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| ETF, Stock Liquidity, and Stock Price Crash Risk |
| ZHU Feifei, WU Weili, YANG Yunhong
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School of Finance, Central University of Finance and Economics;
Guanghua School of Management, Peking University |
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Abstract Financial innovation continually provides the impetus for financial development. Accelerating financial innovation is essential to advancing comprehensive financial reforms and can also be an effective catalyst for increasing resource allocation efficiency and propelling high-quality economic development. In the context of rapidly constructing a new development pattern and striving for high-quality growth in China, the question of how to balance the relationship between financial innovation and financial risk has become significant.
Exchange-traded funds (ETFs) are among the most popular and important financial innovations of recent years. However, although ETFs have proven to be valuable, they have had adverse effects on the stability of the financial market. For example, following the “flash crash” in the U.S. market on May 6, 2010, various publications such as the Kauffman Report attributed the cause of the stock price flash crash to the short selling mechanism of ETFs, and argued that ETFs exacerbate panic selling and trigger systemic risk. ETFs have become increasingly popular among investors in China. However, given the vast differences between China's A-share market and those of Western countries in terms of investor structure, trading systems, and corporate governance, whether financial innovations like ETFs may have unforeseen negative effects on underlying stocks and the financial market requires further examination.
Chinese listed companies play an essential role in maintaining the stability of the financial market through steady stock price development. However, stock price crashes are not uncommon. These crashes generally undermine shareholder rights and investor confidence, leading to a lack of stability in market operation. In a complex and interconnected financial system, the price plunge of a single stock can potentially trigger a domino effect damaging financial market stability. Against this backdrop of rapid ETF growth and frequent stock price crash risk, the question arises of whether the two phenomena are related. If ETFs exert a negative impact on the stock price crash risk of their constituent stocks, what are the underlying mechanisms？ These questions serve as crucial entry points for exploring the relationship between financial innovation and financial risk.
Thus, in this study we investigate non-financial companies listed on the A-share market between 2006 and 2019, with data sourced from the Wind and CSMAR databases. We examine whether and how the proportion of ETF holdings affects the stock price crash risks in listed companies, and thus explore the relationship between financial innovation and financial risk. We find that an increase in the ETF ownership ratio intensifies stock price crash risk. Channel analyses show that ETF ownership enhances stock liquidity, thereby attracting more short-term investors and enticing management to conceal negative company news. When accumulated negative news is collectively released, it can trigger a stock price crash. However, external factors such as the imperfect A-share pricing mechanism and analysts' optimistic bias are not the primary reasons for the increased risk of stock price crashes due to ETFs. We also find that the effect of ETFs on stock price crash risk is even more pronounced in companies with more severe agency conflicts, poorer corporate governance, and a higher degree of information asymmetry.
This study makes three main contributions. First, by focusing on the corporate governance of micro-level listed companies, we demonstrate that although financial innovation improves stock liquidity, it also fosters opportunistic tendencies in management, ultimately leading to stock price crashes. Our study not only extends the ETF and stock price crash risk literature but also extends the research perspectives by providing local empirical evidence concerning the relationship between financial innovation and financial risk. Second, we construct the instrumental variable based on the adjustment of CSI 300 and CSI 500 indexes, and we test the relationships between various types of ETF ownership ratios and stock price crash risk. These can help deal with potential endogeneity issues and enables us to accurately identify the causal effect of the ETF ownership ratio on stock price crash risk. Third, the study identifies poor corporate governance in the company itself as the underlying mechanism through which ETFs increase stock price crash risk. This indicates that improving corporate governance not only has positive implications for the sustainable development of a company but also has considerable value in terms of maintaining the stability of the financial market. Regulatory authorities can prevent factors from destabilizing the macro financial market by focusing on the governance of micro-level enterprises, thereby contributing to the high-quality development of the economy and the stability of the financial market.
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Received: 08 January 2022
Published: 02 July 2023
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