Investor Protection and Liquidity of Cross-Listed Securities: Evidence from the ADR Market

Abstract

Using 'American depository receipt' (ADR) data on various countries, this paper sets out to investigate the relationship between investor protection and firm liquidity. Since weak investor protection and poor economic prospects lead to greater expropriation by managers - and thus greater asymmetric information costs - liquidity providers will incur relatively higher costs and will therefore offer higher bid-ask spreads. Our empirical results demonstrate that the level of investor protection afforded to ADRs, as well as the quality of law enforcement, have significant effects on firm liquidity. This issue is further analyzed by investigating whether there is any increase in the vulnerability of ADRs of firms operating in countries with relatively poor investor protection mechanisms during a period of financial crisis. We explore this issue by examining whether net-selling pressure was any stronger on ADRs from countries with poor investor protection mechanisms during the period of the Asian financial crisis.