Credibility of Disclosures in Weak Enforcement Institutions: Evidence from Shanghai-Hong Kong Connect

Abstract

I study whether voluntary disclosure can be credible when the enforcement institutions to deter managers from engaging in cheap-talk are weak. Using the case of China, I examine the effect of a market liberalization pilot program’s announcement, which increased foreign investors’ future ability to invest in select Shanghai stocks, on affected firms’ disclosure policies. I find that affected firms did not change public disclosure (press releases and management forecasts), but significantly increased private disclosure (corporate access and private dial-ins) in anticipation of the program’s implementation. Private disclosure increases were concentrated among firms in need of capital and these firms experienced an increase in foreign institutional holdings after the implementation. Further, their stock prices suffered less during a subsequent market crash and they retained more foreign institutional investors. Overall, the results suggest that voluntary disclosure supports investor confidence even in weak environments, albeit through private (instead of public) channels.

Keywords: private disclosure, reputation, credibility, institutional investors, market liberalization

JEL Classification: F61, G01, G23, G38, M41