The impact of stock market liberalization on corporate diversification: evidence from China

Exploiting the introduction of the Shanghai-Hong Kong Stock Connect (SHKC) program as a shock to the liberalization of China’s stock market, we employ a difference-in-differences (DiD) model to investigate the effect of stock market liberalization on the level of corporate diversification. Our baseline results show that stock market liberalization is associated with a lower level of corporate diversification. The decline in controlling shareholder tunneling and information asymmetry are two plausible mechanisms through which stock market liberalization diminishes corporate diversification. Further analyses show that the impact of stock market liberalization is more pronounced for firms located in regions with weak law enforcement and for non-state-owned enterprises. Moreover, we rule out alternative explanations that the relaxation of financial constraints and the reduction of agency costs between managers and shareholders discourage firms from pursuing diversification. Overall, this study sheds light on how stock market liberalization shapes corporate business strategy in emerging markets.