Enhancing the efficiency of securities markets in East Asia

Abstract

We explore the relative efficiency of stock markets across countries using newly available data on transactions costs and the quality of the informational environment of stock markets. These new measures are constructed from firm-level stock returns in a panel of 60 countries for the period 2000–2004. We develop a framework to understand the linkages between efficiency, liquidity, transactions costs, and informational quality and then study their determinants. We find that some institutional arrangements – such as the availability of stock lending and short selling – and the openness of markets are associated with lower transactions costs. We also find that, although disclosure rules for directors and officers of listed firms are essential, the ability of shareholders to seek redress is more conducive to a better informational environment in stock markets. This in turn serves as the basis for policy recommendations for the East Asian region. In particular, the region needs to continue to strengthen the implementation and enforcement of corporate governance, to further enhance the market and institutional infrastructure, and focus on measures to foster a larger and more diversified investor base, in order to continue to see gains in the efficiency of stock markets.

Keywords:

• liquidity of stock markets; capital markets; stock markets; East Asia; transactions costs; corporate governance

Acknowledgements

This article was written while the second author was at the World Bank. The findings, interpretations, and conclusions of this paper do not necessarily represent the views of the World Bank, its Executive Directors, the countries they represent, or those of the Ministry of Finance, Mexico. The paper was written while the second author was at the World Bank. We would like to thank Thorsten Beck, Stijn Claessens, and Erik Feijen for their helpful comments.

Notes

 1. See Fama's survey articles (1970, 1991) and Schwert (2003) for overviews of the paths that the literature has followed in testing for market efficiency.

 2. In the theoretical finance literature, a market is weakly efficient if it reflects all available past information. Semi-strong form efficiency occurs when prices reflect all available public information, and strong form efficiency is when prices reflect all available public and private information. Researchers disagree on the actual level of efficiency of mature markets.

 3. Value traded (the value of stock trades in a year divided by the size of the economy) is a commonly used indicator of liquidity. However, it is an imperfect measure since its value can change without any increase in the volume of trades, for example, if prices rise. For that reason, turnover (the value of stock trades in a year divided by market capitalization) is a better measure because is not affected by prices. De la Torre and Schmukler (2005) indicate that they also ran the regressions using turnover without any significant difference in the results.

 4. Some costs such as ‘market impact’ are not straightforward to classify as either implicit or explicit.

 5. We chose to use Doing Business indicators instead of the earlier measures from La Porta, Lopez-de-Silanes, and Shleifer (2006) and Djankov et al. (2005) on which they are based, because they have broader country coverage and a consistent methodology applied in each country. In particular, the way the three measures are obtained is by assuming a specific business transaction that involves self-dealing. There are two companies B (for buyer) and S (for seller). A hypothetical Mr James owns 60% of B, owns 90% of S, and has a majority in both boards of directors. Company S wants to dispose of some assets and Mr James proposes that company B buy them, at a price that is above market value. The transaction is approved, and the mandated disclosures are made. However, since the transaction is unfair, shareholders of B sue Mr James and any other parties that approved the transaction. Using this common framework, Doing Business then asks lawyers from each country a set of questions regarding what disclosures should have been obligatorily made, what is the specific liability that directors and managers face, and how easy it is for shareholders to sue those who were responsible. A score is then computed for each of these categories.

 6. In a margin purchase, losses are limited to (purchase price) × (margin ratio), whereas gains are unlimited at [(unlimited sale price) × (margin ratio) − purchase price]. In a short sale, losses are unlimited at [(unlimited purchase price) × (margin ratio) − sale price], while the gains are limited to (sale price) × (margin ratio).

 7. For a deeper discussion of margin trading see Bris, Goetzmann, and Zhu (2003) and Endo and Rhee (2005).

 8. A short squeeze is a situation in which the lack of supply or an excess demand for a traded stock forces the price upward. For example, if a stock price starts to rise rapidly, short sellers may be forced to liquidate and cover their positions by purchasing the stock. This will push up the stock price even higher.

 9. However, China is currently undertaking major reforms to increase investors' access to shares. Thailand has also recently loosened restrictions on foreign investors. These figures are based on the IFC's Investible Return Index (IFCI), which includes a subset of stocks included in IFC's Global Index (IFCG), both now managed by Standard and Poor's. Stocks in the IFCI are selected using a two-step process: first, S&P determines which securities may be legally held by foreigners and next S&P screens stocks according to their size and liquidity. Thus the IFCI is designed to measure the composite stock market return of what foreign investors might receive from investing in emerging market securities that are legally and practically available to them. Note that the degree of investor accessibility may not be a good proxy of actual foreign ownership: a stock that is designated as investible may or may not be owned by foreign investors.

10. The combination of closely held shares and a sizable proportion of shares that are inaccessible to foreign investors can sizably dampen liquidity. The percentage of closely held shares is generally high in East Asian countries; as of 2004, it was 30% in Indonesia and 40% in the Philippines. In the other countries the figures are lower: 28% in China and Hong Kong (China), 10% in Korea, 17% in Malaysia, 25% in Singapore, and 21% in Thailand – however, they are significantly higher than the USA at 1.5%, Canada at 2%, and the UK at 3.3%.