Capital market internationalization and equity financing costs: firm-level evidence from China

In recent years, the Chinese capital market has been increasingly integrated into the international capital market, although the level of integration remains low. We exploit the unique variations in China’s capital market integration to study the effect of capital market internationalization on the cost of equity financing. Using firm-level panel data from China, we measure capital market integration at the corporate level using the degree of co-movement between a company’s share price and the international capital market. After controlling for year effects and industry effects, we find that the growing integration of the capital market is significantly increasing Chinese companies’ equity financing costs. This surprising result still holds after controlling for the endogeneity problem. One possible explanation is the asymmetric approach of China’s capital market internationalization, i.e. while the Chinese capital market is increasingly open to international investors, it remains difficult for Chinese investors to invest abroad. Consequently, while international investors bring more risk into the Chinese market, domestic investors in China lack effective ways to diversify the risk in the global market. This additional source of non-diversifiable risk demands a higher return to capital, which raises the equity financing costs in China.