STOCK MARKET LIBERALIZATION AND THE COST OF EQUITY CAPITAL: AN EMPIRICAL STUDY OF JSE LISTED FIRMS

The main objective of the study has been to provide new insights into ongoing recent studiesexamining the impact of stock market liberalization at both macro and micro (firm) levels. Thestudy focused on a single country, South Africa, whose exchange, the Johannesburg StockExchange (JSE), liberalized in the 1990s. Consistent with empirical evidence from other studiesthe study finds support at market, firm and sectoral level for the prediction by international assetpricing models that stock market liberalization reduces the cost of capital. More important, thestudy makes five major contributions to the literature on the impact of stock market liberalizationin emerging markets.First, it demonstrates that some emerging market specific risks such as political and economicrisks can act stronger binding constraints to foreign investment than direct legal barriers whichforeign investors are frequently able to circumvent. The second contribution is the observationthat there are some firms (in the minority however) that will experience a significant increase inthe cost of capital following liberalization, a situation where the local price of risk is higher thanthe global price of risk, contrary to international asset pricing theory. The third contribution is thatit has been empirically proved that the reduction in firms’ cost of capital following stock marketliberalization is permanent. It is not a transitory phenomenon. The fourth contribution of the studyhighlights the influence of firm specific characteristics such as size of the firm, book-to-marketratios and leverage ratios on firms’ response to impact of stock market liberalization. Thepreference for large firms by foreign investors is supported, contrary to Merton’s (1987)recognition hypothesis, and hence highlights the inconclusiveness of the debate on whether stockmarket liberalization benefits both large firms and small firms. The fifth contribution is theobservation that the effective liberalization date is not the same for all firms but varies from firmto firm.