidity of domestic firms. We do not, however, examine the net effect of internationalization (Hargis and Ramanlal, 1998). Specifically, many researchers show that internationalization benefits those firms that choose to internationalize. Furthermore, research finds that domestic market liquidity is important for the cost of capital, firm performance, and economic growth.9 Thus, if internationalization helps international firms and hurts domestic firms, a critical question emerges: what is the net effect for the domestic economy of firms that cross-list, issue depositary receipts, or raise capital abroad? We leave this for future research. The rest of the paper is organized as follows. Section II discusses the data. Section III presents the results. Section V concludes. 9 See Amihud and Mendelson (1986), Demirguc-Kunt and Maksimovic (1998), Levine and Zervos (1998a), and Beck and Levine (2003). 7 II. Data To assess the impact of internationalization on domestic stocks, we need the following data: 1. firm-level data on the international equity activities of firms, including a. dates of capital raisings, cross-listing, and depositary receipts, b. international trading data, 2. firm-level data on domestic stock transactions, 3. firm-level data on a range of firm altributes, and 4. country-specific data on macroeconomic, institutional, and financial conditions. An important contribution of this paper is that we collect considerably more data on the international equity market activities of companies than past studies. The data for identifying each firm's international activities come from two main sources: the Bank of New York and Euromoney. Besides the Bank of New York's standard database (the Complete Depositary Receipt Directory) that contains informnation on current depositary receipt activities, the Bank of New York gave us access to their historical databases and reports on (i) depositary receipt program initiation dates, (ii) termination dates (if any), (iii) capital raisings, and (iv) trading activities. These data form a comprehensive database on American ancl Global depositary receipt programs. The historical data start in January 1956, but the vast majorilty of programs begin after 1980. We augment the information on dating the initiation of international equity market activities with data from Euromoney. They provide the dates when firms raise equity capital in international capital markets, including cross-listings and issuance of global depositary receipts. Thus, the Euromoney data substantively enhances our ability to identify firms that internationalize. The Euromoney database covers 8,795 cross-border equity issuance and cross- listing operations from 5,665 firms in 86 countries over the period January 1983 - April 2001. In terms of trading, we had access to data irom the London and Frankfurt Stock Exchanges (LSE 8 and FSE respectively) on the trading of depositary receipts and cross-listed firm. However, LSE trading data for these firms do not begin until 1997 and the data for the FSE do not start until 1999. Thus, they cannot be usefully incorporated into our panel studies that trace the impact of internationalization on the liquidity of domestic stocks and also assess the dynamic effects of trading in international markets on the domestic market. Thus, consistent with existing studies, we do not include LSE and FSE trading data. This will underestimate the amount of trading abroad, but this is unlikely to bias systematically the results in a particular direction. See Claessens, Klingebiel, and Schmukler (2002b) for a description of some trends on the internationalization of stock markets as well as their relation to country characteristics. Consistent with our objective of assembling a broad database on internationalization, we classify firms as international if they (1) issue depositary receipts, (2) cross-list, or (3) raise capital through private placements abroad. The first two clearly involve ongoing trading of domestic stocks in foreign countries. However, raising capital through private placements is different because the new shares are not necessarily traded abroad. Thus, the issuing of depositary receipts and cross-listing may involve the two potential channels discussed in the Introduction: migration/spillovers and trade diversion. Raising capital abroad in the absence of cross-listing, however, will only potentially involve trade diversion in the domestic market since simply raising capital abroad cannot induce migration. As noted below, we confirm this paper's findings with various sub-samples. The firm-level domestic stock market trading data are from the Standard & Poor's Emerging Markets Data Base (EMDB), which was formerly collected by the International Finance Corporation. In cross-checking with country sources, the EMDB is very accurate, but for Argentina, we discovered that the EMDB information is inconsistent over time. Thus, unlike 9 previous studies, we circumvent this problem by collecting the data directly from the Buenos Aires Stock Exchange. The EMDB provides data on domestic market capitalization and domestic value traded in current U.S. dollars by firm. Although the EMBD is the most comprehensive database on firm-level trading of equities around the world, the EMDB focuses mostly on emerging markets and does not include 1]00 percejnt of local firms (e.g., while varying by country, the EMDB typically covers about 70 percent of market capitalization). We also use balance sheet data on each faim to control for firm-specific characteristics that may influence liquidity. Thus, we control for industr) effects, firm size effects, and firm sales in assessing the impact of internationalization on the liquidity of firms in the domestic market. For simplicity, in the results discussed below, we present the results controlling for firm size, but the results are robust to controlling for the other fium-specific effects. We obtain these data from the Worldscope database (Thomson Financial Company). The firm-level data on domestic stock market trading, the firm-level balance sheet information, and international equiity activities are all matched at the firm level over the period 1989-2000. Appendix Table I lists the 55 countries in the s-tudy and the number of domestic and intemational firms per country, as well as surnmary statistics of the main variables under study. In total, we have over 18,000 firm-year observations. Appendix Table 2 provides additional information on data sources.10 As a robustness check, we also control for country-specific infornation. Data are from the World Bank's World Development Indicators. Data on the efficiency of each country's legal system are obtained from the Intemational Country Risk Guide (Political Risk Services). Information on official restrictions on intemational capital flows is from the International ° Note, that some countries in our sample do not have any international frrms. We keep these in the sample as a control sample. Importantly, we confirm this paper's results when we eliminate countries with zero or only one international firm. 10 Monetary Fund's Annual Report on Exchange Arrangements and Exchange Restrictions. In additional tests, we control for economic growth, inflation, real interest rates, terms of trade changes, time trend, and altemative measures of capital account openness that we describe below. Although our data have the limitations noted above, the database has several advantages over previous work. First, the data cover 55 countries, which - as we noted earlier - almost double the number of countries used in previous studies and increase the power of our tests. Second, our dataset includes information on the intemational equity market activities of firms beyond depositary receipts in New York. We collect information on issuance of equity, including cross-listing, in major financial markets. Thus, we can much more accurately identify which firms have intemationalized. Third, we collect information on the intemational trading activities of each firm with a depositary receipt program. Thus, in assessing the impact of intemationalization on domestic market liquidity, we move beyond considering whether a company has intemationalized or not. By incorporating time-vary trading data, we can assess the dynamic effects of intemationalization. III. Methodology and Results This section empirically examines the impact of international firms, those that issue depositary receipts, cross-list, or raise new capital abroad, on domestic firms, those that do naot internationalize. To do this, we first exarrine whether internationalization has a direct effect on the liquidity of domestic firms? Second, we examine whether internationalization affects domestic liquidity through the migration and spillover channel. Third, we test whether internationalization influences the liquidity of domestic firms through trade diversion. A. Direct Effect 1. Method To examine whether intemationalization is directly related to the liquidity of domestic equities, we estimate the following regression using feasible generalized least squares with standard errors that are robust to heteroskedasticity. T7,c, = r1 xISs,, + r2 xIT,,, + M,,+A x FJC,, +5 xn, +52 X VI +e (1) CiS the turnover ratio of domestic fim j in country c in year t, which equals the total value of trades of firm j's stock during year t divided by firm j's market capitalization.'1 The superscript D designates that it is a domestic firm during the entire sample period, i.e., it never intemationalizes. We define the dependent variable in this wvay because we want to examine the effects of internationalization on the firms that rely on the domestic market throughout the sample period. By focusing on those firms that never access international capital markets, we test how their liquidity changes as other firms intemationalize. In all regressions, we control for t Since in some cases the value traded is zero, we use the natural logarithm of one plus the turnover ratio in the regressions. An altemnative measure of liquidity is the number of shares traded in one year divided by the number of shares outstanding. This alternative abstracts from price changes. But, it is impossible to usefully aggregate across different stocks to obtain country-level liquidity measures using this alternative measure. 12 country and time effects (n, and r, respectively), but do not report these in the tables to save space. IS,, is the share of international fimns in country c at time t. Thus, IS,, is the number of international firms from country c at time t divided by the total number of firms listed in the domestic market for country c at time t. In computing IS,,, , a firm is considered an intemational firm from the year it issues a depositary receipt, cross-lists, or raises capital abroad. If, however, the firm terminates its depositary receipt listing or de-lists from an international exchange, then the numerator of IS,, falls by one.12 IT7', is the aggregate turnover ratio of country c's international firms in international equity markets at time t. Thus, IT7', equals the aggregate value traded of all of country c's intemational firms in international markets divided by the market capitalization of those intemational firms. We include the variable ITi' because we want to control for trading of country c's equities on international exchanges. Information about a country's political and economic conditions may induce trading of that country's stocks in both intemational and domestic markets. This effect would be captured by a positive coefficient on IT7',. To assess the independent impact of the share of firms in a country that are international on domestic liquidity, we seek to abstract from time-varying country specific factors influencing trading. Hence, we include the trading of country c's stocks in intemational markets in regression (1). Mc, is a matrix of macroeconomic and country-specific control variables. We include gross domestic product (GDP) per capita since the level of economic development may influence 12 Since firms can list abroad without listing in the domestic mnarkets, this ratio could, in theory, be larger than one. 13 financial markets development (Levine, 2003). 'We also inc lude an index of the law and order tradition of the economy since the operation of legal systems may influence equity market development (Beck, Demirguc-Kunt, and Levine, 2003; La Porta, Lopez-de-Silanes, Shleifer, and Vishny, 1998). Furthermore, we corttrol for the openness of the capital account to international capital flows (using data from the International Monetary Fund) since international financial integration may influence the liquidity of domestic equity markets (Bekaert, Harvey, and Lundblad, 2001, 2002). We incorporate the macroeconomic and country-specific control variables because we want to assess the independent impact of intemationalization on domestic liquidity. Toward this end, we examined a variety of additional country-specific factors in robustness checks as discussed below. Fj;,C includes firm-specific characteristics in country c during year t. We control for company level traits to assess the independent irrmpact of intemationalization on the trading of firms in the domestic market. In the tables, we include the logarithm of the total assets in U.S. dollars. In robustness checks, we control for many other firn characteristics. 2. Results on the direct effect Contrary to a variety of theoretical models discussed in the Introduction, the Table 1 results indicate that internationalization Ls negatively associated with the liquidity of domestic firms. In particular, the coefficient on the share of intemational firms in country c at time t, yl, is negative and significant at the one-percent level across all of the specifications that control for different combinations of regressors. In terms of the other regressors, we do not find a strong link between the trading of intemational firms in international markets and the liquidity of domestic stocks. Put differently, trading of country c's international stocks on international exchanges ( IT7') is not robustly related with the liquicty of domestic stocks. Also, rich countries and countries with a strong law and order tradition tend to have domestic firms with greater liquidity. Finally, we see that the variable, total assets, enters with a negative coefficient. The reason for the negative coefficient is that total assets is closely linked with market capitalization, which is the denominator of the dependent variable. As we will see below however, when we compare the trading of stocks within a country, the equities of bigger companies trade more than those of smaller companies. In sum, as the share of international firms in an economy rises - i.e., as the fraction of firms in an economy that issue depositary receipts, cross-list, or raise capital abroad rises, the liquidity of remaining firms falls. The adverse impact of internationalization on the liquidity of domestic firms is not only statistically significant; it is economically relevant. For instance, consider the last regression coefficient based on the regression with all of the regressors included (-2.2). This estimate implies that a two-standard deviation increase in the share of international firms (0.086) will cause the liquidity of domestic firms to fall by -0.19. This is substantial given that the mean value of the liquidity of domestic firms (TjDC) iS 0.50.'1 Some caution, however, is needed in interpreting these initial results. Some may argue that the results simply reflect the possibility that firms that internationalize are good firms and firms that do not internationalize are comparatively poor. While potentially true, this would not negate the value of the Table 1 results. First, some theories discussed in the Introduction suggest that internationalization boosts domestic liquidity by making markets more integrated. We find no evidence for this. Second, we confirm the Table 1 results when controlling for many firm- specific traits (as discussed below). Thus, even when controlling for firm quality, we get the same result. Third, the argument that bad firms remain domestic does not necessarily predict 13 Of course, this type of experiment is only for illustrative purposes. Two standard deviations is not a marginal change and we do not specify what drives the change in internationalization. 15 that trading in those firms will diminish as good firms become international, which is what we find in Table 1. Fourth, we obtain the same results even whern we restrict the sample to firms that trade for the entire sample period. Thus, uncompetitive finrms that lose liquidity and drop out of the sample do not drive the results. Fifth, as we show below, the results indicate that the liquidity of intemational firms in the domestic market falls with internationalization, which is inconsistent with a simple story that international firm liquidity thrives while domestic firm liquidity falls. An additional weakness with the results thus far is that we do not provide information on the mechanisms linking internationaliz.ation to dDmestic firm liquidity. Although regression (1) provides information on the direct impact of interaationalization on the liquidity of domestic firms, it does not provide information on the channels through which intemationalization affects the liquidity of doimestic firms. We turn to this now. B. Miaration and Liquidity Spillover Channel The migration and liquidity spillover view predicts a two-stage channel through which internationalization may influence the liquidity of domestic stocks. First, internationalization may reduce the domestic trading of international firms as the trading of intemational finns migrates to more liquid, lower cost international markets. Second, the reduction in trading of international firms in domestic markets because of migration may hurt the liquidity of domestic firms because of liquidity spillovers. Taken together, migration and liquidity spillovers provide a theory of how internationalization might reduce the liquidity of domestic firms. As discussed in the Introduction, theoretical debate exists on each of these two mechanisms that define the migration and spillover channel. We assess empirically each of-these channels. 16 1. The migration part of the migration and liquidity spillover channel To examine the migration component of the migration and liquidity spillover channel we use three different regression specifications. Consider first the simple specification that assesses the impact of internationalization on the domestic liquidity of international firms. T = Y1 xISC, +2 xIxT,, +'MC xF +AxFx,C, x +5 xnC + 32 X + Ct. (2) T' t is the turnover ratio of international firm j in country c in year t. The superscript I designates that it is an international firn, which is a firm that has either issued a depositary receipt, cross-listed, or raised capital abroad at some point in the sample. Thus, the definition of an international firm in equation (2) is consistent with the definition of domestic firms in equation (1). In these first analyses, we simply split the sample between firms that never internationalize and firms that become international at some point in the sample. Below, we will assess the impact of an individual firm's decision to internationalize on its liquidity within the domestic market. ITj§V is the aggregate turnover ratio of country c's intemational firms in international equity markets at time t, excluding the trading of company j. The other variables are the same as those in equation (1). Table 2 provides strong evidence that internationalization exerts a negative impact on the domestic liquidity of international firms. The coefficient on IS,, always enters significantly and negatively. As in Table 1, we control for the international trading of international firms (IT ,). We do this to control for other factors influencing the trading of that country's equities. ITV enters positively, though in some specifications only at the ten-percent level, which indicates a positive link between the trading of a country's stocks abroad and the trading of those 17 international firms in the local market. In suin, after controlling for many factors, we find that as a country's firms internationalize this negatively influences the domestic liquidity of international firms. The second regression we use to examine the migration component of the migration and liquidity spillover channel controls for the domestic liquidity of international firms in addition to the international liquidity of intemational firrns. Thu,s, to assess the independent impact of the share of international firms in a country on the dornestic liquidity of individual international firms we now control for the aggregate liquiclity of international firms in both international and domestic markets. Specifically, we estimate equation (3). T11, =y,xIS,, +y2xITV, i + XTJ! +±>'MCz + >(Fj, +S x C +S2, x +E,j,. (3) TI _ _ __JC, 'I A eCt, is the aggregate domestic tumover ratio of international firms, respectively, excluding the trading of company j. Table 3 shows that internationalization lowers the domestic liquidity of international firms, i.e., there is a negative and significant coefficient on ISC, . Thus, even when controlling for many factors, the domestic liquidity of international firms falls as the share of firms in the economy with intemational equity market operations rises. The Table 3 results also provide some preliminary evidence on spillovers. The coefficient on TV enters positively and significantly. Thus, aggregate trading of international firms in the local market positively influences the trading of individual intemational firms in the local market. We examine liquidity spillovers in greater depth below. 18 The third regression we employ to test for migration examines the relative trading of an international firm in international and domestic markets. Thus, we examine whether the fraction of trading of an international firm shifts from domestic to international markets as more firms internationalize. So far, we have examined the impact of internationalization on the level of the domestic trading of intemational firms. But the domestic liquidity of international firms can be influenced by several factors, including how attractive an international company is relative to other companies. Therefore, a more direct method for studying migration is to analyze the share of the company's liquidity in the domestic market relative to its total liquidity. Thus, we estimate the following regression for international firms. T' T' +It'= Y, xISc + Y2 xITI, + /3xTJI/,+ O'Mc, +-t XAF,, + .i- xnC + -2 xr, + cj,,, * (4) T.c j,T!cS, JC The dependent variable in this equation measures the level of domestic liquidity of firm j relative to firm j's total liquidity, which includes the domestic liquidity of firm j and the international liquidity of firm j. Since the market capitalization is the same in the numerator and denominator, this measure is equivalent to using the ratio of value traded in the domestic market to total value traded. Importantly, we control for the aggregate liquidity of country c's international firms, excluding firm j ( ,' ). Thus, we control for the aggregate liquidity of firm j's markets when assessing the impact of intemationalization on whether the trading of firm j shifts abroad. Table 4 presents regressions that are consistent with migration. There is a negative and significant coefficient on ISct . This indicates that internationalization (an increase in the proportion of intemational firms in the domestic market) reduces the proportion of trading of international firms in domestic markets. As above, we control for many factors, including the 19 liquidity of country c's stocks (IT, in international markets and also the domestic liquidity of country c's international firms (Ti', ) Table 4 also provides evidence consistent with tdhe existence of liquidity spillovers. Note that TV , has a positive and significant coefficient. A.lso, note that this holds while controllingy for the liquidity of country c's international stocks in international markets (IT-I,,). Thus, proportion of trading of firm j that occurs in the domestic market is positively affected by the aggregate liquidity of the domestic market (excluding firm j), i.e., aggregate liquidity influences the liquidity of individual stocks. 2. The liquidity spillover part of the m,igration and liquiaity spillover channel Next, we further examine liquidity spillovers. Does aggregate trading in a market influence the liquidity of individual domestic stocks? If there is migration - if intermationalization induces a shift in the trading of internalional firms from domestic to itnternational markets - and if there are liquidity spillovers, then this represents a two-part channel through which internationalization affects the liquidity oi domestic firms. Besides the evidence on liquidity discussed above that focuses on whether aggregate liquidity influences the trading of international firmns in the local market, we estimate an extension of equation (1) that focuses on the liquidity of domestic: firms. T, =r,xISC,+2xITc' + x T' +S M,+A,xF>,, + xn +52xr,+ ejc,. (5) The difference between equation (1) and equation (5) is thalt equation (5) controls for the aggregate liquidity of international firms in the domestic market. Specifically, Ti, equals the domestic turnover of international finns in country c at time t. 20 Table 5 provides positive evidence of liquidity spillovers. As shown, there is a positive and significant coefficient on Tc, in all of the specifications. The aggregate liquidity of international furms in the domestic market positively influences the liquidity of individual domestic firms above and beyond (i) the aggregate liquidity of international firms in intemational markets ( IT', ), (ii) the degree of internationalization ( IS,, ), (iii) macroeconomic and country-specific controls ( Mc, ), (iv) finr-specific traits ( FJ,, ), and (v) country and time effects (n and , respectively). Thus, the positive coefficient on T.', presents evidence of positive liquidity spillovers. The regression results presented in Tables 2-5 are consistent with the migration and liquidity spillover channel. We find that (a) internationalization reduces the domestic liquidity of intemational firms and (b) the domestic liquidity of intemational firms exerts a positive impact on the liquidity of domestic firms. Taken together, these results imply that internationalization hurts the liquidity of domestic firms through the migration and liquidity spillover channel. Note, however, that the migration and liquidity spillover channel is not the whole story. In Table 5 when we control for the liquidity of international firms in the domestic market, IS,, still enters negatively and significantly. Thus, the liquidity of domestic firms is negatively influenced by the share of international fimns in a market beyond the aggregate trading of intemational firms in the domestic economy (T',') and in international markets ( IT2',,) and after controlling for country-specific and finn-specific factors. If migration and liquidity spillovers were the only channel through which internationalization affected the liquidity of domestic stocks, then IS,, should enter insignificantly after controlling for the liquidity spillover channel. 21 The fact that IS,, remains significant suggests that internationalization is influencing domestic liquidity through an additional mechanism. C. The Trade Diversion Channel 1. Method Trade diversion is an additional channel through which internationalization can influence domestic stock liquidity. We assess whether intemationalization induces a compositional shift in the domestic market from the trading of domestic stocks to the trading of international stocks. More specifically, does the proportion of r,he overall liquidity of the domestic stock market accounted for by a particular firm rise simply because it becomes an international firm? To study the trade diversion channel, we estimate the following equation: Sjc, =,AxIj,+02xIT! +O'Mt +cxMCapj,,,+1xFj,,+d,xn,+,52x-,+Ej,. (6) = is firm j's share of tumover in country c in year t relative to the total turnover of Tc,tI country c's domestic stock market in year t, where total turnover includes the domestic trading of both domestic and intemational firms. We also used value traded instead of the turnover ratio and obtained similar results. Ijc, is a dummy variable that equals one if the company is international and zero otherwise. Note, that this dummy tums from zero to one when a firm intemationalizes. IT, is the intemational trading of companyj and equals zero for domestic firms. 22 MCap,,c is the market capitalization of firm j. We include this variable to control for the fact that the share of turnover in firm j might tend to rise when the price of the stock rises or when the number of shares outstanding increase.14 Finally, we continue to control for the trading of international fimns in international markets. We do this to control for as many firm- and country-specific factors as possible and focus on the marginal impact of intemationalization of the proportion of domestic liquidity accounted for by intemational firms. We control for firm-specific factors, macroeconomic traits, year dummies, and country dummies. 2. Results on the trade diversion channel The Table 6 results indicate that internationalization reduces the proportion of liquidity of domestic firms in the local market through the trade diversion channel. The coefficient, 01, on I>,, enters with a positive coefficient in all of the Table 6 specifications. Thus, the proportion of the overall liquidity of the domestic stock market accounted for by a particular finn rises simply because it becomes intemational. Furthermore, note that the size of a company (total assets) is positively associated with the share of liquidity of that company in the local market. In sum, the results are consistent with the view that internationalization induces a compositional shift in the local market toward comparatively less trading of domestic stock and greater liquidity of intemational stocks. As noted in the Introduction, alternative theories predict trade intensification, not trade diversion. These altemative views hold that internationalization will induce more active trading of domestic stocks, not less. In contrast, our results support the view that intemationalization 14 In the previous specifications, we do not include market capitalization among the independent variables because the dependent variables are already scaled by market capitalization. 23 induces trade diversion. As firms internationalize, the domestic market becomes more focused on trading those international companies. D. Robustness Issues First, there may be concerns that the entry and exit of domestic and international firms will affect the results. Thus, estimated all regressions holding constant the number of firms in the sample. We obtained the same results with the control sample. Second, we incorporated additional macroeconormic and country-specific control variables to evaluate the independent impact of internationalization on domestic liquidity. For instance, we included the inflation rate since inflation may interfere with trading and reduce market liquidity (Boyd, Levine, and Smith, 2001). We also controlled for economic grow:h since business-cycle phenomenon may influence market activity. We examined terms of trade changes since shocks may importantly influence equity market transactions. In other specifications, we included the real interest rate, a broad i:ldex of financial liberalization developed by Kaminsky and Schmukler (2002), and a time trend. Including these additional macroeconomic controls did not change the r esults on the impact of intemationalization on the liquidity of domestic firms. Third, we included an assortment of microeconomic regressors to control for firm- specific and industry-specific factors influencing stock liquidity. This is important since firm- specific traits may lead high-performing firms to internationalize and poorly performing firms to remain domestic. Thus, we included industry dummy variables and information on firm sales and profits. Controlling for these additional mi croeconomic factors did not change the findings. Moreover, even when including array of firm-specific variables, macroeconomic controls, 24 industry dummy variables, year dummies, and country dummy variables, we continued to confirm the papers findings. While we are unable to rule out the possibility that some third factor is driving the results, the findings remained robust to many controls. Fourth, to measure spillover effects in a different way, wz estimated equations (3), (4), and (5) including the aggregate domestic liquidity of both domestic and intemational firms, instead of the liquidity of only intemational firms. We confirmed this paper's conclusions. Fifth, our measure of intemationalization is based on the number of firms becoming intemational. It may be appropriate to weight intemationalization by the size and activity of the firm that is cross-listing, issuing depositary receipts, or raising capital abroad. Thus, we computed an intemationalization measure based on the value traded of the internationalizing firm. We again confirmed this paper's findings. Sixth, we re-defined intemationalization by excluding the cases in which firms raise private capital in intemational markets and, at the same time, do not issue a depositary receipts or cross-list. These cases are only a small proportion (less than 10 percent) of the intemationalization episodes. Excluding them did not alter the results of the paper. Seventh, we also experimented with interaction terms. We examined whether intemationalization has a different impact on domestic firms depending on their size or other characteristics. Thus, we assessed whether the liquidity of big firms that do not internationalization falls more or less than smaller firms that do not internationalize. We also examined firm profitability, sales, etc. We found no evidence of these interaction terms entering significantly. 25 Eighth, in our sample, 19 out of 55 countries have zero or only one intemational firm. Thus, we re-did the analyses eliminating all 19 of these countries. We got the same results with this altemative sample. VI. Conclusions This paper finds that the intemationalization of stock mar.kets has a negative effect on the stock market liquidity of domestic firms. We studied in detail how this effect takes place. Liquidity migrates to intemational financial markets, having negative spillover effects on the liquidity of domestic firmns in domestic markets. Furthermore, there is trade diversion in domestic markets as trading shifts from domestic to intemational stocks within the local market. As a result, we were able to identify two channels through which intemationalization hurts domestic firms. The findings in this paper have opened several avenues for future research. First, a theoretical model that more comprehensively specifies the mechanisms influencing the impact of intemationalization on domestic markets would substantively sharpen the interpretation of this paper's results and shape future empirical work. Second, although this paper finds strong evidence of liquidity spillovers, we do not identify the source: of these spillovers. To better understand the operation of financial markets, future research might usefully dissect the sources of liquidity spillovers. Third, it would be interesting to understand the net effect of internationalization. Some papers have argued that internationalization has positive effects on the firms that intemationalize. This paper has shown that internationalization hurts the liquidity of domestic firms. What is the net effect for the economy? What is the future for domestic 26 markets and companies that are unable to internationalize? 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TPD, iS the logarithm of one plus the tumover ratio of domestic firtn j in country c during year t, where the turnover ratio equals the value traded of firm j in country c during year t divided by that firm's market capitalization. ISc,, is the share of intemational firms in country c at time t and is the measure of internationalization. IT' is the logarithm of one plus the aggregate turnover ratio of country c's international firms in C,1 international equity markets during year t. M;, is a matrix of macroeconomic and country-specific control variables, which in the table includes the logarithm of real per capita gross domestic product (Log of GDP per capita), an index of the law and order tradition of the country (Law and Order), and an index of capital account openness (Capital Account Liberalization). Fjc,, is a vector of firmj characteristics in country c during year t, which in the table includes the logarithm of total assets of the firm as a proxy for firm size (Log of Total Assets). In the regression n, and T', represent country-specific and year-specific dummy variables (Country Dummies and Year Dumnmies respectively), but the results on these coefficients are not reported in the tables. T-statistics are in brackets. ***, **, * mean significant at 1%, 5%, and 10%. Dependent Variable: Log of One Plus the Turnover Ratio of Domestic Firms is j -0.942 * -2.483 * -2.422 * -2.340 * -2.362 * -2.203 * [4.349] [6.714] [6.413] [6.1301 [6.323] [5.622] ITI 0.023 -0.048 -0.077 -0.005 .3 [0.513] [0.866] [1.346] [0.087] [0.908] [0.792] Log of GcP ner canita 0.123 *** 0.112 ** [2.642] [2.397] Law and Order 0.034 *** 0.025 ** [2.964] [2.189] Capital Account 0.032 -0.034 Liberalization [1.521] [1.558] Log of Total Assets -0.062 *** -0.063 *** -0.062 *** -0.058 * -0.059 * [8.891] [8.921] [8.940] [8.243] [8.310] Country Dummies Yes Yes Yes Yes Yes Yes Year Dummies Yes Yes Yes Yes Yes Yes Number of Firms 2,531 1,290 1,290 1,290 1,276 1,276 Number of Observations 14,382 6,735 6,735 6,735 6,556 6,556 R-squared 0.629 0.67 0.67 0.67 0.654 0.655 Table 2: Effects of Internationalization on International Firms Thi; table rceorta iegiessioiit uf ihe impact of internationaiization on the liquidlity ot international firmns within the domestic market. Using firm-level data from 55 Countries, during the years 1989-2000, and cmploying a feasible generalized least squares estimator with heteroskedasticity-consistent standard errors, the table reports results of the following regression equation: TjI! =ri xIS,, + y2xITJI, +O'M^, +4 xFj], + tY xn,+J Xr, + cj11. TC! is the logarithm of one plus the turnover ratio of international firnm j in country c during year t, where the tumover ratio equals the value traded of firm j in country c during year t divided by that firm's market capitalization. IS,,, is the share of intemational firms in country c at time t and is the measure of intcrnationalization. IT! is the logarithm of one plus the aggregate turnover ratio of country c's intemational firms in international equity markets during year t, excluding the trading of company j. Mc., is a matrix of macroeconomic and country-specific control variables, which in the table includes the logarithm of real per capita gross domestic product (Log of GDP per capita), an index of the law and order tradition of the country (Law and Order), and an index of capital account openness (Capital Account Liberalization). Fjc,, is a vector offirmj characteristics in country c during year t, which in the table includes the logarithm of total assets of the firm as a proxy for firm size (Log of Total Assets). In the regression n, and - represent country-specific and year-specific dummy variables (Country Dummies and Year Dummies respectively), but the results on these coefficients are not reported in the tables. T-statistics are in brackets. * * * mean significant at 1%, 5%, and 10%. Dependent Variable: Log of One Plus the Turnover Ratio of International Firms is -1.187 **-1.319 **-1.388 **-1.152 **-1.377 **-1.345** [4.776] [3.774] [3.905] [3.344] [3.971] [3.899] IT! 0.137 ** 0.113 * 0.119 * 0.155 ** 0.111 * 0.171 * J. ¢, t [1.997] [1.778] [1.839] [2.393] [1.736] (2.586] Log of GDP per capita -0.038 -0.084 [0.716] [1.557] Law and Order 0.047 *** 0.053 * [3.395] [3.610] Capital Account 0.007 0.013 Liberalization [0.249] [0.440] Log of Total Assets -0.012 * -0.012 -0.013 * -0.012 * -0.012 * [1.653] [1.570] [1.822] [1.663] [1.685] Country Dummies Yes Yes Yes Yes Yes Yes Year Dummies Yes Yes Yes Yes Yes Yes Number of Firms 634 548 548 548 548 548 Number of Observations 3,863 2,945 2,945 2,945 2,910 2,910 R-squared 0.643 0.658 0.658 0.659 0.654 0.656 Table 3: Effects of Internationalization on International Firms - Beyond Spillovers This table reports regressions of the impact of internationalization on the lquidity of interaional firms within the domestic market. Using firm-level data from 55 countries, during the years 1989-2000, and employing a feasible generalized least squares estimator with heteroskedasticity-consistent standard errors, the table reports results of the following regression equation: T = x IS', + Y2 x IT;c, +f6 XT!F C ++ AIx nc + 62 x X, + T C ,, is the logarithm of one plus the turnover ratio of international firm j in country c during year t, where the turnover ratio equals the value traded of firm j in country c during year t divided by that firm's market capitalization. ISc, is the share of international firms in country c at time t and is the measure of internationalization. IT' is the logarithm of one plus the aggregate turnover ratio of country c's international firms in international equity markets during year t, excluding the trading of company j. Tjl, is the logarithm of one plus the turnover ratio of international firms within the domestic market, excluding the trading of company j. Mc, is a matrix of macroeconomic and country-specific control variables, which in the table includes the logarithm of real per capita gross domestic product (Log of GDP per capita), an index of the law and order tradition of the country (Law and Order), and an index of capital account openness (Capital Account Liberalization). F' c,, is a vector of firm j characteristics in country c during year t, which in the table includes the logarithm of total assets of the firm as a proxy for firm size (Log of Total Assets). In the regression nc and r, represent country-specific and year-specific dummy variables (Country Dunimies and Year Dummies respectively), but the results on these coefficients are not reported in the tables. T-statistics are in brackets. * * * mean significant at 1%, 5%, and 10%. Dependent Variable: Log of One Plus the Turnover Ratio of International Firms iSC, -0.796 *** -0.849 ** -0.845 * 0.744 ** -0.885 ** -0.834 ** [3.256] [2.449] [2.459] [2.162] [2.560] [2.448] IT!' 0.025 0.006 0.006 0.037 0.001 0.037 [0.4021 [0.l91 9r0. 112] n[.664] 1 [0013].643 T ' 0.498 *** 0.445 ** 0.445 *** 0.437 *** 0.443 *** 0.432 *** J. c. * [10.973] [8.914] [8.990] [8.768] [8.745] [8.641] Lug uf GD per capita 0.002 -0.027 [0.044] (0.5463 Law and Order 0.032 ** 0.032 ** [2.363] [2.301] Capital Account 0.009 0.010 Liberalization [0.341] [0.376] Log of Total Assets -0.011 -0.011 -0.012 * -0.011 -0.012 [1.548] [1.526] [1.664] [1.559] [1.601] Country Dummies Yes Yes Yes Yes Yes Yes Year Dummies Yes Yes Yes Y.2s Yes Yes Number of Firnms 634 548 548 548 548 548 Number of Observations 3,863 2,945 2,945 2,945 2,910 2,910 R-squared 0.663 0.675 | 0.675 0.675 0.67 J 0.671 Table 4: Effects of Internationalization on Migration This table reports regressions of the impact of intemationalization on the relative liquiditv of intermational firns in domestic versus international markets. Using firm-level data from 55 countries, during the years 1989-2000, and employing a feasible generalized least squares estimator with heteroskedasticity-consistent standard errors, the table reports results of the following regression equation: T,! I(T! + IT!,>) = y x IS,, + y2 X IT!, + xTl C,, + ' M,,t +Z xFj,,,, + xn+62xr, Ej,. The dependent variable measures the level of domestic turnover of firm j relative to firm j's total turnover, which includes domestic turnover and turnover in international markets. Specifically, T,, is the logarithm of one plus the tumover ratio in the domestic market of international firm j in country c during year t, where the turnover ratio C, I equals the value traded of firm j in country c during year t divided by that firm's market capitalization and where IT],,, equals the logarithm of one plus the turnover ratio in intemational markets of firm j from country c during year t. ISc is the share of intemational firms in country c at time t and is the measure of intemationalization. IT! is the logarithm of one plus the aggregate tumover ratio of country c's intemational firms in international equity markets during year t, excluding the trading of company j. TJi, is the logarithm of one plus the tumover ratio of international firms within the domnestic market, excluding the trading of company j. Me, is a matrix of macroeconomic and country-specific control variables, which in the table includes the logarithm of real per capita gross domestic product (Log of GDP per capita), an index of the law and order tradition of the country (Law and Order), and an index of capital account openness (Capital Account Liberalization). Fj C, is a vector of firm j characteristics in country c during year t, which in the table includes the logarithm of total assets of the finm as a proxy for firm size (Log of Total Assets). In the regression n, and T, represent country-specific and year-specific dummy variables (Country Dummies and Year Dummies respectively), but the results on these coefficients are not reported in the tables. T-statistics are in brackets. ***, * * mean significant at 1%, 5%, and 10%. Dependent Variable: Log of One Plus the Share of Value Traded Domestically of International Firms IS,., -0.807-*** -0.816 *** -0.901 *** -0.799 *** -0.815 *** -0.876 [7.186] [5.914] [6.168] [5.957] [5.888] [6.136] IT! -0.108 *** -0.120 *** -0.114 *** -0.116 *** -0.115 *** -0.099 X .1 [3.407] [3.253] [3.097] [2.988] [3.101] [2.540] T l 0.068 *** 0.071 *** 0.068 *** 0.069 * 0.072 *** 0.066 [7.511] [5.974] [5.867] [5.618] [6.064] [5.453] Log of GDP per capita -0.044 ** -0.048 [2.198] [2.242] Law and Order 0.005 0.010 [1.101] [2.066] Capital Account -0.023 * -0.019 Liberalization [1.723] [1.388] Log of Total Assets -0.002 -0.001 -0.002 -0.002 -0.001 [0.544] [0.382] [0.586] [0.554] [0.460] Country Dummies Yes Yes Yes Yes Yes Yes Year Dummies Yes Yes Yes Yes Yes Yes Number of Firms 621 535 535 535 535 535 Number of Observations 3,628 2,768 2,768 2,768 2,733 2,733 R-squared 0.974 0.971 0.971 0.971 0.971 0.971 Table 5: Effects of Internationalization on Domestic Firms - Beyond Spillovers This table reports regressions of the impact of intemationalization on the liquidity of domestic firms. Using firm-level data from 55 countries, during the years 1989-2000, and employing a feasible generalized least squares estimator with heteroskedasticity-consistent standard errors, the table reports results of the following regression equation: TP=,x IS,,, +;v.x IT' +fi xT% + O'M,,, + A x F,,~,, 8 n +i2 xr, +e Tj D TJ'c, = r, t lsc + Y2 C'IT +iT+' + XF,A c+ T+ C!t *,. TDC,,, is the logarithm of one plus the turnover ratio of domestic firm j in country c during year t, where the turnover ratio equals the value traded of firm j in country c during year t divided by that firm's market capitalization. IS,, is the share of intemational fimis in country c in year t and is the measure of internationalization. IT" is the logarithm of one plus the aggregate turnover ratio of country c's international I 41 firms in intemational equity markets during year t. TC equals the logarithm of one plus the domestic turnover of intemational frmns in country c at during year t. M,, is a matrix of macroeconomic and country-specific control variables, which in the table includes the logarithm of real per capita gross domestic product (Log of GDP per capita), an index of the law and order tradition of the country (Law and Order), and an index of capital account openness (Capital Account Liberalization). Fj C, is a vector of firm j characteristics in country c during year t, which in the table includes the logarithm of total assets of the firm as a proxy for firm size (Log of Total Assets). In the regression n, and ra represent country-specific and year-specific dummy variables (Country Dummies and Year Dummies respectively), but the results on these coefficients are not reported in the tables. T-statistics are in brackets. ***, **, * mean significant at 1%, 5%, and 10%. Dependent Variable: Log of One Plus the Turnover Ratio of Domestic Firms IS,, -0.525 ** I -1.269 * -1.222 *"" I -1.234 *** -0.990 * -0.927 ** [2.454] [3.711] [3.521] L3.509] [2.832] [2.565] -0.006 -0.095 * -0.120 ** -0.078 -0.095 * -0.123 ** [0 1501 [l808] [2.2331 [1.554] [1.804] [2.443] 0.455 * 0.418 ** 0.416 *** 0.412 * 0.430 * 0.429 * [18.391] [11.767] [t l.703] [11.653] [11.833] [11.966] Lon of CMDP ner capita 0.108 ** 0.118 * [2.408] L2.6.2] Law and Order 0.013 -0.001 [1.090] [0.055] Capital Account -0.064 "*" -0.068 *"* Liberalization [2.980] [3.102] Log of Total Assets -0.063 *** -0.064 *4' -0.063 **" -0.059 * -0.060 * [9.145] [9.151] [9.155] [8.516] [8.539] Country Dummies Yes Yes Yes Yes Yes Yes Year Dummies Yes Yes Yes Yes Yes Yes Number of Firms 2,531 1,290 1,290 1,290 1,276 1,276 Number of Observations 14,382 6,735 6,735 6,735 6,556 6,556 R-squared 0.642 | 0.678 0.678 0.678 0.663 0.663 Table 6: Effects of Internationalization on Domestic Firms - Trade Diversion Effects This table reports regressions of the impact of intemationalization on the share of firm's liquidity in the domestic market. Using firm-level data from 55 countries, during the years 1989-2000, and employing a feasible generalized least squares estimator with heteroskedasticity-consistent standard errors, the table reports results of the following regression equation: Sj,,,, = , xIjC! + xITJ. +'M, + KxMCapj, +A xFjc +1 Xn +62xr, +j . S;,c = Tj, /TTD+l is firm j's share of turnover in country c in year t relative to the total turnover of country c's domestic stock market in year t, where total turnover includes the domestic trading of both domestic and international firms. Ij, is a dummy variable that eqalals one if the company is international and zero otherwise. This dummy tmrns from zero to one when a firm internationalizes. IT! , is the logarithm of one plus the turnover of firm j from country c in international markets during year t. MCapj c, is the market capitalization of firm j in country c during year t, where the turnover ratio equals the value traded of firm j in country c during year t divided by that firm's market capitalization. Me,, is a matrix of macroeconomic and country-specific control variables, which in the table includes the logarithm of real per capita gross domestic product (Log of GDP per capita), an index of the law and order tradition of the country (Law and Order), and an index of capital account openness (Capital Account Liberalization). Fj c, is a vector of firmj characteristics in country c during year t, which in the table includes the logarithm of total assets of the firm as a proxy for firm size (Log of Total Assets). In the regression n, and r, represent country-specific and year-specific dummy variables (Country Dummies and Year Dummies respectively), but the results on these coefficients are not reported in the tables. T-statistics are in brackets. ***, **, * mean significant at 1%, 5%, and 10%. Dependent Variable: Log of One Plus the Share of Firm j Value Traded ,i.1 0.080 *** 0.079 *** 0.080 *** 0.079 *** 0.079 *** 0.080 * [3.948] [3.587] [3.624] [3.587] [3.646] [3.688] IT'jc, 0.223 *** 0.091 0.094 0.091 0.087 0.089 [2.921] [1.110] [1.155] [1.106] [1.061] [1.091] MCap J,, -0.122 *** -0.133 *** -0.134 *** -0.133 *** -0.133 * -0.134 * [19.864] [14.705] [14.766] [14.670] [14.593] [14.625] Log ofGDP per capita 0.134 *** 0.138 * [3.062] [3.102] Law and Order -0.001 -0.009 [0.098] [0.699] Capital Account 0.018 0.010 Liberalization [0.680] [0.371] Log of Total Assets 0.023 *** 0.023 *** 0.023 *** 0.025 *** 0.025 * [2.765] [2.689] [2.752] [2.916] [2.842] Country Dummies Yes Yes Yes Yes Yes Yes Year Dummies Yes Yes Yes Yes Yes Yes Number of Firms 3,252 1,839 1,839 1,839 1,825 1,825 Number of Observations 18,488 9,744 9,744 9,744 9,526 9,526 R-squared 0.681 0.718 0.718 0.718 0.715 0.716 Appendik Table I (Continued) Bask Statistics and Means Log Tnrnover In Log Ratlo of Value Log Turnover In Number of Number of Number of Log Turnover the Domestlc Traded In the Domeste Log Sbare of Internation Catauzation Ceuntry Flrm lternational Domestic Sample Period (Domestie Mnarke Market to Total Value International Markets C tiflon Frnms Firm Firms) (Internatlonal Traded Firms (International (U.S. dolla, Firms) (international Firms) Firms) 29 Mauritsu 17 0 17 1996- 2000 0.039 0.000 0.000 0.000 0 000 84.5 30 Mexico 101 42 59 1989- 2000 0 253 0.373 0.522 0 153 0.480 1,443 8 31 Morocco 21 2 19 1996 -2000 0.089 0.149 0.693 0010 0 000 488A 32 Namnbia 8 0 8 1999 - 2000 0.082 0.000 0 000 0 000 0.000 29.3 33 Nigeria 41 0 41 1989 -2000 0024 0.000 0.000 0000 0 000 66.0 34 Oman 34 0 34 1999 - 2000 0 152 0.000 0.000 0000 0.000 76 2 35 Pakistan 124 5 119 1989 -2000 0 210 1.030 0.693 0004 0 000 80 2 36 Peru 43 8 35 1992-2000 0.511 0.228 0.590 0015 0 151 230 1 37 Puibppmes 78 38 40 1989 - 2000 0424 0.324 0.685 0096 0 032 566 8 38 Poland 45 17 28 1992 - 2000 0.572 0.31I 0.693 0.038 0 000 395.7 39 Pomtugal 47 12 35 1989- 1999 0230 0.269 0.671 0039 0.034 669.9 40 Romania 53 2 51 1997 - 2000 0 243 0037 0.693 0000 0.000 17.7 41 Russia 42 5 37 1996 - 2000 0156 0.275 0.627 0 015 0.015 1,395.4 42 Saudi Arabia 22 0 22 1997 - 2000 0 305 0000 0.000 0 000 0.000 2,133.5 43 Slovak Republic 20 2 18 1996 - 2000 0 354 0 143 0.693 0 009 0.000 60.7 44 Slovenia 20 2 18 1996- 2000 0 332 0.324 0 693 0 030 0.000 104.7 45 South Africa 102 33 69 1992 - 2000 0 179 0.233 0 601 0.029 0.033 1,749.1 46 South Kora 230 30 200 1989 - 2000 1 196 0 891 0 683 0 014 0.042 809.7 47 Sn Lanka 66 2 64 1992 - 2000 0125 0.216 0.693 0.004 0.000 26.2 48 Taiwan, Pmvince ofChina 143 30 113 1989 - 2000 1.506 1.203 0.691 0 027 0.022 1,615.9 49 Thailand 125 31 94 1989 - 2000 0 789 0602 0.693 0.048 0.000 633.8 50 Trinidad and Tobago 12 0 12 1996 - 2000 0047 0 000 0.000 0000 0.000 215.0 51 Tunisia 18 3 17 1996 - 2000 0093 0 134 0.693 0 007 0.000 136 4 52 Turkey 78 16 62 1989 - 2000 1.019 0.659 0 691 0 026 0.002 632.8 53 Ukrame 19 0 19 1997 - 2000 0 080 0 000 0000 0.000 0.000 80.2 54 Venezuela 23 6 17 1989 - 2000 '0.190 0.222 0 570 0.037 0 302 328.1 55 Zimbabwe 34 3 31 1989 - 2000 0 099 0.159 0.693 0020 0 000 64.4 _ Total - 3,253 640 2,613 0 344 0 288 0 491 0023 0043 523 501 Appendix Table 2 Series Description and Data Sources This table shows the description of the data used and their coverage and sources, Series Description Source Variables related to the The datat come from Bank of New York (1989-2000) and Euromoney (1980-2000). This information is Bank of New York and Bturomoney internationalization of stock used to classify firms as domestic or intemational companies. Internaional companies are the ones markets that issue a depositary receipt, cross-list, or raise capital in a foreign stock exchange at any time in the sample. Different variables are consttucted using this variable. See text for details. Domestic market capitalization Market capitalization in domestic stock markets. Standard & Poor's (former International Finance Corporation) Emerging Markets (current U.S. dollars) Database Domestic value traded Value traded in domestic stock markets. S'-d--rd & Poor's (former lnte,m,tionn, F,sn1 Cppnorntion) Fmerging Markets (current U.S. dollars) Database Value traded in foreign markets Value traded in depositosy receipts covering the period 1989-2000. Series are computed on a firm- Bank of New York (mmenret U.S. dollars) level basis by adding the different depositary receipts that belong to each company on a yearly basis. GDP per capita at market priies GrOss domestic product (GDP) divided by mid-year population. The GDP at purchaser prices data is World Bank: World Development Indicators (current U.S. dollars) converted from domestic currencies using yearly official exchange rates. For the eases in which the official exchange rate is different from the market rate, the latter is used. Law and order Qualitative variable that ranges from I to 6, where higher numbers indicate higher "levels" of law and PoGitical Risk Services: International Country Risk Ciwde order. Law and order are assessed separately, with each sub-component comprising zero to three points. The law sub-component is an assessment of the strength and impartiality of the legal system, while the order sub-component is an assessment of popular observance of the law. Thus, a country can have a high rating in terms of its judicial system, for example 3, but a low rating, for example 1, if the law is ignored for a political aim, e.g. widespread strikes involving illegal practices. The data cover the period 1984-2000 for all countries. Capital account liberalization Dummy that equals one on and after the year of capital account liberalization, and zero elsewhere. The International Monetary Fund: Annual Report on Exchange Arrangements and (IMF) data cover the puiiod 1975-2000 for all countrics. Exchange Restrictions Total assets Total assets as reported in Worldscope for each firm-year, in million of U.S. dollars. The sample Worldscope covers the period 1989-2000 for al I countries. Policy Research Working Paper Series Contact Title Author Date for paper WPS3027 Financial Intermediation and Growth: Genevieve Boyreau- April 2003 P. Sintim-Aboagye Chinese Style Debray 38526 WPS3028 Does a Country Need a Promotion Jacques Morisset April 2003 M. heghali Agency to Attract Foreign Direct 36177 ;nvestment? A Small Analytical Model Applied to 58 Countries WPS3029 Who Benefits and How Much? How Alessandro Nicita April 2003 P. Flewitt Gender Affects Welfare Impacts of a SLsan Razzaz 32724 Booming T-extile Industry WPS3030 The Impact of Bank Regulations, Asl1 Demirgur.-Kunt April 2003 A. Yaptenco Concentration, and Institutions on Luc Laeven 31823 Bank Margins Ross Levine VVPS303i Imports, Entry, and Competition Law Hiau Looi Kee April 2003 P. Flewitt as Market Disciplines Bernard Hoekman 32724 WPS3032 Information Diffusion in International Alejandro lzquierdo April 2003 M. ,=eghali Markets Jacques Morisset 36177 Marcelo Olarreaga WPS3033 The Role of Occupational Pension Dimnitri Vittas April 2003 P. linfante Funds in Mauritius 37642 WPS3034 The Insurance Industry in Dimitii Vittas April 2003 ,'. infante Mauritius 37642 WPS3035 Traffic Fatalities and Economic Elizabeth Kopits April 2003 V. Soukhanov Growth Maureen Cropper 35721 WPS3036 Telecommunications Reform in George R. G. Clarke April 2003 P. Sintim-Aboagye Malawi Frew A. Gebreab 37644 Henry R. Mgombelo WPS3037 Regulation and Private Sector Sheoli Pargal April 2003 S. Pargal Investment in Infrastructure: 81951 Evidence from Latin America WPS3038 The Debate on Globalization, Martin Ravallion May 2003 P. Sader Poverty, and Inequality: Why 33902 Measurement Matters WPS3039 Scaling Up Community-Driven Hans P. Binswanger May 2003 T. Nguyen Development: Theoretical Swaminathan S. Aiyar 31389 Underpinnings and Program Design Implications WPS3040 Household Welfare Impacts of Shaohua Chen May 2003 P. Sader China's Accession to the World ME.rtin Ravallion 33902 Trade Organization WPS3041 Bank Concentration and Crises Thorsten Beck May 2003 K. Labrie As!1 Demirgu,-Kunt 31001 Ross Levine WPS3042 Bank Supervision and Corporate Thorsten Beck May 2003 K. Labrie Finance As11 Demirgu,-Kunt 31001 Ross Levine Pcilicy Ru!saarch Working Paper Series Contacl: TiVe Aulho Date for paper 'A)vS3043 T-he Ircenti;re-Comptis! Dosir- 'crston l3a:. May 2003 <. Labrie of Deposit Insui ancs 3 -d Bark; 31001 Failure Kosolution: Co icepts arc Coujlthl Stliffes 'Aj OS3C4Ar lmoreCrlioLoc' NeTs C31r.0c: Fu1l'/ Vead over N/lay 2003 H. Sladovich Subsi.utetc for 1-ic: Iird Bernarml Ba-ce'e 37698 iH,ectiveress of \Ma!aria Pravex,itci Parnar '/elayudhan in Sol-onr ,slan js Pltxr \Wilkai Fatricia NA. Graves VVFPS3045 Causes anr' CorseqLcnces c; C V I Kla is CeIicij£si May 2003 IV. Fernandez SLrife: Morolevel Eviderce from 33766 U gan da