How to survive and compete: the impact of information asymmetry on productivity

This paper studies the impact of information asymmetry on productivity through the foreign direct investment (FDI) channel. Higher information asymmetry (lower transparency) could increase the information cost for investors to distinguish between good and bad investments and thus impede investment, particularly, FDI in which investors are “information disadvantageous of alien”. FDI is an important determinant of productivity growth. Naturally, we connect the two key economic variables and study the influence of information asymmetry on productivity through the channel of FDI. We use data from China’s publicly listed manufacturing firms. Based on a market micro-structure model, we estimate the unobserved information asymmetry using the probability of informed trading (PIN). We estimate the unobserved firm-level productivity using the proxy variable method, assuming that the evolution of productivity is not exogenous but can be shifted by FDI. We find that information asymmetry affects the productivity of domestic firms both positively and negatively, depending on firms’ technology-intensity. When domestic firms are technology-intensive, they can benefit from the knowledge spillovers of FDI. In that case, we find lower information asymmetry, associated with more FDI, results in higher productivity. When domestic firms are non-technology-intensive, they can be hurt by the foreign competition. In this case, we find that lower information asymmetry results in lower productivity.