Is Financial Globalization in Reverse after the 2008 Global Financial Crisis? Evidence from Corporate Valuations

Craig Doidge is Professor of Finance at the University of Toronto; G. Andrew Karolyi is the Harold Bierman, Jr. Distinguished Professor of Management at the Cornell University SC Johnson Graduate School of Management; and René M. Stulz is the Everett D. Reese Chair of Banking and Monetary Economics at the Fisher College of Business at The Ohio State University. This post is based on their recent paper.

Before the 2008 global financial crisis (GFC), it seemed that financial globalization was increasing inexorably. For financial economists, one natural indicator of financial globalization is the extent to which similar firms are valued similarly across the globe. In a world of perfectly integrated financial markets, the same firm should be valued the same everywhere. Before the GFC, valuations had not fully converged, but there is much evidence that the forces of globalization affected valuations, if not across the globe, then at least within the world of developed economies.

In our paper, Is Financial Globalization in Reverse after the 2008 Global Financial Crisis? Evidence from Corporate Valuations?, available at SSRN, we investigate whether the forces of financial globalization weaken after the 2008 global financial crisis (GFC) by assessing how the valuations of non-US firms evolve relative to the valuations of comparable US firms from before to after the GFC. Our evidence says that financial globalization is indeed in reverse after the 2008 global financial crisis but not necessarily in a way one may have expected.

To investigate how the valuations of non-US firms evolve relative to the valuations of comparable US firms, we use the Tobin’s q ratio, a widely used valuation metric. We estimate Tobin’s q using the ratio of the market value of a firm’s asset divided by the book value of the firm’s assets. We regard a large and persistent valuation difference between non-US and otherwise equivalent US firms as a measure of global financial market segmentation. Before the GFC, US firms have higher valuations than comparable non-US firms. We call this valuation difference the “valuation gap” of non-US firms. With Tobin’s q, the valuation gap can change because the numerator and/or the denominator of q changes. The numerator is the present value of cash flows to capital providers and the denominator is the book value of assets. The present value of cash flows can change because of changes in discount rates and/or changes in expected cash flows.

We compute valuation gaps from panel regressions of Tobin’s q valuation ratios annually for nearly 20,000 firms from 52 countries around the world from 2001 to 2018 on firm- and country-level fundamentals. To test whether the valuation gap changes from before to after the GFC, we use a pre-GFC period from 2001 to 2007 and a post-GFC period from 2010 to 2018. The valuation gap does not change significantly from before to after the GFC. Every year, non-US firms are valued less than comparable US firms. However, the evolution of this valuation gap is strikingly different for firms from developed markets (DMs) compared to those from emerging markets (EMs). The valuation gap widens for firms from DMs by 39.3% and narrows for firms from EMs by 38.8%. In other words, financial market integration advances for firms from EMs and reverses for firms from DMs. This finding suggests that financial globalization has gone in reverse among DMs, but has advanced among EMs.

An obvious issue with the sample of EMs is that China is much larger than any other EM by market capitalization and by firm counts. Moreover, China has strong barriers to international investment and its financial markets are mostly segmented from those of other countries, so that there is no reason for its firms to be valued like US firms. We examine whether our key results hold if we do not include China: the DM gap still increases significantly but the EM gap no longer decreases. Regardless, with or without China, the divergent post-GFC evolution of valuation gaps for DM and EM firms is robust and statistically significant. These results hold if we capitalize (rather than expense) research and development investment for US firms. They are also pervasive across industry sectors and firm types.

Historically, the cross-listing of shares (via American Depositary Receipts, ADRs, or directly) by non-US firms on major US exchanges has fostered financial globalization by enabling non-US firms to access US capital markets and US institutions that help to protect shareholders. As more firms cross-list their shares in the US, there can be a spillover impact on other firms within the same country, so cross-listings help spur on greater capital inflows and thus advance financial integration. We investigate whether the valuation gap of non-US firms cross-listed on US exchanges evolves differently from the valuation gap of non-US firms that are domestically-listed, local firms.

We find that, on average, cross-listed firms are never valued less than comparable US firms. We also show that there is no significant change in the valuation gap for cross-listed firms from before the GFC to after. These results hold for both firms from DMs and EMs. These different results for cross-listed non-US firms relative to their domestically-listed, local peers prompt us to assess the “cross-listing premium,” which is the higher valuation of a non-US firm cross-listed on a US stock exchange relative to a comparable local firm. The cross-listing premium is positive and remains intact post-GFC. There is no statistically significant change in the cross-listing premium for DM or EM firms.

Cross-listed firms continue to be valued at a premium to local firms from their respective home markets. So, one remaining possible explanation for our findings concerning the valuation gap is that firms are simply not taking advantage of cross-listings as they once did, sot that the role of a US cross-listing as an integrating mechanism is now diminished. Indeed, the propensity of non-US firms to cross-list in the US decreases sharply, and in both DMs and EMs, consistent with a decrease in their economic importance. We interpret this decrease in the propensity to cross-list as more evidence of a reversal in financial globalization. If cross-listed firms continue to be valued at a premium to local firms and if their valuations, as a result, are closer to those of comparable US firms, having proportionately fewer cross-listed firms overall means that non-US countries have fewer firms with valuations closer to those of similar US firms. This, in turn, would lead to an increase in the valuation gap.

The complete paper is available here.

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