CUHK Business School Research Reveals Strong Link Between Stock Market Liberalisation in Emerging Markets and Increased Innovation

CHINA - Media OutReach - 17 January 2020 - There
is little doubt that the liberalisation of stock markets in emerging markets
has been a positive force in the world economic order. One previous study has
found that stock market liberalisation leads to a 1 percent increase in a
country's annual real GDP growth.


Closer to home, economic reforms in
modern China have been hailed as a success leading to the Asian behemoth's rise
as a world power.


What is less well understood is how
the government removal of restrictions on foreign investors' participation in
domestic stock markets promotes economic activity. This is a question posed by
a group of researchers, who believe the answer lies in the positive effect of
economic reforms on innovation.


One theory has been that stock
market liberalisation allows risk to be shared among a greater number of market
participants -- and thereby reducing the cost of capital for firms. The problem
with that, according to Prof. Wenrui Zhang,
Assistant Professor of Department of Finance at The Chinese University of Hong
Kong (CUHK) Business School and Prof. Bohui Zhang, Executive Associate Dean and
Presidential Chair Professor at CUHK-Shenzhen's School of Management and
Economics, is that it fails to explain the magnitude of the benefit.


There has also been a lack of
empirical research looking at how innovation -- which tends to involve long-term
investment in risky and intangible assets -- works to increase productivity in
the wake of the opening up of markets.


"While some studies show that
stock market liberalisation leads to an increase in capital expenditure, it is
unclear ex ante how stock market
liberalisation affects a country's innovative activities," Prof. Wenrui
Zhang said.


Innovation as key contributor

The study, entitled "Stock Market Liberalization and Innovation," identifies technological innovation as a key
contributor to economic windfall, as opposed to other channels such as an
increase in the liquidity of the stock market, improvement in information flow,
or better corporate governance and rule of law.


It was conducted in collaboration
with Prof. Fariborz Moshirian of the University of New South Wales and Prof.
Xuan Tian of Tsinghua University.


Focusing on public firms from 20
developed and emerging economies that experienced stock market liberalisation
between 1981 to 2008, it found a link with increased innovation output. On
average, after a country liberalises its stock market, firms' patent counts and
citation counts experienced an increase of 13 percent and 16 percent,

Industries that are more innovative
in nature also seem to see its innovation output boosted to a higher degree
once a country opens its equity market, with the most innovative industries
seeing the number of patents and citations increase by 24 percent and 25
percent, respectively, compared to industries that are regarded as the least


"The findings (together with
those in the previous studies) suggest that stock market liberalisation is
beneficial to the economy in both the short run and the long run. More
importantly, in the long run, the enhancement of innovation output as a result
of liberalisation is likely to be the driver of productivity growth and in turn
economic growth," Prof. Wenrui Zhang said.


Three channels to boost growth

An analysis of data also lent more
credence to the theory that stock market liberalisation encouraged innovation
through better access to financing. The researchers postulate that by allowing
foreign investors to purchase shares in domestic companies, the liberalisation
of stock markets encourages innovation by giving these companies better access
to capital.


Opening up markets also allows risk
from innovative activities to be shared among a bigger investor pool, and
because foreign investors tend to induce better corporate governance in newly
liberalised markets through insisting on higher standards and better compliance


"To the extent that the
liberalisation of domestic equity markets attracts more foreign investors who
are better monitors and in turn enhance domestic firms' corporate governance,
stock market liberalisation could restrain managers' opportunistic behaviors in
innovative investment and promote domestic firms' innovation output," said
Prof. Wenrui Zhang.


Furthermore, the benefits extended
to both existing as well as newly listed firms. In particular, stock market
liberalisation turns firms that are not known for being innovative into
innovators and attracts innovative companies to go public. However, the effect
on private firms was less pronounced than on public companies. The results also
suggested that firms in countries where the equity market is opened to foreign
participation is more open towards the adoption of foreign technology, which is
crucial particularly for emerging markets in boosting innovation.


It was also found that the opening
up of a country's stock market leads to firms being more efficient in capital
allocation both across and within industries, when it comes to investing in


Finally, the researchers caution
while their study appears to link stock market liberalization to more
innovation, there could be other factors involved, such as the possibility that
some companies wait until the stock market opens up before patenting their more
important innovations.


"Importantly, the three
channels we document -- that of better access to financing, increased
risk-sharing and better corporate governance -- are not necessarily mutually
exclusive and could jointly contribute to the positive effect of stock market
liberalisation," added Prof. Wenrui Zhang.


Moshirian, Fariborz and Tian, Xuan and Zhang, Bohui
and Zhang, Wenrui, Stock Market Liberalization and Innovation (December 2,
2019). Journal of Financial Economics (JFE), Forthcoming. Available at SSRN: or


This article was first published in the China
Business Knowledge (CBK) website by CUHK Business School:

About CUHK Business School

Business School comprises two schools -- Accountancy and Hotel and
Tourism Management -- and four departments -- Decision Sciences and
Managerial Economics, Finance, Management and Marketing. Established
in Hong Kong in 1963, it is the first business school to offer BBA, MBA and
Executive MBA programmes in the region. Today, the School
offers 8 undergraduate programmes and 20
graduate programmes including MBA, EMBA, Master,
MSc, MPhil and Ph.D.


the Financial Times Global MBA Ranking 2019,
CUHK MBA is ranked 57th. In FT's 2019 EMBA ranking, CUHK EMBA is ranked 24th
in the world. CUHK Business School has the largest number of business alumni (36,000+)
among universities/business schools in Hong Kong -- many of whom are key
business leaders. The School currently has about 4,400
undergraduate and postgraduate students and Professor Lin Zhou is the Dean of CUHK
Business School.


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