Navigating Weak Institutions through Foreign Brokers
49 Pages Posted: 22 Jun 2017 Last revised: 9 Oct 2018
Date Written: June 12, 2017
I study how firms signal their quality and attract foreign investors when they operate in a market characterized by weak enforcement and legal protection. Using a proprietary dataset, I examine Chinese firms’ use of public and private communication channels in response to a market liberalization pilot program. I find that affected firms did not respond to the liberalization via public communication channels, but find that they increased the number of selective private meetings hosted by major foreign investment banks. These firms experienced an increase in foreign institutional holdings after the liberalization’s implementation. Further, they exhibited more stable stock performance and retained foreign investors during a subsequent market crash. Overall, the results suggest that firms use communication channels certified by reputable foreign investment banks to signal their quality and attract, as well as maintain, foreign investment.
Keywords: investment bank; reputational bonding; credibility; signaling; institutional investors; emerging market; market liberalization; Shanghai-Hong Kong Connect
JEL Classification: F61, G01, G23, G38, M41
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