Foreign institutional investors and share pledging: Evidence from China's stock market openness reform

Abstract

This study explores the governing influence of foreign institutional investors (FIIs) on controlling shareholders' share pledging activities. The Shanghai–Hong Kong and the Shenzhen–Hong Kong Stock Connect programs represent exogenous shocks to Chinese stock market openness by introducing FIIs. Using a staggered difference-in-differences research design, our results demonstrate that stock market openness caused controlling shareholders at connected firms to be less likely to pledge shares and more likely to inject funds from pledging back into the underlying firm compared with controlling shareholders at unconnected firms. Additional analyses validate our conjecture that the monitoring role of FIIs diminishes connected firms' agency problems. Furthermore, the effects of stock market openness are more significant for nonstate-owned enterprises and firms in regions with strong institutional environments. The results of this study imply that FIIs can act as an effective governance mechanism in emerging markets to improve stock market integrity and protect minority investors.