The impact of capital account liberalization measures

Int. Fin. Markets, Inst. and Money 22 (2012) 16–34

Contents lists available at ScienceDirect

Journal of International Financial Markets, Institutions & Money j ou rn al ho me pa ge : w w w . e l s e v i e r . c o m / l o c a t e / i n t f i n

The impact of capital account liberalization measures Chaiporn Vithessonthi a,∗, Jittima Tongurai b a

Mahasarakham Business School, Mahasarakham University, Khamriang, Kantarawichai, Mahasarakham 44150, Thailand NIDA Center for Integrated Tourism Management Studies, National Institute of Development Administration, Bangkapi, Bangkok 10240, Thailand b

a r t i c l e

i n f o

Article history: Received 1 May 2010 Accepted 4 July 2011 Available online 13 July 2011 JEL classification: F31 G14 G15 G32 Keywords: Abnormal returns Event studies Capital account liberalization Cost of capital Thailand

a b s t r a c t In this paper we analyze whether capital account liberalization leads to higher asset prices. Based on a sample of 242 non-financial firms listed on the Stock Exchange of Thailand at the time of the announcement of the relaxation of capital control in Thailand on January 29, 2007, we find positive and significant abnormal returns on Day −2, Day 1, and Day 3 relative to the announcement day. Our findings suggest that capital account liberalization favorably affects stock prices of firms, though the effect varies across industries. From a public policy perspective, our results suggest that liberalizing capital account by relaxing capital control measures could improve firm value in the short-term, which may, in turn, boost the level of economic growth in the long run. In addition, the results show that there is a significant fall in the mean beta in the post-liberalization period, thereby implying the lower cost of capital. © 2011 Elsevier B.V. All rights reserved.

1. Introduction Since the end of the 1980s, there have been an increasing number of developing countries that pursue the capital account liberalization, though subsequent policy shifts (i.e., the re-imposition of capital control and later the abolition of capital control) are often seen in these countries. As the literature on the effects of liberalization policy, specifically capital account liberalization, financial market liberalization and stock market liberalization, on economic growth, performance, efficiency, volatility, and domestic asset prices of emerging market economies has been growing (Chari and Henry, 2004; Edwards, 2001; Grilli and Milesi-Ferretti, 1995; Henry, 2000b; Kim and Singal, 2000; Patro and Wald,

∗ Corresponding author. Tel.: +66 43 754 333; fax: +66 43 754 422. E-mail addresses: [email protected] (C. Vithessonthi), [email protected] (J. Tongurai). 1042-4431/$ – see front matter © 2011 Elsevier B.V. All rights reserved. doi:10.1016/j.intfin.2011.07.003

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2005; Vithessonthi and Tongurai, 2008), we observe that prior studies are essentially limited to studying the first time liberalization and the results of empirical research are less conclusive. Accordingly, we attempt to fill a gap in the current literature by examining the microeconomic effects of a subsequent policy change from capital control to capital account liberalization that occurred in Thailand in 2007. Our paper compliments previous studies that test the effects of initial liberalization policy (in particular the first stock market liberalization) on equity prices of emerging market economies in Latin American and Asia (e.g., Chari and Henry, 2004; Henry, 2000b; Kim and Singal, 2000; Mitton, 2006; Patro and Wald, 2005). Two motivations give rise to this study. First, there are a number of developing countries that reimposed capital controls and reversed such policies at a later date. The cases of on-again, off-again capital account liberalization in developing countries are not rare. If the re-imposition of capital control policy permanently increases investors’ assessment of a country’s risk, it is likely that a subsequent foreign exchange policy change toward capital account liberalization would not significantly reduce risk premium, as a result an equity price revaluation in response to a policy reversal to capital account liberalization might not be as significant as expected. To the best of our knowledge, no research has been undertaken for the assessment of the effects of re-liberalization of capital account transactions. Second, an empirical study by Vithessonthi and Tongurai (2008), which has found that firms experience negative abnormal returns around the announcement of the imposition of capital control in Thailand in December 2006, stimulates us to explore further whether the policy reversal from capital control to capital account liberalization would create the opposite impact (i.e., positive abnormal returns) around the announcement date of the policy change. As an exploratory study in this line of research, we focus on a single country, Thailand, as a means to allow us to examine the repercussions of a monetary and foreign exchange policy change more precisely and lessen the problem of identifying liberalization dates that is normally faced in this line of research (e.g., Bekaert and Harvey, 2000; Henry, 2000a; Mitton, 2006). The objectives of this paper are two folded. First, by focusing on the firm level for all industries excluding financial services, we attempt to assess direction (positive or negative) and magnitude of the reactions of Thai stock market to the announcement of the foreign exchange policy change toward liberalization made on January 29, 2007. Our study thus provides empirical evidence, contributing to research on the effects of capital account liberalization at the firm level. Based on the standard CAPM, reactions to unanticipated policy changes are predicted to differ across industries (Bernanke and Kuttner, 2005). Our second objective is to capture industrial differences in reactions to such policy change by examining the effects of policy announcement toward capital account liberalization in various industry sectors. We find that positive abnormal returns around the capital account liberalization are observed for a short period of time, providing evidence that capital account liberalization in Thailand could be considered favorable information that increases firm value. The evidence of stock price reaction to the capital account liberalization at the industry level also provides some support to the notion that capital account liberalization is beneficial to firm value. However, we find that at the industry level, abnormal returns are not observed at the same time across industry subsamples. In addition, we do not observe significant abnormal returns for some industry subsamples, suggesting that in the view of the investors, capital account liberalization may benefit only firms in certain industries. 2. Literature review 2.1. Effects of capital account liberalization on economic growth and asset prices Although capital account liberalization is expected to offer economic benefits (e.g., allocating resources more efficiently, increasing opportunities to risk diversification, and promoting financial development) (Edison et al., 2004), opponents of capital account liberalization argue that liberalization, particularly in the countries that lack well-developed and well-supervised financial sectors, good institutions and governance, and sound macroeconomic policies, may not generate efficiency or trivial welfare benefits, but instead will induce speculative short-term capital flows that may exacerbate the adverse effects of negative shocks on economic growth and increase the likelihood of financial crises (Bhagwati, 1998; Cooper, 2000). Some scholars (Edwards, 1999a; Kose et al., 2009; McKinnon, 1991)

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suggest that capital account should only be liberalized after the domestic financial sector and labor markets had been reformed and after the liberalization of trade in goods had become consolidated. Research examining the impact of capital account liberalization on economic growth has begun in the late 1990s (see e.g., Bosworth and Collins, 1999; Edwards, 2001; Grilli and Milesi-Ferretti, 1995; Quinn, 1997). Nevertheless, the results are inconclusive. On the one hand, the study of Grilli and Milesi-Ferretti (1995) finds no evidence to suggest that capital account liberalization has a significant effect on growth of income per capita. On the other hand, the results of Quinn (1997), Bosworth and Collins (1999), and Edwards (2001) generally lead to the conclusion that capital account liberalization significantly raises economic growth. However, Edwards (2001) cautions that opening a country’s capital account at low levels of GDP will lower the growth. The literature on capital account liberalization, or a more narrow scope–stock market liberalization, primarily focuses on examining the effects of initial or first-time liberalization, which has occurred in emerging markets countries in the late 1980s (e.g., Bekaert and Harvey, 2000; Chari and Henry, 2004; Henry, 2000b, 2003, 2007; Mitton, 2006; Taskin and Muradoglu, 2003). The results of most empirical studies suggest that liberalization has a positive effect on developing economies through the decreased costs of capital and the increased returns (Bekaert and Harvey, 2000; Bekaert et al., 2005; Henry, 2000a,b; Kim and Singal, 2000; Klein and Olivei, 2008). More specifically, when the country liberalizes stock market, it can achieve better international risk sharing, which lowers the equity premium, and hence, reduces the cost of capital in the economy (Chari and Henry, 2004; Iwata and Wu, 2009). Nonetheless, capital account liberalization may not be permanent as we have witnessed instances that a country with financially liberated markets has re-imposed capital controls. The temporary capital controls were re-imposed in several emerging markets economies in the 1990s, for example, a restriction on capital outflows by the Malaysian authority in 1998 (Soo, 2005) and a control on capital inflows in Chile in 1991 (e.g., Edwards, 1999b; Forbes, 2007). The cases of on-again, off-again capital account liberalization in developing countries have not yet been fully explored. To the best of our knowledge, no research has been undertaken for the assessment of the effects of re-liberalization of capital account transactions. A study of Henry (2000b) is perhaps the only published article that investigates the effects of subsequent liberalizations after the initial liberalization. As most countries’ stock market liberalization is a process generally involved several liberalizations subsequent to the first, he has found that, on average, subsequent stock market liberalizations are associated with much less and statistically insignificant revaluations of stock prices than the first liberalization. There are two possible interpretations for the results (Henry, 2000b). First, if the subsequent liberalizations are anticipated at the time of the first stock market liberalization, the revaluation effects of the subsequent liberalizations would not be detectable. Second, if the first liberalization effectively integrates the domestic financial markets to the global market, subsequent liberalizations would provide minimal diversification benefits. It is worth noting that the implications of the swing of policies between capital control and liberalization (e.g., a scenario where capital controls were re-imposed and then removed) on stock prices have not been examined in the study of Henry (2000b) nor in other studies. 2.2. From capital control to its revocation: experience of Thailand Thailand began the process of capital account liberalization in the late 1980s (Xiaoke, 2003). By the end of 1991, foreign capital was allowed to move in and out of the country freely as foreign exchange regulations in the country were minimal and basically enforced in the area of capital outflow by Thai residents for outward portfolio and property investments, and for outward foreign direct investment. From then, there were two occasions that the controls on capital inflows were re-imposed. The first one occurred when the Bank of Thailand imposed a control in the form of seven percent unremunerated reserve requirement during 1995–1996 to address the issue of large capital inflows (Magud and Reinhart, 2006). As Thailand’s economic condition was deteriorating and financial crisis was looming, the control on capital inflows was, therefore, considered unnecessary. The monetary authorities’ policy thus shifted to the prevention of capital outflows. After the Thai economy recovered from the 1997 financial crisis, massive foreign capital started flowing into the country again, intensifying the pressure on the value of Thai baht, as seen in Fig. 1. Precipitous baht appreciation caused by persistent

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Fig. 1. Nominal exchange rates and capital flows of Thailand (January 2000–August 2008).

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and substantial capital inflows was seen as a crucial factor leading the Bank of Thailand to impose a control on capital inflows in the form of 30 percent unremunerated reserve requirement on December 18, 2006, to be effective on December 19, 2006 (Bank of Thailand, 2006a). It was the second occasion of the re-imposition of a control on capital inflows in Thailand. The capital control measure required that 30 percent of all foreign exchange transactions in the amount exceeding 20,000 US dollars, except those related to current account transactions (including trade in goods and services, and repatriation of investments abroad by residents) and foreign direct investment, be held in the form of non-interest-bearing deposit at the Bank of Thailand. The remaining 70 percent of funds was thus available for investment in Thailand. Investors would be able to withdraw the total amount of the withheld 30 percent of capital if they invested in Thailand for a period of one year or longer. Otherwise, one-thirds of the withheld funds would be confiscated, leaving only two-thirds of the amount being refunded to foreign investors. By nature, the unremunerated reserve requirement measure is designed to discourage short-term capital flows as it levies more heavily on short-term investors whose holdings of Thai assets (i.e., equity securities) are usually less than one year. Thus, the shorter the length of time that investment funds remain in Thailand, the higher the implicit tax burden will be. In spite of the intention of stabilizing foreign exchange rates in order to maintain competitiveness of Thailand’s exports, the Thai stock market reacted negatively to the capital control announcement (Vithessonthi and Tongurai, 2008). As evident in Fig. 2, there was a sharp fall of the SET index by 14.84 percent to close at 622.14 points on December 19, 2006 (the effective date of the capital control measure). The capital control announcement also had an immediate effect on equity flows. Compared to the monthly average net equity inflows of 328 million US dollars between July and November 2006, Thailand experienced net equity outflows of 814 million US dollars in December 2006. To address the stock market panic, the joint public announcement of the Bank of Thailand and the Ministry of Finance with the purpose of clarifying the implementation of unremunerated reserve requirement was made on December 20, 2006 (Bank of Thailand, 2006b). The announcement specified that equity investments in Non-voting Depository Receipts (NVDR), the Stock Exchange of Thailand (SET), and the Market for Alternative Investment (MAI), as well as investments in derivatives instruments traded on the Thailand Futures Exchange (TFEX) and the Agriculture Futures Exchange of Thailand (AFET) were exempted from the 30 percent unremunerated reserve requirement measure. The exemption however did not include investment in unit trusts, mutual funds and warrants. The announcement seems to appease the investors as we observe a bounce back of the SET index to close at 691.55 points on December 20, 2006 (see Fig. 2). The Bank of Thailand’s policy stance softened in 2007. It moved toward the relaxation of capital control that it announced on December 18, 2006 as we observe subsequent announcements that increasingly eased the unremunerated reserve requirement measure. To reduce the adverse effects of the unremunerated reserve requirement on financial costs of businesses that need to raise funds from abroad, the Bank of Thailand issued the announcement no. 5/2550 on January 29, 2007 (Bank of Thailand, 2007c) allowing businesses to fully hedge their foreign currency loans, debt issuance and credit packing with foreign exchange swaps or cross currency swaps as an alternative to unremunerated reserve requirement. The unremunerated reserve requirement measure was relaxed further by the Bank of Thailand’s announcement no. 13/2550 dated March 1, 2007 (Bank of Thailand, 2007d). Investors were given higher degrees of flexibility in holding securities for the period shorter than three months with a view to reinvesting in other types of debt securities, provided that the investment was fully hedged and deposited into a Special Non-residents Baht Account for Debt Securities and Unit Trusts (SND) with daily outstanding balance of not exceeding 300 million baht per non-resident. In addition, foreign investors were allowed to choose freely to comply with unremunerated reserve requirement or fully hedge their investments, provided that hedging must be in the forms of foreign exchange swaps or cross currency swaps with a maturity of three months or longer, and the swap contracts cannot be unwind and must be rolled over throughout the investment periods. The unremunerated reserve requirement measure was eased once again by the announcement no. 62/2550 issued by the Bank of Thailand on December 17, 2007 (Bank of Thailand, 2007e). Loans, investment in fixed income securities and mutual fund units were given a fully hedge option as an alternative to the reserve requirement. The reserve requirement on investments in equity-like securities, includ-

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11-day event window

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ing warrants and exchange traded fund (ETF) units, was waived. With the Bank of Thailand’s gradual relaxation of capital control and public comments of the new government of its stance on the removal of capital control since it took office on January 28, 2008, the capital control in the form of 30 percent unremunerated reserve requirement was expected to be revoked in the near future. Nonetheless, the market did not expect it to happen before the second half of 2008 (The Nation, 2008a,b). Sooner than did the market expect, the Bank of Thailand announced the lifting of the reserve requirement on shortterm capital inflows on February 29, 2008, to be effective on March 3, 2008 (Bank of Thailand, 2008). Since then, the control on capital inflows has no longer been implemented in Thailand and financial institutions can exchange foreign currencies against Thai baht from their customers in full amount without withholding 30 percent of foreign currencies as reserves in all cases. Through mechanisms that lead to the falling costs of investment and subsequently increasing returns on investment, we predict that, other things being equal, the announcement of policy change toward capital account liberalization will have a positive effect on the investment in domestic assets (e.g., stocks). According to international asset pricing model, capital account liberalization, which opens up domestic financial markets and removes investment barriers, will promote risk sharing between domestic and foreign investors, and thus reduce risk premium demanded by foreign investors (e.g., Alexander et al., 1987; Bonser-Neal et al., 1990; Henry, 2000b; Patro and Wald, 2005; Stulz, 1999). Holding expected future cash flows constant, a reduction in equity risk premium will lead to a fall in the cost of equity, and thus a revaluation of stock prices (Henry, 2000b, 2003; Patro and Wald, 2005). We therefore hypothesize that the announcement that implies a policy shift toward capital account liberalization being made for the first time on January 29, 2007 is likely to induce a reduction in the cost of equity leading to a one-time revaluation of stock prices. Specifically, firms in Thailand are likely to experience positive abnormal returns around the announcement of the capital account liberalization on January 29, 2007.

3. Data and methods 3.1. Data and sample selection Among the Bank of Thailand’s announcements that occurred between the announcement of reserve requirement on short-term capital inflows on December 18, 2006 and the announcement of lifting of the reserve requirement on short-term capital inflows on February 29, 2008, the announcement on January 29, 2007 was the first announcement that allowed firms and investors to choose between fully hedging their foreign exchange transactions or unremunerated reserve requirement (Bank of Thailand, 2007c). We choose the first announcement of capital account liberalization in Thailand on January 29, 2007 as our sample event because the market may consider the Bank of Thailand’s policy stance that permits a choice of foreign exchange hedging as softening and shifting toward liberalization. From the original list of 393 non-financial firms listed on the Stock Exchange of Thailand (SET) on the announcement date, we filter out IPO firms in 2006 as well as firms with infrequent trading (i.e., firms with more than 30 missing daily return data during the estimation period). The resulting sample consists of 242 firms for the event study analysis. To verify that the effects of the announcement of the capital account liberalization on January 29, 2007 are not confounded by other monetary and foreign exchange policy changes, we examine the announcements of the Bank of Thailand within a 16-day event window (Day −10 through Day 5) around the announcement of the first relaxation of capital control. There were two announcements issued by the Bank of Thailand during January 15, 2007 and February 5, 2007, as seen in Fig. 2. The announcement made on January 15, 2007 centered around the relaxation of exchange control regulations on capital outflows and holding of foreign currency (Bank of Thailand, 2007a). The announcement made on January 17, 2007 was to convey the Monetary Policy Committee’s decision in changing the policy rate from 14-day repurchase rate to 1-day repurchase rate together with a cut of the policy rate by 25 basis points. After half a year of maintaining the policy rate at 5 percent per annum, the rate was cut to 4.75 percent (Bank of Thailand, 2007b). We therefore decide to narrow down the event window to 10 days (Day −5 through Day 5) around the announcement of the first relaxation of capital control. We confirm that there was no change in monetary and foreign

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exchange policies within the range of our new event window (January 22, 2007 and February 5, 2007) that may confound the effects of our study. 3.2. Event study methodology Examining how asset prices react to new information is challenging. Bernanke and Kuttner (2005), Rigobon and Sack (2004), and Farka (2009) suggest that examining the effect of monetary policy decisions on stock prices are complicated by two main issues. First, the endogeneity problem, arising from the interaction between stock prices and monetary policy decisions, may result in biased estimates. Second, a number of other variables such as relevant information released around the announcement of monetary policy decisions are likely to influence asset prices. Both issues have significantly complicated the estimation of the reaction of asset prices to monetary policy decisions. The endogeniety issue can be addressed by using daily and intraday data when there is only one monetary policy decision during the announcement date (Bernanke and Kuttner, 2005; Farka, 2009). Given that there was only one announcement of the capital account liberalization measures during the course of a day, the endogeneity problem, arising from the interaction between stock prices and the capital account liberalization, is less likely to occur. Therefore, we can use a daily data set to address the endogeneity issue in our study. Several scholars (e.g., Barclay and Litzenberger, 1988; Bernanke and Kuttner, 2005; Farka, 2009) suggest that an event window must be sufficiently small to minimize the confounding effects, and that a high frequency data set (e.g., intraday data) can address the omitted variable bias and may be appropriate when investors can quickly digest the new information. Due to the unavailability of intraday data we follow the approach used by Bernanke and Kuttner (2005) by focusing on a short event window so as to minimize the confounding effects that may occur due to the omitted variables (e.g., firm-specific relevant information) during the event window. We readily admit that a caveat to this approach is that we would not be able to examine the long-term impact of capital account liberalization on asset prices. When there are several factors that may influence asset prices, lengthening the event window to capture the long-term effects of capital account liberalization on equity prices would invalidate the event study assumption and compound the omitted variable bias. In light of this discussion, we therefore focus on examining the short-term impact of capital account liberalization on asset prices. The test procedure in this study follows the event study methodology, which is common in financial research (Barclay and Litzenberger, 1988; Brown and Warner, 1985), to measure abnormal stock returns for sampled firms around the announcement of foreign exchange policy change toward liberalization. We use the market model to estimate expected stock returns for the sampled firms. According to the market model, the return on an individual stock is linearly related to the market return as follows: rit = ˛i + ˇi rmt + εit

(1)

where rit and rmt are the daily stock returns for firm i and the value-weighted market portfolio on day t, respectively, ˛i and ˇi are the firm-specific parameters of the market model, and εit is a disturbance term for stock i in t. Consistent with most studies using the event study method, the period of 240 days before the start of the event window (i.e., Day −250 through Day −11) is chosen as the estimation period, which provides us approximately a one-year’s worth of trading activity. Using the parameter estimates from the ordinary least square (OLS) regression, we estimate the daily returns for each firm over the event period, covering a period of 5 days prior to the announcement date and 5 days after the announcement date (i.e., t = −5 through t = 5 relative to the event date). The daily firm-specific abnormal return (ARit ) is measured as the difference between the firm’s actual daily stock return and the stock return predicted by the market model using the estimated parameters. The firm’s actual daily return is measured by taking the natural logarithm of the firm’s close price on day t divided by the firm’s close price on day t − 1. Following prior studies (Brown and Warner, 1985), we also calculate the cumulative abnormal returns (CARs) of each security to capture shareholder wealth effects attributable to the announcement of the relaxation of capital control.

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After calculating the abnormal return, we estimate the standardized abnormal return (SARit ) by dividing the abnormal return for firm i on day t during the announcement period by the standard error of the forecast. Then, we calculate the total standardized abnormal return (TSAR) for each day in the event period by aggregating the SAR across all firms. To test whether the abnormal return for each day in the event window is equal to zero, we use the following test statistics: Z-statisticst =



TSARt

N [(Di i=1

(2)

− 2)/(Di − 4)]

where TSARt denotes the total standardized abnormal return for each day in the event window, Di denotes the number of observed trading day returns for firm i over the estimation period, and N represents the number of firms in the sample. To test whether the cumulative abnormal returns between the event period D and Dk are equal to zero, we use the following test statistics: Zt =



 1  N 0.5

t=



SARit

(( −  + 1)((Di − 2)/(Di − 4)))

0.5

(3)

where N denotes the number of firms in the sample, SARit represents the SAR for firm i for each day in the event window,  and k are set at the earliest date in the event window (Day −5) and the later date in the event window (i.e., ranges from Day −5 through Day 5) respectively, and Di denotes the number of observed trading day returns for firm i over the estimation period. From the methodological perspective, it is crucial to note that a “zero” abnormal return does not necessarily imply that the liberalization does not affect stock prices. There are several scenarios that the “zero” abnormal returns may exist. For instance, suppose the market model perfectly predicts stock prices. The zero abnormal return can be expressed: ARit = rit − rˆit = 0

(4)

where rit and rˆit denote actual and expected returns, respectively. Eq. (4) can be rewritten and rearranged as ˆ mt ) = (˛ − ˛ ˆ mt = 0 ˆ + ˇr ˆ i ) + (ˇ − ˇ)r (˛ + ˇrmt ) − (˛

(5)

ˆ denote estimated ˆ and ˇ where ˛ and ˇ denote actual parameters of the market model at time t and ˛ parameters of the market model. ˆ m,t = 0, the abnormal return is then zero. In this case, it is crucial When (˛ − ˛) ˆ = 0 and (ˇ − ˇ)r that the parameters estimated from the market model (using past returns) must be identical to the actual parameters at time t (e.g., the announcement date); otherwise, the abnormal return would be non-zero when the market return is non-zero. We have shown that in a case of the “zero” abnormal return under the condition of the perfect market model, the fact that market return is non-zero does not imply that the liberalization does not affect stock prices. If the liberalization exerts an effect on the risk (and the cost of capital), the actual beta should be different from the estimated beta. 4. Results and discussion Table 1 provides the results of the event study that calculates abnormal returns (ARs) and cumulative abnormal returns (CARs) for the sample firms around the announcement of capital account liberalization in Thailand on January 29, 2007. The abnormal return on the announcement date has the expected sign but is not statistically significant. However, the abnormal return on Day −2 is positive and statistically significant (p-value = 0.001), whereas the abnormal return on Day 1 is also positive and statistically significant (p-value = 0.069). In addition, the abnormal return on Day 3 is also positive and statistically significant (p-value = 0.001). Although we do not observe the significant abnormal return on the announcement date, the results presented in Table 1 suggest that stock prices react positively around the announcement of capital account liberalization. The results in Table 1 also show that the CARs for several periods are statistically significant. For instance, the CAR for a seven-day period (−5, 1) is 1.10 percent and statistically significant (p-value = 0.074), whereas the CAR for an eight-day

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Table 1 Abnormal returns for sampled firms around the capital account liberalization announcement in Thailand (n = 242). Time

Abnormal return (%)

Z-statistic

p-value

Cumulative abnormal return (%)

Z-statistic

p-value

% Positive abnormal return

−5 −4 −3 −2 −1 0 1 2 3 4 5

−0.137 0.091 −0.196 0.660 0.254 0.049 0.379 0.212 0.610 −0.171 0.270

−0.342 −0.167 −1.033 3.205 1.176 0.074 1.820 1.208 3.393 −0.517 1.260

0.733 0.868 0.302 0.001 0.240 0.941 0.069 0.227 0.001 0.605 0.208

−0.137 −0.046 −0.242 0.418 0.672 0.721 1.100 1.312 1.922 1.751 2.021

−0.342 −0.360 −0.890 0.832 1.270 1.189 1.789 2.100 3.111 2.788 3.038

0.733 0.719 0.374 0.405 0.204 0.234 0.074 0.036 0.002 0.005 0.002

50.41 57.85 34.30 59.50 55.79 55.37 57.85 52.48 56.20 37.60 47.93

period (−5, 2) is 1.31 percent and statistically significant (p-value = 0.036). These results suggest that when a country’s foreign exchange policy becomes more liberal, the market is likely to revise upwards the value of the firms, potentially with a view that the cost of capital for local firms will be lower as a consequence of an expected surge of foreign capital inflows and a reduction of equity risk premium. To examine whether the evidence of the positive abnormal returns around the announcement of capital account liberalization reflect an irrational overreaction that will eventually disappear (or reverse), we run additional tests of the CARs for longer event window periods (up to Day 60). For the sake of brevity, we do not present all the results (available upon request). The findings show that CARs appear to be positive and statistically significant up to Day 17. That is, the CAR for a 23-day period (−5, 17) is 2.21 percent and statistically significant (p-value = 0.081). In addition, CARs from (−5, 18) to CARs (−5, 45) are generally positive but statistically insignificant. Given that a period of 17 days after the announcement is long enough for the investors to reflect on the news and stock prices to properly adjust, the evidence of the positive CAR (−5, 17) suggests that a positive stock price reaction to the liberalization does not appear to be an artifact of the overreaction of the investors. Although capital account liberalization (and capital market liberalization in a narrower sense) should promote economic growth (Bekaert et al., 2005), the effect of capital account liberalization on firms may vary for several reasons. First, the effect of capital account liberalization on domestic interest rates may influence the timing of and magnitude of changes in revenue differently across firms in different industries. A change in interest rates as a result of capital account liberalization is unlikely to have the same effect on the buying decisions of durable and non-durable products. Second, firms with immediate need of external financing should benefit more from an expected fall in interest rates than firms that do not need additional financing in a near future. Thus, we should expect that the effect of the announcement of capital account liberalization depend on how capital account liberalization affects revenues and costs of firms. Furthermore, empirical research provides evidence to suggest that the effect of financial liberalization on stock prices depends on firm characteristics such as firm size (see e.g., Christoffersen et al., 2006; Patro and Wald, 2005). To explore the effects of a capital control policy change in different industry environment, we spilt our sample into seven industry subsamples. Table 2 reports abnormal returns and cumulative abnormal returns for the agro and food industry subsample with a sample size of 20 firms. The abnormal return on the announcement date for the agro and food industry subsample has a positive sign but is not statistically significant. We only observe a positive and significant abnormal return of 0.71 percent on Day 3 (p-value = 0.087) and a negative and significant abnormal return of 1.20 percent on Day 4 (p-value = 0.006). In addition, the CARs for the agro and food industry subsample are not significant. Table 3 reports abnormal returns and cumulative abnormal returns for the consumer products industry subsample with a sample size of 13 firms. The results reported in Table 3 reveal that the abnormal return on the announcement date is slightly positive, albeit statistically insignificant. However, we observe the positive and significant abnormal returns of 1.42 percent and 0.58 percent on Day 1 and Day 2, respectively (p-values = 0.064 and 0.095, respectively). As with the agro and food industry subsample, the abnormal return for the consumer products industry subsample on Day 4 is

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Table 2 Abnormal returns for the agro & food industry subsample around the capital account liberalization announcement in Thailand (n = 20). Time

Abnormal return (%)

Z-statistic

p-value

Cumulative abnormal return (%)

Z-statistic

p-value

% Positive abnormal return

−5 −4 −3 −2 −1 0 1 2 3 4 5

−0.353 0.381 −0.616 0.544 0.547 0.033 −0.357 −0.096 0.706 −1.199 −0.481

−0.610 0.823 −1.328 0.879 1.209 0.303 −0.886 −0.174 1.712 −2.748 −1.113

0.542 0.411 0.184 0.379 0.227 0.762 0.376 0.862 0.087 0.006 0.266

−0.353 0.028 −0.588 −0.044 0.504 0.537 0.180 0.083 0.789 −0.410 −0.891

−0.610 0.151 −0.644 −0.118 0.435 0.521 0.148 0.076 0.643 −0.259 −0.583

0.542 0.880 0.520 0.906 0.663 0.602 0.883 0.939 0.520 0.795 0.560

40.00 100.00 5.00 70.00 70.00 40.00 55.00 50.00 65.00 20.00 45.00

Table 3 Abnormal returns for the consumer products industry subsample around the capital account liberalization announcement in Thailand (n = 13). Time −5 −4 −3 −2 −1 0 1 2 3 4 5

Abnormal return (%)

Z-statistic

p-value

Cumulative abnormal return (%)

Z-statistic

p-value

% Positive abnormal return

−0.407 0.398 −0.516 0.528 0.106 0.128 1.424 0.584 1.025 −1.452 −0.416

−0.383 0.541 −0.774 −0.743 −0.273 0.269 1.855 1.667 1.505 −2.966 −0.940

0.702 0.589 0.439 0.458 0.785 0.788 0.064 0.095 0.132 0.003 0.347

−0.407 −0.009 −0.524 0.004 0.110 0.237 1.662 2.245 3.271 1.819 1.403

−0.383 0.112 −0.356 −0.680 −0.730 −0.557 0.186 0.763 1.221 0.221 −0.073

0.702 0.911 0.722 0.497 0.465 0.578 0.853 0.445 0.222 0.825 0.942

69.23 100.00 0.00 46.15 61.54 69.23 69.23 76.92 61.54 0.00 46.15

−1.45 percent and statistically significant (p-value = 0.003). However, none of the CARs is statistically significant. These results provide moderate support to the argument that capital account liberalization positively affects stock prices. Table 4 reports abnormal returns and cumulative abnormal returns for the industrials industry subsample with a sample size of 41 firms. At first glance, the results in Table 4 reveal that none of the abnormal returns, except the one on Day −4, is statistically significant. In the same vein, the CARs for all periods, except CAR (−5, −4) and CAR (−5, −1), are statistically insignificant. These results do not Table 4 Abnormal returns for the industrials industry subsample around the capital account liberalization announcement in Thailand (n = 41). Time

Abnormal return (%)

Z-statistic

p-value

Cumulative abnormal return (%)

Z-statistic

p-value

% Positive abnormal return

−5 −4 −3 −2 −1 0 1 2 3 4 5

−0.433 −0.267 −0.168 −0.128 −0.158 −0.085 −0.131 0.324 0.219 −0.431 0.759

−1.063 −1.485 −0.347 −0.415 −0.630 0.088 0.461 0.743 0.185 0.238 1.436

0.288 0.138 0.729 0.678 0.529 0.930 0.645 0.457 0.853 0.812 0.151

−0.433 −0.699 −0.867 −0.995 −1.153 −1.238 −1.369 −1.045 −0.826 −1.257 −0.498

−1.063 −1.801 −1.671 −1.654 −1.762 −1.572 −1.281 −0.936 −0.821 −0.703 −0.238

0.288 0.072 0.095 0.098 0.078 0.116 0.200 0.349 0.412 0.482 0.812

48.78 58.54 39.02 34.15 46.34 58.54 51.22 53.66 48.78 34.15 48.78

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Table 5 Abnormal returns for the property and construction industry subsample around the capital account liberalization announcement in Thailand (n = 74). Time

Abnormal return (%)

Z-statistic

p-value

Cumulative abnormal return (%)

Z-statistic

p-value

% Positive abnormal return

−5 −4 −3 −2 −1 0 1 2 3 4 5

−0.036 −0.286 −0.464 1.111 0.286 −0.232 0.424 0.054 1.151 0.161 0.008

0.644 −0.776 −1.154 2.681 0.971 −1.094 1.386 0.020 3.513 1.337 −0.476

0.519 0.438 0.249 0.007 0.331 0.274 0.166 0.984 0.000 0.181 0.634

−0.036 −0.322 −0.786 0.325 0.611 0.379 0.803 0.856 2.007 2.168 2.176

0.644 −0.093 −0.742 0.698 1.059 0.520 1.005 0.947 2.064 2.381 2.127

0.519 0.926 0.458 0.485 0.290 0.603 0.315 0.344 0.039 0.017 0.033

54.05 44.59 29.73 70.27 56.76 54.05 60.81 50.00 67.57 51.35 40.54

support the notion that the market reacts positively to capital account liberalization. The evidence of insignificant abnormal returns for the firms in the industrials industry suggests that the effect of capital account liberalization is less important than the positive effect associated with capital account liberalization on firms in other industries. Table 5 reports abnormal returns and cumulative abnormal returns for the property and construction industry subsample with a sample size of 74 firms. The results provide some evidence to suggest that the market reacts positively to the announcement of capital account liberalization. Specifically, the abnormal return on Day −2 is 1.11 percent and statistically significant (p-value = 0.007), and the abnormal return on Day 3 is 1.15 percent and statistically significant (p-value = 0.000). However, the results reveal that the abnormal return on the announcement date is negative, albeit statistically insignificant. Table 5 also shows that the CAR for a nine-day period (−5, 3) is 2.01 percent and statistically significant (p-value = 0.039). Likewise, the CARs for a 10-day period (−5, 4) and for an 11-day period (−5, 5) are positive and statistically significant (p-values = 0.017 and 0.033, respectively). Overall, these results imply that firms in the property and construction industry benefit from capital account liberalization. Table 6 reports abnormal returns and cumulative abnormal returns for the resources industry subsample with a sample size of 18 firms. The results do not provide support to the notion that capital account liberalization positively affects stock prices of firms in the resources industry. Specifically, none of the abnormal returns is statistically significant. Similarly, none of the CARs is statistically significant. Taken together, these results do not confirm the existence of strong reaction of the resources stocks to the announcement of capital account liberalization. It is plausible that these firms are more resilient to changes in interest rates because energy prices, rather than marginal changes in interest rates, are likely to influence the overall consumption of energy, which is the factor that largely Table 6 Abnormal returns for the resources industry subsample around the capital account liberalization announcement in Thailand (n = 18). Time

Abnormal return (%)

Z-statistic

p-value

Cumulative abnormal return (%)

Z-statistic

p-value

% Positive abnormal return

−5 −4 −3 −2 −1 0 1 2 3 4 5

−0.433 0.428 0.701 0.593 −0.535 0.173 0.109 0.199 −0.107 −0.565 0.125

−0.527 0.666 1.854 1.106 −1.312 1.102 0.004 0.928 −0.420 −1.355 0.352

0.598 0.505 0.064 0.269 0.189 0.271 0.997 0.353 0.675 0.176 0.725

−0.433 −0.005 0.696 1.289 0.754 0.927 1.036 1.234 1.128 0.563 0.688

−0.527 0.099 1.151 1.550 0.799 1.179 1.093 1.351 1.134 0.647 0.723

0.598 0.921 0.250 0.121 0.424 0.238 0.274 0.177 0.257 0.517 0.470

44.44 55.56 66.67 55.56 22.22 66.67 55.56 66.67 44.44 27.78 44.44

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Table 7 Abnormal returns for the services industry subsample around the capital account liberalization announcement in Thailand (n = 49). Time

Abnormal return (%)

Z-statistic

p-value

Cumulative abnormal return (%)

Z-statistic

p-value

% Positive abnormal return

−5 −4 −3 −2 −1 0 1 2 3 4 5

0.011 0.675 −0.013 1.019 0.327 0.296 1.015 0.609 0.244 −0.409 0.354

0.257 0.902 −0.496 2.888 0.612 0.075 1.593 1.287 0.675 −0.701 1.268

0.797 0.367 0.620 0.004 0.540 0.940 0.111 0.198 0.500 0.483 0.205

0.011 0.686 0.673 1.692 2.019 2.315 3.330 3.939 4.183 3.774 4.128

0.257 0.819 0.382 1.775 1.862 1.730 2.204 2.517 2.598 2.243 2.521

0.797 0.413 0.702 0.076 0.063 0.084 0.028 0.012 0.009 0.025 0.012

48.98 53.06 36.73 67.35 69.39 57.14 63.27 55.10 44.90 36.73 44.90

affects operating performance of firms in the resources industry. Therefore, the expected lower interest rates may not have a significant impact on the revenue stream of these firms. If the investors do not expect these firms to seek additional external financing in short- and medium-term to fund new capital investments, then the observed insignificant abnormal returns would support the view that these firms are unlikely to benefit from expected lower costs of capital. Table 7 reports abnormal returns and cumulative abnormal returns for the services industry subsample with a sample size of 49 firms. The results reported in Table 7 reveal that the abnormal return on Day −2 is 1.02 percent and statistically significant (p-value = 0.004). In addition, none of the abnormal returns on other days in the event window is statistically significant. However, we observe positive and significant CARs for many periods. For instance, the CAR for a six-day period (−5, 0) is 2.32 percent and statistically significant (p-value = 0.084), while the CAR for a seven-day period (−5, 1) is 3.33 percent and statistically significant (p-value = 0.028). On the basis of the positive and significant CARs, there is evidence to support the notion that firms in the services industry appear to benefit from capital account liberalization. Given the mixed findings, the interpretation of these results must be made with caution. Table 8 presents abnormal returns and cumulative abnormal returns for the technology industry subsample with a sample size of 27 firms. As can be seen in Table 8, the abnormal return on Day −1 is 0.93 percent and statistically significant (p-value = 0.079). In addition, the abnormal returns on Day 4 and Day 5 are positive and statistically significant. Table 8 also reveals that the CAR for an 11-day period (−5, 5) is 4.43 percent and statistically significant (p-value = 0.028). Thus, these results showing that firms in the technology industry benefit from capital account liberalization provide some support to our prediction. Table 8 Abnormal returns for the technology industry subsample around the capital account liberalization announcement in Thailand (n = 27). Time

Abnormal return (%)

Z-statistic

p-value

Cumulative abnormal return (%)

Z-statistic

p-value

% Positive abnormal return

−5 −4 −3 −2 −1 0 1 2 3 4 5

0.243 0.167 −0.221 0.142 0.927 0.551 0.098 −0.217 0.646 1.193 0.901

0.108 0.213 −0.330 0.499 1.757 0.803 −0.023 −0.706 1.113 1.855 1.985

0.914 0.832 0.741 0.618 0.079 0.422 0.982 0.480 0.266 0.064 0.047

0.243 0.410 0.189 0.331 1.258 1.809 1.907 1.690 2.336 3.529 4.430

0.108 0.227 −0.005 0.245 1.005 1.245 1.144 0.821 1.145 1.673 2.193

0.914 0.821 0.996 0.807 0.315 0.213 0.253 0.412 0.252 0.094 0.028

44.44 55.56 48.15 51.85 48.15 51.85 51.85 33.33 59.26 37.04 70.37

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Table 9 Abnormal returns, using the adjusted closing prices, for sampled firms around the capital account liberalization announcement in Thailand (n = 242). Time

Abnormal return (%)

Z-statistic

p-value

Cumulative abnormal return (%)

Z-statistic

p-value

% Positive abnormal return

−5 −4 −3 −2 −1 0 1 2 3 4 5

0.699 0.178 −1.490 0.995 1.074 0.203 −0.084 0.094 0.138 −1.355 1.450

4.885 0.433 −9.473 5.550 6.420 1.005 −0.822 0.343 0.207 −7.883 8.652

0.000 0.665 0.000 0.000 0.000 0.315 0.411 0.731 0.836 0.000 0.000

0.706 0.884 −0.606 0.389 1.463 1.666 1.582 1.676 1.813 0.459 1.909

4.885 3.760 −2.399 0.697 3.494 3.600 3.022 2.949 2.849 0.210 2.809

0.000 0.000 0.016 0.486 0.000 0.000 0.003 0.003 0.004 0.834 0.005

68.18 59.50 18.60 69.83 79.34 55.37 37.60 45.04 46.69 21.07 83.06

As a robustness test, we follow Michaely (1991) approach by adjusting the closing prices around the announcement date by the expected daily returns. Table 9 shows the results of the event study that calculates abnormal returns (ARs) and cumulative abnormal returns (CARs) for the sampled firms using the adjusted prices surrounding the announcement of capital account liberalization (for Days −5 to 5 relative to announcement date (Day 0)). With respect to abnormal returns around the announcement date, the pattern of new findings is similar to the results shown in Table 1. However, we observe that when using the adjusted prices, four days (out of five days) before the announcement date exhibit significant abnormal returns, where using the raw close price, only one day before the announcement date is a significant abnormal return. The results in Table 9 also show that abnormal returns on Days 4 and 5 are significant (negative and positive, respectively) and that the cumulative abnormal return (−5, 0) of 1.67 percent is significant (p-value = 0.000). By comparing the mean cumulative abnormal return over the 11-day event window (−5, 5) calculated with the closing prices (CAR (−5, 5) = 2.02%, p-value = 0.002) and that of the adjusted closing prices (CAR (−5, 5) = 1.91%, p-value = 0.005), one can observe that the results are almost indistinguishable. Taken together, the new results using the adjusted prices are generally consistent with our prior results (i.e., Table 1). There is an interesting question of whether the magnitude of the impact of liberalization after the re-imposition of capital control in Thailand on stock prices would be smaller than that of initial liberalization. Based on the empirical evidence found in the cross-country study of Henry (2000b), we expect that subsequent liberalizations should affect stock prices less than does the first liberalization. If the market considers the imposition of capital control on December 18, 2006 as a temporary measure and expects that the removal of capital control would be forthcoming in the near future, then it is less likely that a strong revaluation effect of liberalization will be observed at the time of the announcement of liberalization on January 29, 2007. The fact that there was a strong negative reaction to the imposition of capital control implies that either (1) the investors were irrational and overreacted to the capital control imposition if they expected the control to be soon removed or (2) the investors were rational and reacted to the news negatively because they simply did not expect that the policy will be reversed in the near future. Our findings raise many interesting questions that are worth exploring in future research. First, in addition to the difference in directions of market reactions on the announcement date (Day 0), specifically positive abnormal returns in agro & food, consumer products, resources, services, and technology sectors and negative abnormal returns in industrial and property & construction sectors on the announcement date, none of the results is statistically significant. For ease of illustration, we plot the abnormal returns for the full sample as well as for industry subsamples during the event window in Figs. 3–5. We observe that property & construction and services sectors have significant positive abnormal returns on Day −2, consumer products sector has significant positive abnormal returns on Day 1, agro & food and property & construction sectors have significant positive abnormal returns on Day 3. Market reactions to the announcement of capital account liberalization seem to vary across industries. Second, the timing of market reactions to the announcement of capital account

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2.00

Abnormal returns (%)

1.50 1.00 0.50 0.00 -5

-4

-3

-2

-1

0

1

2

3

4

5

-0.50 -1.00 -1.50 -2.00 full sample

agro & food

consumer products

industrials

Fig. 3. Abnormal returns for agro and foods industry subsample, consumer products industry subsample, industrials industry subsample, and full sample around the capital account liberalization announcement in Thailand.

liberalization that is statistically significant is also a puzzle. Taking the full sample as a benchmark, significant positive abnormal returns are evident in Day −2, Day 1 and Day 3. Among all industry sectors, only property & construction sector shows significant positive abnormal returns on Day −2 and Day 3 that are consistent with the full sample, though with higher magnitude of stock price reaction. Three industry sectors, including agro & food, consumer products, and services, show only one coincidental results with those of the full sample, again with greater magnitude. Industrials and technology sectors have no significant abnormal returns that coincide with the full sample and resources sector has no abnormal return results that are statistically significant. Third, the pattern of market reactions also needs further investigation. For example, fluctuation in abnormal returns of industrials sector, though

2.00

Abnormal returns (%)

1.50 1.00 0.50 0.00 -5

-4

-3

-2

-1

0

1

2

3

4

5

-0.50 -1.00 -1.50 -2.00 full sample

property&construction

resources

Fig. 4. Abnormal returns for property and construction industry subsample, resources industry subsample, and full sample around the capital account liberalization announcement in Thailand.

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2.00

Abnormal returns (%)

1.50 1.00 0.50 0.00 -5

-4

-3

-2

-1

0

1

2

3

4

5

-0.50 -1.00 -1.50 -2.00 full sample

services

technology

Fig. 5. Abnormal returns for services industry subsample, technology industry subsample, and full sample around the capital account liberalization announcement in Thailand.

quite moderate, does not move in tune with the full sample; changes in abnormal returns of property & construction, consumer products, and services sectors, though consistent with the benchmark, are overshooting than the full sample. As the event study approach, by design, is to measure the short-term effect of new information on asset prices, it is less appropriate to measure the long-term effect of capital account liberalization on the economy. To address an important question of whether capital account liberalization has the long-term effects on the cost of capital, we look at the effect of capital account liberalization on risk at the disaggregated level by examining whether there is a change in a measure of risk at the firm level. As Chari and Henry (2004) have found that stock market liberalization reduces the systematic risk and that the firm-specific changes in systematic risk directly affect firm-specific stock prices, the reversal of capital control should then lower the systematic risk and the firm-specific risk. As a beta coefficient from the capital asset pricing model can be used to measure individual securities’ risk (see e.g., Babcock, 1972; Bernardo et al., 2007; Boquist et al., 1975; Da and Warachka, 2009), we test whether there is a difference in the beta coefficients before and after the liberalization of capital control measures. If the capital account liberalization lowers the cost of capital, we should observe that there is a fall in the beta coefficients in the post-liberalization period. We measure the beta coefficient difference as a pre-liberalization beta coefficient minus a post-liberalization beta coefficient. The pre-liberalization beta coefficient is calculated from the market model using an estimation window of 240 days (i.e., from January 17, 2006 through January 12, 2007 – that is, from Day −250 through Day −11), while the post-liberalization beta is calculated from the market model using an estimation window of 240 days (i.e., from January 30, 2007 through January 21, 2008 – that is, from Day 1 through Day 240). A positive beta coefficient differential could be interpreted as a fall in the risk (and the cost of capital). We find that a mean beta coefficient before the liberalization is 0.848, a mean beta coefficient after the liberalization is 0.553, a mean beta coefficient difference is 0.295 (t-value = 11.227, p-value = 0.000), and a standard deviation of beta coefficient difference is 0.409. These results suggest that the average beta coefficient of firms during the post-liberalization period is lower than the average beta coefficient of firms during the pre-liberalization period. Based on this evidence, one may conclude that the liberalization of capital control measures has a negative effect on the risk (and the cost of capital), which was measured by the beta of the market model. However, given that the liberalization occurred only one month after capital control was implemented, we are uncertain whether a fall in the beta coefficient is attributable to the liberalization. The skeptics of capital market liberalization (e.g., Edwards, 2007; Edwards and Rigobon, 2009; Stiglitz, 2000, 2003) may argue that capital control, which plays a major

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role in promoting stability by changing the composition of capital inflows and by mitigating a risk of sudden capital flights (and external shocks), rather than capital account liberalization, in fact accounts for a fall in the risk. The effects of both policies on firm risk cannot be clearly identified because the timing of the imposition of capital control and the revocation of capital control is very short (i.e., within a period of 28 trading days), thereby making it difficult to conclude whether the observed evidence of a fall in the risk measured by the beta is associated with the imposition of capital control or the capital account liberalization. 5. Conclusion In summary, this research provides empirical evidence regarding the effects of capital account liberalization on firm value. In particular, we find that stock market reacts slightly positively to the announcement of capital account liberalization in Thailand on January 29, 2007. We also find evidence of positive abnormal returns on stocks in property and construction industry, services industry, and technology industry, but further examination suggests that these firms tend to exhibit abnormal returns prior to the announcement of capital account liberalization. The seemingly moderate gain around the announcement of capital account liberalization may be attributable to the fact that the market has been anticipating such announcement for several days. Contrary to the theory that all market participants learn about the future opening at the same time, information leakage prior to any official announcement is common in emerging markets (Henry, 2000b). Therefore, the market may not be completely surprised by the news, and thus makes it difficult for us to use the event study method to observe the evidence of excess returns around the announcement date. We can be reasonably certain that on the basis of the findings in this paper the market seems to react relatively stronger to capital control announcements than to capital account liberalization announcements. For instance, our finding suggests that the non-financial firms in Thailand exhibit a positive abnormal return of 0.66 percent on Day −2 relative to the announcement of capital account liberalization in Thailand (see Table 1), whereas Vithessonthi and Tongurai (2008), using a market model to estimate stock returns, find that the financial institutions exhibit a significant negative abnormal return of 0.79 percent and 1.26 percent on Day 1 and Day 2, respectively, relative to the announcement of capital control in Thailand in 2006. However, the comparison must be made with caution due to a different sample in the two studies. The sample in our study is non-financial firms, whereas the sample in their study consists of financial institutions. Nevertheless, an interesting question that arises is: why does capital account liberalization not affect stock prices as much as does capital control? One plausible explanation is that in the context of Thailand a certain component of country risk premium hike following the capital control in Thailand may remain unchanged even after the revocation of capital control because it is seen as compensation for greater foreign exchange policy uncertainty inherent in the country. In addition, it has been well documented in the literature that investors react asymmetrically to good and bad news (see e.g., Bernanke and Kuttner, 2005; Farka, 2009), suggesting that the finding of a positive but small reaction to the announcement of the liberalization in Thailand is consistent with prior studies reporting that good news tends to have a small effect on stock prices than bad news. Having documented the reaction of stock returns to the monetary authority’s capital account liberalization in previous section, we now turn to a more difficult and challenging question of what explains the observed response. There are three broad reasons why an unexpected change in foreign exchange policy (i.e., from a more restrictive foreign exchange policy to a more liberal foreign exchange policy), at least with respect to the timing of such change in the context of Thailand, may lead to a rise in stock prices: it may be associated with a rise in the expected future cash flows arising from increasing economic efficiency and growth after the liberalization (Chari and Henry, 2004; Patro and Wald, 2005), a decrease in the expected cost of capital used to discount those cash flows due to falling risk premium and risk free rates following the liberalization (Bekaert and Harvey, 2000; Chari and Henry, 2004; Henry, 2000b; Kim and Singal, 2000; Patro and Wald, 2005), or a decrease in the expected excess returns associated with holding financial assets as a result of greater levels of integration to the world market after the country liberalizes its financial markets (Chari and Henry, 2004). In this respect, the results of this study suggest the need for future research. Several important research questions could

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be posed based on the findings of this study. For example, although our findings reveal that there is a significant fall in the mean beta coefficient in the post-liberalization period (i.e., 240 days following the announcement date) that implies the lower cost of capital, the question of whether capital account liberalization benefit firms in the long run (e.g., one year or longer) remains unanswered.

Acknowledgements We are grateful for guidance and helpful comments from G. Geoffrey Booth (the editor) and three anonymous referees. We also thank Piman Limpaphayom and participants at the 2009 Financial Management Association Annual Meeting in Reno for their comments on earlier versions of this paper.

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