Globalization and stock price crash risk: evidence from the US granting permanent normal trade relations to China

Abstract

China’s remarkable growth in exports has sparked concerns regarding the negative effects of the China trade shock; yet its positive aspects often go overlooked. This study uncovers a previously unexplored advantage of the China trade shock – its positive influence on financial stability. We focus on its influence on the stock price crash risk of US firms by leveraging the US granting of Permanent Normal Trade Relations (PNTR) status to China in 2000 as a quasi-natural experiment. Our study identifies a reduction in stock price crash risk for US firms after PNTR. This result remains robust after controlling for various other contemporaneous policies that may be spuriously correlated with the PNTR shock, such as the Sarbanes–Oxley Act, the burst of the Internet bubble in 2000, and policy changes in China. Further examination of the effects of PNTR on Chinese imports, earnings management, investment efficiency, and governance, along with an analysis of cross-sectional variations, indicates that the disciplinary channel, as opposed to the offshoring channel, is likely the primary underlying mechanism. This study enriches our understanding of the consequences of the China trade shock.

Plain language summary

In recent years, the world has witnessed a significant rise in globalization (the process of interaction and integration among people, companies, and governments worldwide), which has greatly benefited the global economy. However, events like Brexit (the withdrawal of the United Kingdom from the European Union) and the US-China trade war (a conflict between the United States and China over trade policies) have sparked debates about the true costs and benefits of globalization. A pivotal moment in this ongoing process was China's entry into the World Trade Organization (WTO - an international organization that deals with the global rules of trade between nations), which marked a significant shift and led to a surge in globalization. This study concentrates on the effects of the China trade shock—specifically, the impact on financial stability in the US, as measured by stock price crash risk (the probability of a sudden and significant decrease in the price of a company's stock).

The research investigates how the China trade shock, following the US granting Permanent Normal Trade Relations (PNTR - a legal designation in the United States for free trade with a foreign nation) status to China in 2000, affects the likelihood of sudden and significant stock price declines, known as stock price crashes. These crashes can have severe consequences, including the loss of investor wealth and potential financial crises. The study uses a quasi-natural experiment approach (a method used in social sciences to estimate causal relationships), leveraging the policy shock of PNTR, to identify the causal influence of the China trade shock on the stock price crash risk of US firms.

The study analyzes extensive data on stock transactions and financial information from the Center for Research in Security Prices (CRSP - a database of historical stock market data) and Compustat databases (a database of financial, statistical and market information on active and inactive global companies), covering the period from 1998 to 2003, with a total of 11,812 firm-year observations. The research is completed, and the findings show a significant decrease in stock price crash risk following the PNTR policy. This decrease is both statistically and economically meaningful, suggesting that globalization, through the China trade shock, can decrease the risk of stock price crashes for US firms.

The results suggest that the China trade shock may discipline managers to avoid opportunistic behavior (actions taken to benefit oneself at the expense of others), which is a major contributor to stock price crashes. Additionally, the shock allows US firms to offshore production to China, taking advantage of lower labor costs, which could improve firm performance and reduce the likelihood of stock price crashes.

In conclusion, the research uncovers a positive effect of the China trade shock on financial stability by reducing stock price crash risk. This finding contributes to the broader understanding of globalization's impact and suggests that the integration of China into the global trade system has benefits beyond economic growth, potentially leading to more stable financial markets. The study's insights could be valuable for investors, regulators, and policymakers as they navigate the complexities of globalization and its effects on financial stability.

This text was initially drafted using artificial intelligence, then reviewed by the author(s) to ensure accuracy.

Résumé

La croissance remarquable des exportations de la Chine a suscité des inquiétudes quant aux effets négatifs du choc commercial chinois, mais ses aspects positifs sont souvent négligés. Cetie recherche met en lumière un avantage jusqu'ici inexploré du choc commercial chinois, à savoir son influence positive sur la stabilité financière. Nous nous focalisons sur son influence sur le risque de krach boursier des entreprises américaines en exploitant l'octroi par les États-Unis du statut de relations commerciales normales permanentes (Permanent Normal Trade Relations - PNTR) à la Chine en 2000 en tant qu'expérience quasi-naturelle. Notre recherche identifie une réduction du risque de krach boursier pour les entreprises américaines après l'octroi du statut de PNTR. Ce résultat reste robuste après avoir contrôlé diverses autres politiques contemporaines susceptibles d'être faussement corrélées avec le choc de PNTR, telles que la loi Sarbanes-Oxley, l'éclatement de la bulle Internet en 2000 et les changements de politique en Chine. Un examen plus approfondi des impacts du statut de PNTR sur la gestion des bénéfices, l'efficience des investissements, la gouvernance, et les importations chinoises, accompagné d’ailleurs d’une analyse des variations transversales, indique que le canal disciplinaire, par opposition au canal de délocalisation, est probablement le principal mécanisme sous-jacent. Cetie recherche enrichit notre compréhension des conséquences du choc commercial chinois.

Resumen

El crecimiento sorprendente de las exportaciones en China ha suscitado preocupaciones sobre los efectos negativos del impacto comercial de China; aún esto sus aspectos positivos se pasan por alto a menudo. Este estudio revela una ventaja del impacto comercial de China que previamente estaba inexplorada, su influencia positiva en la estabilidad financiera. Nos enfocamos en su influencia en el riesgo de caída del precio de las acciones de las empresas estadounidenses al apalancarse en la concesión por parte de los Estados Unidos del estatus de Relaciones Comerciales Normales Permanentes (PNTR por sus iniciales en inglés) en el año 2000 como un experimento cuasi natural. Nuestro estudio identifica una reducción del riesgo de caída del precio de las acciones para las empresas estadounidenses luego del PNTR. Este resultado sigue siendo sólido luego de controlar varias otras políticas contemporáneas que pueden estar erróneamente correlacionadas, como la Ley Sarbanes-Oxley, el estallido de la burbuja de internet en el 2000, y los cambios de política en China. Además de examinar los efectos del PNTR en las importaciones chinas, la gestión de ganancias, la eficiencia de las inversiones, y la gobernanza, junto con un análisis de variaciones trasversales, indica que el canal disciplinario, opuestamente al canal de externalización en el extranjero, es probablemente el mecanismo subyacente. Este estudio enriquece nuestro entendimiento del impacto comercial chino.

Resumo

A notável expansão das exportações Chinesas suscitou preocupações em relação aos efeitos negativos do choque comercial da China; no entanto, seus aspectos positivos muitas vezes passam despercebidos. Este estudo revela uma vantagem anteriormente inexplorada do choque comercial da China – sua influência positiva na estabilidade financeira. Centramo-nos na sua influência no risco de queda acentuada de preços das ações de empresas norte-americanas, aproveitando a concessão pelos EUA do estatuto de Relações Comerciais Normais Permanentes (PNTR) à China em 2000 como um experimento quase natural. Nosso estudo identifica uma redução no risco de queda acentuada de preços das ações de empresas norte-americanas após o PNTR. Este resultado permanece robusto após controlá-lo por várias outras políticas contemporâneas que podem estar espuriamente correlacionadas com o choque do PNTR, como a Lei Sarbanes-Oxley, o estouro da bolha da Internet em 2000 e mudanças políticas na China. Uma análise mais aprofundada dos efeitos do PNTR nas importações chinesas, na gestão de resultados, na eficiência de investimentos e na governança, juntamente com uma análise das variações transversais, indica que o canal disciplinar, em oposição ao canal de offshoring, é provavelmente o principal mecanismo subjacente. Este estudo enriquece nossa compreensão das consequências do choque comercial da China..

摘要

中国卓越的出口增长引发了人们对中国贸易冲击的消极影响的担忧;但它的积极方面却常常被忽 视。这项研究揭示了中国贸易冲击的—个先前未被探索的优势—它对金融稳定的积极影响。我 们利用2000年美国给予中国永久正常贸易关系（PNTR）地位作为准自然实验, 重点关注其对美国 企业股价崩盘风险的影响。我们的研究发现, 在PNTR 之后美国公司的股价崩盘风险降低。在控 制了可能与 PNTR 冲击虚假相关的各种其它同期政策（例如《萨班斯-奥克斯利法案》、2000 年互 联网泡沫的破裂以及中国的政策变化）后, 这—结果仍然稳健。进—步考察 PNTR 对中国进口、 盈余管理、投资效率和治理的影响, 以及对横截面变化的分析, 表明纪律渠道（而不是离岸渠 道）可能是主要的潜在机制。这项研究丰富了我们对中国贸易冲击后果的认识。