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

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. •Our study contributes to the debate about the role of foreign investors and whether, like “locusts,” they damage local capital markets by seeking short-term profits (Bena et al., 2017). In particular, this paper considers the effect of foreign ownership in shaping financial reporting quality (Ferreira and Matos, 2008; Kim, Miller, Wan and Wang, 2016; Beuselinck, Blanco and García Lara, 2017).•Our findings of the improved information quality effectively highlight the causal impact of foreign investors on corporate information disclosure and have policy implications for other emerging countries that might benefit by establishing similar programs.•We also contribute to the literature related to the impact of capital market liberalization (Chan & Kwok, 2017; Epstein & Schneider, 2008). We provide evidence that foreign investment improves firms' information environments (as reflected in the market trading behavior) and demonstrate an overall positive influence of capital market liberalization.