margin trading and corporate investments: evidence from a ......margin trading and short selling to...

Margin andInvestments

Nathan DongColumbia Univ

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Margin Trading and Corporate Investments:Evidence from a Quasi-natural Experiment in China

Nathan Dong

Columbia University

Ming Gu

Xiamen University

Weiwei HuangRenmin University

of China

K.C. John WeiHong KongPolytechnicUniversity

December 13, 2018

1 / 25 Emerging Markets Finance Conference Finance Research Group, IGIDR 2018



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Research questionsDo trading activities matter for corporate decisions?

Does trading activity on Wall Street influence corporatepolicies in financing, investment, and organizationalpractices on Main Street?The relation between financial markets and the realeconomy (mainly in corporate investment)

Chen, Goldstein & Jiang (2007)Bakke & Whited (2010)Bond, Edmans & Goldstein (2012)Foucault & Fresard (2014)

Few studies have reliably estimated the real impactfrom the stock market to the firm due to a lack ofidentification strategies for exogenous shocks

Edmans, Goldstein & Jiang (2012)Mutual fund flows → Stock price changes → TakeoversDerrien & Kecskes (2013)Brokerage M&As → Analyst coverage → Investments




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Evidence in the U.S.Regulation SHO program

The Securities and Exchange Commission (SEC)adopted a new regulation governing short sellingactivities in the U.S. equity markets in July 2004

Regulation SHO allowed stocks in the pilot programexempted from short-sale price tests between May,2005 and August, 2007

Studies employ SHO pilot program as an exogenousshock to examine the effects of short selling on

Market quality: Alexander & Peterson (2008)Short-sale trades and volume: Diether et al. (2009)Bond yields: Kecskes et al. (2013)Earnings mgmt: Fang et al. (2015), Masa et al. (2015)Insider trading: Masa et al. (2015)Small firms: Grullon et al. (2015)Short-selling↑ → Price↓ → Equity issues & investment↓




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Background in China

On March 31, 2010, the China Securities RegulatoryCommission (CSRC) introduces the pilot program ofmargin trading and short selling to help incorporatemore information into stocks pricesInitially, 90 blue chip stocks are selected in the programin 2010. After several rounds of qualification standardsloosening, there are a total of 900 stocks included inthe pilot program in September 2014The lift of the margin-trading and short-selling bansreduced stock return volatility and enhanced marketliquidity

Chang et al. (2014)Wang & Wei (2017)

Similar effects in India: Kahraman & Tookes (2017)




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Hypothesis Development

An increase in margin trading activity improves liquidityand reduces information asymmetry and thus the costof equity capital becomes lowerA more informative and a higher level of equity pricecan help drive down the cost of debt capital (Sunder2004)Investments of financially constrained firms are lessresponsive to investment opportunities becauseexternal financing is costly. Thus, the benefit of areduction in external financing costs could be greaterfor financially constrained firms (Hubbard 1998)Price efficiency increased for firms that were includedin the pilot program (Wang & Wei 2017)




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Hypothesis Development

Increase in trading activity on the secondary marketshelps reduce information asymmetry and, hence, thecost of external financing. This, in turn, improves theprofitability of investment opportunities and the optimalamount of corporate investment and associatedfinancingSuch effects depend on the degree of financingconstraints at the time of the shocks in capital markets




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Preview of Main Findings

The level of corporate investments including capital andR&D expenditures increased after margin trading andshort selling are allowed. More importantly, the effectsmainly come from margin trading activityWe use the leveraged mutual fund ownership toinstrument for margin trading and find a significantlypositive relationship between margin trading eligibilityand the level of investmentThe positive relationship between margin trading andcorporate investments is more significant in firms withhigher degree of financial constraintsWe attribute the willingness to increase capital andR&D expenditures to that firms can raise debt capital ata lower cost




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SampleTreatment Group

Our study covers the period from January 1, 2006through December 31, 2014. (PRE period, DURINGperiod, indicator variable PILOT)In the balanced sample, the treatment (control) groupcontains firms (never) participating in the pilot programconsecutively from 2011 to 2014

150 pilot stocks in the treatment groupIn the unbalanced panel, the treatment group includesfirms participating in the pilot program in any year after2011

189 firms in 2011193 firms in 2012411 firms in 2013478 firms in 2014

Univariate DiD tests on the balanced sample and OLSregressions on the unbalanced sample




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VariablesCSMAR

Dependent variables: Capex (capital expenditures) andCapex+R&D (the sum of capital and R&Dexpenditures), standardized by previous-year totalassets in percentageExplanatory variables

MarignBuy : total RMB remaining balance of marginbuying∆MarignBuy : the net change in purchases on marginSimilar for short selling

Control variables include market-to-book (M/B), cashflow, log(TA), profitability and financial leverageInstrumental variables (IV)

Ownership of leverage mutual funds for margin tradingIO, illiquidity, coverage, and turnover for short selling




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Summary StatisticsTreatment vs. Control Firms


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Summary StatisticsTreatment vs. Control Firms




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Empirical ResultsDifference-in-Difference Tests of Capital and R&D Expenditures


↗4% ↗2%

↗3% ↗1%



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Empirical ResultsDifference-in-Difference Regressions of Capital and R&D Expenditures


↗15% ↗13% ↗16% ↗14%



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Empirical ResultsEffects of Margin Trading on Capital and R&D Expenditures


We also tried to includemeasures for short-selling trading and theresults remain qualita-tively and quantitativelysimilar (Appendix B)



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2SLS RegressionsOwnership of Leveraged Mutual Funds as an Instrument

We use the fraction of leveraged mutual fund ownershipin a firm as an instrument for margin trading

Leveraged mutual funds are not related to active controlof the managers of a firm, since mutual funds aretypically passive investors neither related to activismnor related to informationInvestors can purchase leveraged mutual funds to meettheir sole leverage needs

1st Stage:Margin buyi,t = α1 + β1Mutual fundi,t + γ1Xi,t + εi,t

2nd Stage:CapExi,t = α2 + β2 Margin buy i,t + γ2Xi,t + ei,t




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2SLS RegressionsOwnership of Leverage Mutual Funds as an Instrument




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Three Underlying Channels1. Stock Price Informativeness

The first channel: the change in the informativeness ofstock pricesExplanatory variables

After the margin trading ban was lifted in 2010, there isan increase in price efficiency and a decrease in stockreturn volatilityChang et al. (2014), Wang & Wei (2017)

The pilot program enhances the liquidity and theinformation efficiency of stock prices, leading to moreefficient capital allocation, by providing more relevantinformation to managers that guide their investmentdecisions




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Three Underlying Channels2. Financing Costs

Hubbard (1998) suggests that investments of financiallyconstrained firms are less responsive to investmentopportunities because external financing is costlyRajan and Zingales (1998) find that industry sectorswith higher external financing needs grow faster incountries with more developed financial marketsThus, the benefit of a reduction in external financingcosts could be greater for financially constrained firmsIf the pilot program improves capital allocationefficiency by reducing external financing costs andrelaxing external financial constraints, we expect thatthe effect is more pronounced for firms that have ahigher degree of financial constraints




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Empirical ResultsSample Partitioned by Financial Constraints


More significant effects for firmswith high financial constraintsusing Kaplan & Zingales (1997)



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Empirical ResultsSample Partitioned by Financial Constraints


More significant effects for firmswith high financial constraintsusing Whited & Wu (2006)



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Three Underlying Channels3. Cost of Debt

A more informative equity price and a higher level ofequity price can be associated with a lower cost of debt(Sunder 2004)Thus, a more efficient market price of equity helpsreduce the cost of raising external debt capitalIf this is the case that those firms that are included inthe pilot program can raise new debt capital moreeasily, the managers of pilot firms will be more likely toinvest in capital and R&D expenditures




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Empirical ResultsEffects on Corporate Financing


↗debt issues X

There are still many restrictions on equity financing and debtremains the primary instrument for raising capital in China



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Empirical ResultsEffects on Investment-Q Sensitivity


Investment becomesmore sensitive to Qhence investmentefficiency is improved(Chen et al. 2007;Foucault & Fresard2012)



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Conclusion

We identify the exogenous policy shock using therecent removal of margin trading bans in China, whichaffects the real economy by reducing firms’ financingconstraints and costs of capitalWe show the positive association between margintrading and corporate investments, and the magnitudeof the effect is greater among firms that have a higherdegree of financing constraintsThis study suggests the direction of growth-orientedreform policies in China: relaxing external financingconstraints to allow capital to flow to the bestinvestment opportunities


margin trading and corporate investments: evidence from a ......margin trading and short selling to...

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