Foreign investment and information quality – A quasi-experiment from China

Abstract

This study examines the effect of foreign investment on firms' information quality. We use a unique setting—the Shanghai-Hong Kong Stock Connect Program in China—that provides an exogenous shock to foreign investment and allows global investors to trade on stocks that were previously inaccessible to them. Combining a difference-in-differences model and a propensity-score matching research design, we find that information quality significantly improves in firms selected for this program, relative to other firms. The effect is more pronounced in companies without previous foreign investors and with high financing constraints, weak corporate governance, and low accounting quality, suggesting that foreign investment exerts a governing effect. Overall, our study contributes to the debate about the role of foreign investors by presenting direct evidence that foreign investment as a result of capital market liberalization plays an active role in improving corporate governance and enhancing the corporate information environment.