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

January 17, 2020 - 03:05
CUHK Business School Research Reveals Strong Link Between Stock Market Liberalisation in Emerging Markets and Increased Innovation

HONG KONG, 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, respectively.

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 innovative.


"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 monitoring.


"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 innovation.


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

CUHKBusiness School comprises two schools -- Accountancy and Hotel andTourism Management -- and four departments -- Decision Sciences andManagerial Economics, Finance, Management and Marketing. Establishedin Hong Kong in 1963, it is the first business school to offer BBA, MBA andExecutive MBA programmes in the region. Today, the Schooloffers 8 undergraduate programmes and 20graduate programmes including MBA, EMBA, Master,MSc, MPhil and Ph.D.


Inthe Financial Times Global MBA Ranking 2019,CUHK MBA is ranked 57th. In FT's 2019 EMBA ranking, CUHK EMBA is ranked 24thin 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 keybusiness leaders. The School currently has about 4,400undergraduate and postgraduate students and Professor Lin Zhou is the Dean of CUHKBusiness School.


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