STOCK MARKET LIBERALIZATION AND LARGE SHAREHOLDERS’ TUNNELING BEHAVIOR: EVIDENCE FROM THE MAINLAND CHINA-HONG KONG STOCK CONNECT PROGRAM

Liberalización del mercado de valores y comportamiento de tunneling de los grandes accionistas: Evidencia del Programa de Conexión Bursátil entre China Continental y Hong Kong

ABSTRACT

This study investigates the influence of stock market liberalization on large shareholders’ “tunneling” behavior. It uses data from A-share listed corporations on the Shanghai Stock Exchange and Shenzhen Stock Exchange for the time period ranging from 2007 to 2018. Employing the Mainland China-Hong Kong Stock Connect program as a natural experiment, we construct a staggered difference-in-differences model and report that stock market liberalization significantly inhibits large shareholders’ tunneling behavior. Further tests found that an increase in stock selling pressure, balancing of stockholder’s rights, and improvement of the information environment are potential mechanisms. Heterogeneity tests reveal that the negative association between stock market liberalization and large shareholders’ tunneling behavior is more prominent in state-owned enterprises and companies that do not use Big 4 auditors. This study confirms that stock market liberalization plays a disciplinary role in mitigating firms’ agency costs in an emerging economy.

Keywords:
stock market liberalization; large shareholders’; tunneling behavior; mainland China-Hong Kong stock connect; corporate governance; emerging economy

RESUMO

Usando dados de empresas listadas em ações A na Bolsa de Valores de Xangai e na Bolsa de Valores de Shenzhen de 2007 a 2018, este estudo investiga o impacto da liberalização do mercado de ações sobre o comportamento de “tunneling” dos grandes acionistas. Empregando o Programa de Conexão de Bolsas da China Continental com a de Hong Kong como um experimento natural, construímos um modelo de diferença-em-diferenças escalonado e descobrimos que a liberalização do mercado de ações inibe significativamente o comportamento de tunneling dos grandes acionistas. Outros testes concluem que o aumento da pressão de venda de ações, o equilíbrio dos direitos dos acionistas e a melhoria do ambiente de informações são mecanismos potenciais. Os testes de heterogeneidade constatam que a relação negativa entre a liberalização do mercado de ações e o comportamento de tunneling dos grandes acionistas é mais acentuada nas empresas estatais e nas empresas que não contratam auditores das chamadas Big 4. Este estudo fornece evidências empíricas de que a liberalização do mercado de ações desempenha um papel disciplinador na mitigação dos custos de agência das empresas de uma economia emergente.

Palavras-chave:
liberalização do mercado de ações; conexão de bolsas da China Continental com a de Hong Kong; comportamento de tunneling dos grandes acionistas; governança corporativa; economia emergente

RESUMEN

Utilizando datos de empresas que cotizan en acciones A en la Bolsa de Shanghái y la Bolsa de Shenzhen de 2007 a 2018, este estudio investiga el impacto de la liberalización del mercado de valores en el comportamiento de tunneling de los grandes accionistas. Empleando el Programa de Conexión Bursátil entre China Continental y Hong Kong como experimento natural, construimos un modelo escalonado de diferencias en diferencias y encontramos que la liberalización del mercado de valores inhibe significativamente el comportamiento de tunneling de los grandes accionistas. Otras pruebas revelan que el aumento de la presión de venta de acciones, el equilibrio de los derechos de los accionistas y la mejora del entorno informativo son mecanismos potenciales. Las pruebas de heterogeneidad revelan que la relación negativa entre la liberalización del mercado de valores y el comportamiento de tunneling de los grandes accionistas es más pronunciada en las empresas estatales y en las empresas que no contratan auditores de las denominadas “Big Four”. Este estudio aporta pruebas empíricas de que la liberalización del mercado de valores desempeña un papel disciplinario en la mitigación de los costes de agencia de las empresas de una economía emergente.

Palabras clave:
liberalización del mercado de valores; conexión de las bolsas de China continental y Hong Kong; comportamiento de tunneling de los grandes accionistas; gobierno corporativo; economía emergente

INTRODUCTION

China introduced the Mainland China-Hong Kong Stock Connect program, linking the stock exchanges of Shanghai and Shenzhen to the Stock Exchange of Hong Kong in November 2014 and December 2016, respectively. This program marked a two-way liberalization of the capital markets between Hong Kong and Mainland China. Reportedly, the Stock Connect program (SCP) introduced foreign capital to China’s capital market and stricter corporate governance requirements, information disclosure, and other codes of conduct for listed Chinese enterprises, forcing the accelerated improvement of China’s capital market (Zhong & Lu, 2018).

The separation of control and ownership triggers the issue of principal-agent. Using the data from developed economies, the issue of principal-agent is predominantly based on the notion of a decentralized shareholding structure, emphasizing the agency problem between management and shareholders (Porta et al., 2000a). As agents, management may compromise the shareholders’ interests due to diverse motives. Relative to the decentralized shareholding structure in developed economies, numerous Chinese enterprises have instituted a centralized structure of shareholding since these enterprises were restructured and listed on the stock exchange. Other resources and voting rights that are associated with a controlling stake have also supplemented the large shareholders’ capability to exploit the medium and small shareholders’ interests. Thus, the Chinese agency issue is primarily concentrated on minority and majority shareholders (the principal-principal problem), which, for their private interests, manifests in the appropriation of corporate assets by majority shareholders to the detriment of minority shareholders (Sun et al., 2017). Johnson et al. (2000) call this phenomenon “tunneling.”

Active supervision of large shareholders is critical in reducing the infringement of the minority shareholders’ interests by tunneling behavior (Wu et al., 2016; Ye et al., 2017; Zhang & Liu, 2013). Stock market liberalization implies an increase in external supervision for listed companies, which compels the management to pay more attention to enhancing corporate governance. However, the regulatory mechanism in the Chinese capital market is not sufficient, and many regulatory measures have not been effectively exercised (Gul et al., 2010; Shi & Wang, 2014). The SCP’s implementation marks a further liberalization of the capital market, which influences China’s macroeconomy and the governance level of listed corporations at the micro level. Therefore, this study investigates whether and how SCP influences large shareholders’ tunneling behavior.

As an exogenous shock, SCP only affects some listed corporations (Guo et al., 2018; Pan et al., 2018; Sun et al., 2020). This extends an ideal quasi-natural experiment to test the causal influence of stock market liberalization (Wang & Qi, 2019; Zhong & Lu, 2018; Zhong et al., 2018; Zou et al., 2019). We construct a staggered difference-in-differences (DID) model and establish that stock market liberalization significantly inhibits large shareholders’ tunneling behavior. Further tests found that an increase in stock selling pressure, balancing of stockholder’s rights, and improvement of the information environment are plausible underlying mechanisms. Heterogeneity tests indicate that the inverse connection between stock market liberalization and large shareholders’ tunneling behavior is more substantial in state-owned enterprises (SOEs) and companies that do not use Big 4 auditors.

The following are the major contributions of this study. While scholars have studied the influence of capital market liberalization from a macroeconomic perspective (Andersen & Tarp, 2003; Bekaert et al., 2003; Bekaert et al., 2005; Stiglitz, 2000), this research enriches the understanding of the economic significance of capital market liberalization at the micro level by investigating large shareholder’s tunneling behavior. Besides, this study exploits plausible underlying mechanisms. Reportedly, the improved information environment, increased selling pressure, and enhanced equity checks and balances brought by the SCP effectively optimize corporate governance and curb large shareholders’ tunneling behavior. This research extends the study of the economic repercussions of capital market liberalization from the standpoint of corporate governance and offers novel ideas for institutional changes in capital markets to manage large shareholders’ tunneling behavior. Further, this study provides empirical evidence that capital market liberalization plays a disciplinary role in mitigating firms’ agency costs in an emerging economy.

RELATED LITERATURE, INSTITUTIONAL BACKGROUND, AND HYPOTHESIS DEVELOPMENT

Related literature

Capital market liberalization serves as both a great challenge and an opportunity for emerging economies (Li K. et al., 2004; Peng & Wang, 2022). Studies show that capital market liberalization promotes national macroeconomic growth, improves investment efficiency, provides domestic investors with multiple and diverse choices in allocating assets abroad (Torre et al., 2007), promotes the integration of local and international markets, and improves the governance of domestic listed firms through exchanges between different capital markets (Errunza & Miller, 2000). It can also optimize the information environment of the capital market (Fang et al., 2015; Ferreira & Matos, 2008), increase stock price informativeness (Zhong & Lu, 2018), boost investment (Bena et al., 2017; Li et al., 2024), provide more trade credit (Lin & Ye, 2018), elevate risk-taking (Boubakri et al., 2013), enhance the supervision of listed enterprises (Wang & Qi, 2019), and play a pivotal role in corporate governance (Li et al., 2015). On the contrary, the financial crisis (2008) and the Asian financial crisis (1997) exemplify the ripple effect within a globalized capital market. Capital market liberalization exposes the financial systems of emerging economies to shocks from international capital markets (Kaminsky et al., 2004; Li K. et al., 2004). This can adversely affect fragile financial systems (Allen & Gale, 2000) and reduce capital efficiency because of external factors, such as information asymmetry and moral hazard (Kaminsky et al., 2004).

Compared to mature capital markets, China’s capital market has been relatively closed (Zhong & Lu, 2018), which reduced the impact of the financial crises on China to some extent. However, this closed nature has also resulted in an underdeveloped capital market (Gul et al., 2010; Shi & Wang, 2014). The Chinese capital market suffers from several notable problems, including relative backwardness of the legalization process (Zou et al., 2019), imbalance in investor structure (Gul et al., 2010; You, 2017), and imbalance in the equity structure within firms (Ye et al., 2007). The combination of multiple factors has led to notable information asymmetry issues in China’s capital market (Jiang et al., 2015).

Research on the factors affecting major shareholders’ tunneling behavior includes both external and internal factors. The internal factors mainly include the quality of corporate governance, like the property rights’ nature (Borisova et al., 2015; Khwaja & Mian, 2005; Zou et al., 2019) and shareholding structure (Li Z. et al., 2004; Tang et al., 2005), while external factors are, mainly, audit quality (Zhai et al., 2017), investor protection level (Castro et al., 2004; Claessens et al., 2000; Denis & Mcconnell, 2003; Han et al., 2006), short selling pressure (Hou et al., 2017), and the introduction of qualified foreign institutional investors (Bae et al., 2012). Prior studies have also discussed the governance of large shareholders’ tunneling behavior from the standpoint of stock market liquidity (Xu et al., 2015; Zheng & Yang, 2015), stock price correlation and idiosyncratic volatility (Zhong et al., 2018), stock value and information content (Pan et al., 2018), and capital market information quality (Rejeb & Boughrara, 2013).

Prior research reveals that the SCP introduced experienced foreign investors, who usually have advantages over Chinese individual investors regarding information access and stock valuation (Zhong & Lu, 2018). Foreign investors have contributed significantly toward the improvement in the informativeness of stock prices and the atmosphere of information in the Chinese capital market (Fang et al., 2015; Ferreira & Matos, 2008; Li, K. et al., 2004). In addition, SCP has notable governance effects on participating listed companies, as it increases the pressure on them to be monitored and the penalties for any mistakes or irregularities. Additionally, foreign investors influence management’s decision-making behavior through market transactions, reducing the probability of corporate irregularities (Edmans, 2009; Wang & Qi, 2019). While numerous studies have been conducted on the economic significance of SCP, studies on the influence of the interconnection mechanisms between stock markets on large shareholders’ tunneling behavior are scanty. Therefore, we systematically investigate the effect of the SCP on large shareholders’ tunneling behavior of participating enterprises of the program and the underlying mechanism. Although contemporaneous research provides critical insights into how capital market liberalization curbs tunneling through enhanced information disclosure and corporate governance, our research extends this discourse by uncovering novel mechanisms and contextual nuances. First, we identify foreign investors’ stock selling pressure as a disciplinary force that disincentivizes tunneling by amplifying market scrutiny of opportunistic behavior. Second, we demonstrate that balancing shareholder rights-stemming from foreign investors’ increased equity participation-reduces controlling shareholders’ ability to expropriate resources. These mechanisms, unexplored in prior work, highlight the dual role of foreign investors as both market participants and governance actors, bridging theories of market discipline and shareholder activism. Further, our heterogeneity analyses reveal divergent contextual effects: the tunneling-inhibiting impact of liberalization is stronger in SOEs and firms that do not use Big 4 auditors, contrasting with Yang et al.’s (2022) findings for private firms and low-marketization regions. This suggests that liberalization’s governance benefits are most pronounced in entities traditionally insulated from market pressures (e.g., SOEs reliant on state backing) or lacking stringent oversight (e.g., non-Big 4 audited firms). By broadening the scope of mechanisms and contextual boundaries, our study advances a more granular understanding of how liberalization interacts with institutional settings to constrain agency costs, offering policymakers levers such as fostering foreign investor engagement and recalibrating ownership structures.

Institutional background

China has experienced the liberalization of its capital markets over the past 30 years. First, with the issuance of foreign shares. Second, with the one-way liberalization, represented by Qualified Foreign Institutional Investor (QFII) and other measures. Finally, there is a two-way liberalization represented by the “Shanghai-Hong Kong Stock Connect” program, among other initiatives (Zhang, 2019). The persistent liberalization and deepening reform of the Chinese capital market have not only rendered this market more standardized, transparent, and dynamic, but also profoundly influenced the development of global capital markets (Guo et al., 2018; Pan et al., 2018; Sun et al., 2020; Wang & Qi, 2019; Zhong & Lu, 2018; Zhong et al., 2018; Zou et al., 2019).

On November 17, 2014, the China Securities Regulatory Commission (CSRC) and Hong Kong’s Securities and Futures Commission (SFC) announced the start of the Shanghai-Hong Kong Stock Market Trading Interconnection Mechanism. The stated connect program mainly refers to the approval by the Shanghai Stock Exchange (SSE) and the Stock Exchange of Hong-Kong (HKEX) to permit investors in Hong Kong and Shanghai to sell and purchase shares of participating companies with the help of local securities dealers or brokers. Among them, the “Shanghai Stock Connect” in the initial pilot period includes stocks in the SSE 380 index and SSE 180 index and stocks of corporations cross-listed in Hong Kong. Notably, stocks in the “Hong Kong Stock Connect” program at the initial stage included the constituent stocks of the Hang Seng Composite Index (mid-cap and large-cap) of the HKEX and the stocks of corporations listed on both the HKEX and the SSE.

The “Shenzhen-Hong Kong Stock Connect” program was officially implemented on December 05, 2016, two years after the presentation of the Shanghai-Hong Kong Stock Connect program. The proposed program mainly refers to the approval of the HKEX and the Shenzhen Stock Exchange (SZSE), agreeing that investors in Shenzhen and Hong Kong can sell and purchase the stocks of the participating corporations listed on the other exchange in compliance with the rules. Further, the aforementioned connect program contains the Hang Seng Composite Index (Small Cap) constituent stocks newly added to the scope of Hong Kong Stock Connect and comprises the stocks of enterprises listed on both the HKEX and the SZSE. To a certain extent, this program facilitated the rapid integration of the interconnection between the markets of Hong Kong and Mainland China, and prompted the systematic liberalization of the capital market to attract FDI in China. More firms have gradually participated in the proposed connect program, massively enlarging the number of participating firms. On December 31, 2023, there were 5,346 listed companies in the A-share market, among which 2,528 listed companies participated in the aforementioned program.

The stated program was implemented to promote the steady liberalization of FDI in China’s capital market. It does not present any specific norm or regulation regarding tunneling. Consequently, this research empirically investigates an unintended consequence of the SCP.

Hypothesis development

The separation of control and ownership in Chinese listed companies has long facilitated self-interested behavior by large shareholders, enabling asset misappropriation and minority shareholder exploitation (Allen et al., 2005; Ni & Zhang, 2012). Concentrated shareholding structures exacerbate these agency conflicts, granting dominant shareholders disproportionate power to divert resources. Tunneling undermines minority rights, distorts capital allocation, and stifles financial market development (Jiang et al., 2010; Li Z. et al., 2004; Sun et al., 2020). Weak investor protections and lax penalties further institutionalize tunneling in China’s capital markets (Wu, 2019), perpetuating inefficiencies that hinder sustainable growth (Hou et al., 2017; Sun et al., 2017).

SCP emerged as a transformative mechanism to address these challenges through capital market liberalization, unlike earlier channels such as the QFII and Renminbi QFII (RQFII) programs, which imposed restrictive quotas and bureaucratic hurdles, limiting foreign participation to just 3% of A-share market capitalization by 2019 (Xinhua, 2019). SCP revolutionized market access. By eliminating daily trading quotas, simplifying settlements, and expanding eligibility beyond index-heavy constituents to include innovative and smaller-cap firms, like firms listed on the Science and Technology Innovation Board, the program broadened participation to 2,528 firms by 2023, nearly half of China’s A-share market (Hong Kong Exchanges and Clearing Limited, 2023). This structural shift not only enhanced liquidity, with northbound inflows reaching ¥1.87 trillion (USD 270 billion) by 2023 (Hong Kong Exchanges and Clearing Limited, 2023), but also attracted long-term institutional investors, such as pension funds and global asset managers prioritizing governance and transparency (Zhong & Lu, 2018).

The program’s impact on tunneling operates through three interrelated channels. First and foremost, SCP enhances regulatory and market discipline. Cross-border collaboration between the CSRC and Hong Kong’s SFC strengthened enforcement against misconduct, enabling foreign investors to legally challenge tunneling (Sun et al., 2020; Zou et al., 2019). Concurrently, stringent disclosure requirements and real-time monitoring under SCP raised the reputational and financial costs of expropriation (Guo et al., 2018; Pan et al., 2018). Besides, SCP introduces foreign investor influence as a governance mechanism. While foreign participation predated SCP, the program amplified its scale and efficacy. Foreign investors, including Hong Kong-based institutions, classified as “foreign” under program rules, leverage sophisticated information-processing capabilities to detect tunneling (Bena et al., 2017; Gul et al., 2010) and exert discipline through active stewardship, for example, voting against related-party transactions, or exit threats (Wang & Zhang, 2015). For instance, foreign sell-offs of Chinese tech stocks in 2025 triggered a 62.8% decline in South Korea’s China-focused ETFs, illustrating market-based penalties for governance failures (Jiang, 2025). However, foreign investors represent one component of a broader governance ecosystem reshaped by SCP, which also incentivizes domestic stakeholders to align with global standards to attract capital (Jiang et al., 2010). Moreover, the SCP brings about systemic liquidity and transparency effects. Enhanced liquidity reduces large shareholders’ ability to manipulate prices, while increased analyst coverage and media scrutiny under SCP diminish information asymmetry (Bae et al., 2012; Fang et al., 2015). Participating firms face pressure to improve transparency, as evidenced by higher ESG disclosure rates post-inclusion (Zhong et al., 2018). With the interplay of these mechanisms, we thus posit:

• H1: Ceteris paribus, firms participating in SCP exhibit a significant reduction in large shareholders’ tunneling behavior post-implementation compared to non-participating firms, driven by enhanced market discipline, regulatory oversight, and governance transparency.

RESEARCH DESIGN AND DATA

Sample selection and data sources

This study uses the A-share listed corporations on the SSE and the SZSE from 2007 to 2018 as the initial research sample. The financial data of enterprises are obtained from the China Stock Market & Accounting Research (CSMAR) and RESSET database. The initial sample is processed using these exclusion criteria: (1) Enterprises in the financial industry; (2) particular transfer enterprises, special treatment, and delisted enterprises; (3) observations with missing data; and (4) enterprises that frequently enter and exit the SCP. Besides, continuous variables are winsorized at the 99% and 1% levels to exclude the outliers’ interference. After filtering, we obtained 15,547 enterprise-year observations.

Variable definition

(i) Explained variable. Large shareholders engaged in tunneling may exploit shareholders’ interests through capital appropriation (Li et al., 2008; Xue & Wang, 2004; Yue, 2006), cash dividends (Porta et al., 2000b; Tang & Xie, 2006), and related-party transactions (Hong & Xue, 2008; Yu & Xia, 2004).

The State Council approved the notice of the CSRC on improving the quality of listed corporations in 2005, which clearly requires that the major shareholders’ occupied funds must be refunded by the end of 2006. In 2006, the CSRC published the Notice on Further Improving the Work of Cleaning Up the Funds Occupied by Major Shareholders in Listed Companies, requiring the major shareholders’ funds to be cleaned up. Therefore, measuring tunneling by the funds held by major shareholders is not appropriate for the sample period.

Measuring tunneling by the amount of cash dividends is not appropriate for the sample period, either. This situation can be principally attributed to the fact that before the split-share structure reform in 2005, the major shareholders’ shares could not circulate in the secondary market, and the share price decline caused by excessive cash dividends had relatively little impact on the major shareholders’ interests. After the reform, major shareholders gained the right to liquidity, and the incentive to tunnel through cash dividends was weakened.

Considering the deficiency of measuring major shareholders’ tunneling behavior in the shape of capital appropriation and cash dividends and the influence of regulatory control, this study adopts related-party transactions to measure major shareholders’ tunneling behavior. Related-party transactions mean the commercial transactions between a listed corporation and its largest shareholder or the parent corporation of the largest shareholder, the actual controller, or other companies under the largest shareholder’s control. Following Hou et al. (2017), Li et al. (2008), Sun et al. (2017), Sun et al. (2020), and Yu e Xia (2004), this study estimated the related-party transactions as the “annual amount of related-party transactions/total assets at the period’s beginning.” Since there are distinct differences among industries, we subtract the industry median from the calculated related-party transactions to scale the major shareholders’ tunneling behavior. To check for robustness, this study gauges tunneling in two ways. We construct Tunneling2 in the following procedure.

First, we calculate the sum of annual related-party transactions, excluding the 5 transaction categories of collaborative projects, license agreements, R&D outcomes, compensation of main managers, and other affairs. Afterward, we divide the sum of annual related-party transactions by total assets at the year’s start. Then, the proportion is adjusted by the industry median. We construct Tunneling3 in a similar way. First, we calculate the sum of the two related-party transactions of services and commodities provided or received during the year. Then, we divide the sum by total assets at the year’s beginning. The ratio is then adjusted by the industry median.

(ii) Main explanatory variable. In this study, SCP (Treat×Post) is taken as the main explanatory variable. The Shanghai- and Shenzhen-Hong Kong Stock Connect implementation was sequential, and the time when listed companies became participating enterprises of the connect program is also inconsistent. Treat is equal to 1 when the enterprise is associated with SCP and 0 otherwise. The variable Post is equal to 1 for the year the enterprise joins the program and for all subsequent years, and 0 for the years prior to joining the SCP. Furthermore, the interaction term between Treat and Post, Treat×Post, captures the DID influence, i.e., after SCP implementation, how tunneling changes for the treatment group, compared to the control group.

(iii) Control variables. Drawing on Bharath et al. (2013), Hou et al. (2017), Jian and Wong (2010), and Li Z. et al. (2004), other control variables that may affect large shareholders’ tunneling behavior are included in the regression model, alleviating the endogeneity issue triggered by omitted variables. In addition, the control variables comprise return on assets (ROA), firm size (LogSIZE), TobinQ, separation of ownership and control (Separate), state-owned enterprise (SOE), asset-liability ratio (LEV), institutional ownership ratio (InHold), independent director ratio (InDpt), and audit quality (Big4). Similarly, firms’ fixed influences are controlled for fixed year influences and time-invariant enterprise attributes to account for secular trends. Because tunneling is inclined to be auto-correlated over a period, standard errors by enterprise are clustered to avoid inflated t-statistics.

Table 1 populates the understudied variables and their definitions.

Table 1
Variables and Definition

Variables	Definition	Reference
Tunneling	Annual related-party transactions amount / total assets at the beginning of the year, adjusted for industry median	Hou et al. (2017), Li et al. (2008), Sun et al. (2017), Sun et al. (2020), and Yu and Xia (2004)
Treat	Dummy variable. Takes a value of 1 if the company joins the program during the sample period, and 0 otherwise	Sun et al. (2020)
Post	Dummy variable. Takes a value of 1 for the current year and the following years when the company becomes the target enterprise of the policy, and 0 otherwise	Sun et al. (2020)
Treat×Post	Takes a value of 1 for companies participating in the program in the current year, and 0 otherwise	Sun et al. (2020)
LogSIZE	The logarithm of the enterprise’s total assets for the year	Hou et al. (2017), Sun et al. (2020)
ROA	The enterprise’s closing net profit for the year / closing total assets	Hou et al. (2017), Sun et al. (2020)
LEV	Total liabilities of the enterprise at the end of the year / total assets at the end of the year	Hou et al. (2017), Sun et al. (2020)
TobinQ	The market value of the enterprise’s total assets / replacement cost of the enterprise’s total capital	Hou et al. (2017), Sun et al. (2020)
TopHold	The percentage of shares held by the enterprise’s largest shareholder at the end of the year	Hou et al. (2017), Sun et al. (2020)
InHold	Shareholding of institutional investors as a percentage of the total number of shares of the enterprise. According to the Securities Law of the People’s Republic of China, institutional investors consist of mutual funds, qualified foreign institutional investors, securities dealers, insurance companies, social insurance institutions, trust companies, finance companies, and banks.	Hou et al. (2017), Sun et al. (2020)
InDpt	The proportion of independent directors in the board of directors of the enterprise	Hou et al. (2017), Sun et al. (2020)
Separate	The difference between the control and ownership of the effective controller of the enterprise. It takes a value of 1 if the difference is above the annual median, and 0 otherwise	Hou et al. (2017), Sun et al. (2020)
SOE	State-owned enterprises take the value of 1, and 0 otherwise	Hou et al. (2017), Sun et al. (2020)
Big4	Enterprises that hire the Big 4 accounting firms to audit their annual reports take the value of 1, and 0 otherwise	Hou et al. (2017), Sun et al. (2020)

Model design

We adopt a staggered DID model to ascertain the influence of stock market liberalization on large shareholders’ tunneling behavior. Accordingly, the proposed model is:

$$\begin{array}{c}{\text{Tunneling}}_{i,t}={\beta }_0+{\beta }_1{\text{Treat}}_i\times {\text{Post}}_t+{\beta }_2{\text{LogSIZE}}_{i,t}+{\beta }_3{\text{ROA}}_{i,t}+{\beta }_4{\text{LEV}}_{i,t}+{\beta }_5{\text{TobinQ}}_{i,t}\\ \begin{array}{c}+{\beta }_6{\text{TopHold}}_{i,t}+{\beta }_7{\text{InHold}}_{i,t}+{\beta }_8{\text{InDpt}}_{i,t}+{\beta }_9{\text{Separate}}_{i,t}+{\beta }_{10}{\text{SOE}}_{i,t}\\ +{\beta }_{11}{\text{Big4}}_{i,t}+{\text{Firm}}_i+{\text{Year}}_t+{\epsilon }_{i,t}.\end{array}\end{array}$$

In equation (1), Tunneling_i,t denotes large shareholders’ tunneling of an enterprise i in year t; Treat_i x Post_t is an indicator variable that equals 1 when an enterprise i joins SCP from year t onward and 0 otherwise. This research concentrates on the sign of the regression coefficient β₁ and its significance. If β₁ is significantly negative, SCP can inhibit large shareholders’ tunneling behavior.

EMPIRICAL RESULTS

Descriptive statistics

Table 2 presents the descriptive statistics. Among them, the mean value of Tunneling is documented to be 0.189, the first quartile stands at -0.171, and the third quartile is reportedly 0.308, indicating that large shareholders’ tunneling differs significantly among different enterprises. Parallel to this, the mean value of Treat×Post is recorded as 0.164, which means that nearly 16.4% of the research sample’s observations belong to the SCP. The main variables’ descriptive statistics are comparable to those of prior China-oriented studies (Hou et al., 2017; Wang & Qi, 2019).

Table 2
Descriptive Statistics

Variable	N	Mean	SD	Min	P25	P50	P75	Max
Tunneling	15547	0.189	0.622	-0.883	-0.171	0	0.308	3.936
Treat×Post	15547	0.164	0.370	0	0	0	0	1
LogSIZE	15547	22.04	1.118	19.91	21.23	21.91	22.72	25.25
ROA	15547	0.0371	0.0591	-0.214	0.0122	0.0340	0.0644	0.209
LEV	15547	0.453	0.202	0.0597	0.298	0.453	0.608	0.892
TobinQ	15547	2.087	1.270	0.902	1.279	1.677	2.409	8.201
TopHold	15547	33.26	14.13	8.990	22.18	31.12	42.50	72.43
InHold	15547	0.262	0.231	0	0.0622	0.194	0.427	0.833
InDpt	15547	0.372	0.0521	0.333	0.333	0.333	0.429	0.571
Separate	15547	0.530	0.499	0	0	1	1	1
SOE	15547	0.351	0.477	0	0	0	1	1
Big4	15547	0.0368	0.188	0	0	0	0	1

Benchmark regression

Explicitly, Table 3 represents the benchmark regression outcomes. In 1st Column, tunneling is regressed on the SCP implementation indicator, Treat×Post, without any control variables. Subsequently, in 2nd Column, the model corresponding to Eq. (1) is presented, including firm fixed effects, control variables, and year fixed effects. Afterward, in 3rd Column, industry-by-year fixed effects are added by including the interaction of industry dummies and year dummies to reflect the time-varying industry trends in the model (Bai, 2009).

Table 3
Benchmark Regression

	(1)	(2)	(3)
	Tunneling	Tunneling	Tunneling
Treat×Post	-0.0812***	-0.120***	-0.118***
	(-3.89)	(-5.46)	(-5.38)
LogSIZE		0.0761***	0.0820***
		(3.45)	(3.65)
ROA		1.050***	0.985***
		(7.45)	(7.11)
LEV		0.708***	0.728***
		(8.96)	(9.23)
TobinQ		-0.00254	-0.00485
		(-0.32)	(-0.62)
TopHold		0.000605	0.000802
		(0.45)	(0.59)
InHold		0.0829**	0.102***
		(2.09)	(2.58)
InDpt		-0.253	-0.261
		(-1.32)	(-1.36)
Separate		0.0365	0.0293
		(1.35)	(1.09)
SOE		-0.177***	-0.156***
		(-3.39)	(-3.06)
Big4		-0.0653	-0.0524
		(-1.11)	(-0.92)
N	15547	15547	15547
Adj. R2	0.008	0.041	0.047
Firm	Yes	Yes	Yes
Year	Yes	Yes	Yes
Industry×Year	No	No	Yes

The regression results indicate that large shareholders’ tunneling behavior is significantly reduced, and the average treatment effect of SCP is as high as 62.4% (-0.118 ÷ -0.189) after a firm joins SCP. The regression results support H1: stock market liberalization exerts a noticeable inhibiting influence on large shareholders’ tunneling behavior. This indicates that SCP has improved participating firms’ corporate governance, effectively safeguarding the medium and small shareholders’ interests and alleviating agency problems.

Robustness check

Parallel trend test

The samples of the control and treatment groups exhibit insignificant ex-ante differences before the proposed program, which is a necessary prerequisite for using the DID model. We construct 11 indicators surrounding SCP’s implementation. Before 1-Before 6, Current, After1-After4 are dummy variables that equal one if the firm will become a participating firm of SCP in 1-6 years, in the current year, 1-4 years after the firm becomes a participating firm of SCP, respectively, 0 otherwise. After that, Equation 1 is recalculated by replacing the Treat×Post dummy with the interaction of Treat and the 11 dummies (Table 4). Overall, no significant difference exists beforehand, indicating that the assumption of the parallel trend test is confirmed.

Table 4
Parallel Trend Test

	Tunneling
Treat×Before6	0.0554
	(1.07)
Treat×Before5	0.00547
	(0.10)
Treat×Before4	-0.0335
	(-0.62)
Treat×Before3	-0.0647
	(-1.18)
Treat×Before2	-0.104
	(-1.46)
Treat×Before1	-0.0718
	(-1.29)
Treat×Current	-0.0200*
	(-1.74)
Treat×After1	-0.0713*
	(-1.80)
Treat×After2	-0.0862**
	(-2.13)
Treat×After3	-0.0854*
	(-1.89)
Treat×After4	-0.117*
	(-1.75)
Control	Yes
N	10287
Adj. R2	0.031
Firm	Yes
Year	Yes
Industry×Year	Yes

Alternative measure of explained variable

The benchmark regression estimation uses the sum of related-party transactions to gauge large shareholders’ tunneling behavior. However, according to CSMAR, related-party transactions can be divided into 17 different categories, and some may pose identification concerns. Therefore, we measure tunneling in two different ways as specified in Section 3.2 and re-estimate Eq. (1) (Table 5). Treat×Post is still negative at the 1% level of statistical significance, signifying that SCP demonstrates a substantial negative effect on large shareholders’ tunneling behavior, further verifying H1.

Table 5
Robustness Check: Alternative Measures of Tunneling

	(1)	(2)
	Tunneling2	Tunneling3
Treat×Post	-0.0714***	-0.0693***
	(-2.83)	(-2.75)
Control	Yes	Yes
N	11592	11592
Adj. R2	0.043	0.049
Firm	Yes	Yes
Year	Yes	Yes
IndustryXYear	Yes	Yes

FURTHER ANALYSIS

Underlying mechanism

In this study, H1 postulates that SCP effectively augments the information environment in the capital market, alleviates principal-agent issues, and restrains the large shareholders’ opportunistic behavior. Specifically, the program inhibits large shareholders’ tunneling behavior through three channels: increasing selling pressure, strengthening equity checks and balances, and improving the information environment.

The disincentivizing effect of stock selling pressure from foreign investors

The inclusion of foreign investors can expose firms to greater monitoring pressure and increase the cost of mistakes by shareholders and management (Stulz, 1995), lessening agency costs and improving corporate governance (Peng & Wang, 2022). In this study, we filter the names of the top 10 actively traded stocks in the SSE and the SZSE as of December 31, 2018. If the trading activity of a Hong Kong based investor is among the top 10, then the variable Top10 considers the value of 1, and 0 otherwise. We then construct the interaction term of Top10×Treat×Post and add it to the regression (Table 6, Column 1). The coefficient of Top10×Treat×Post is significantly negative, with a 5% significance level, which means that after the connect program’s implementation, foreign investors pressured the management to sell stocks, which in turn enhanced the external governance effect and effectively curbed the tunneling behavior of large shareholders.

Table 6
Underlying Mechanism: Equity Checks and Balances, Selling Pressure, and Information Transparency

	(1)	(2)	(3)
	Tunneling	Tunneling	Tunneling
Top10×Treat×Post	-0.0259**
	(-2.58)
HKSCCL×Treat×Post		-0.0174**
		(-2.41)
Opaque×Treat×Post			-0.0108***
			(-2.84)
Treat×Post	-0.0265***	-0.0283***	-0.0292**
	(-4.43)	(-2.82)	(-2.57)
Top10	0.0232**
	(2.48)
HKSCCL		0.0174**
		(2.37)
Opaque			0.107***
			(3.83)
Control	Yes	Yes	Yes
N	25514	22387	15611
Adj. R2	0.117	0.114	0.089
Firm	Yes	Yes	Yes
Year	Yes	Yes	Yes
Industry×Year	Yes	Yes	Yes

The inhibiting effect of increasing the share of foreign shareholders

The connect program allows foreign shareholders to leverage their scale and information convenience to enhance equity checks and balances, which play a supervisory and governance role in monitoring firms (Zhong & Lu, 2018). According to the requirements of the Certain Provisions on the Interoperability Mechanism for Trading on the Mainland and Hong Kong Stock Markets announced on September 30, 2016, Hong Kong Securities Clearing Company Limited (HKSCCL) serves as a nominee holder for Hong Kong investors to exercise shareholders’ rights. Considering that the currently listed companies only disclose the names and shareholding proportions of their top ten shareholders, HKSCCL takes a value of 1 when HKSCCL is among the top ten shareholders of the listed corporation in the present year, and 0 otherwise. Similarly, the HKSCCL×Treat×Post term is added to the regression analysis (Table 6, Column 2). The coefficient of HKSCCL×Treat×Post is profoundly negative at the 5% significance level. This indicates that after foreign shareholders become the top 10 shareholders, they play an effective external governance role in monitoring large shareholders’ behavior. This validates a potential underlying mechanism of how capital market liberalization curbs large shareholder tunneling by strengthening equity checks and balances.

The disincentive effect of increased information transparency

Following Hutton et al. (2009), we first calculate discretional accrual using the modified Jones model. Then, the sum of discretional accruals for the past three years is computed to measure information opaqueness (Opaque). The superior the value, the inferior the information transparency. Table 6, Column 3 presents the derived outcomes. The coefficient of Opaque×Treat×Post is considerably negative, with a 5% level of statistical significance, whereas the Opaque term is substantially positive at a 1% significance level. Thus, the connect program inhibits large shareholders’ tunneling behavior by improving the information environment.

Heterogeneity test

Impact of audit quality

The outcomes of grouped regressions based on whether any Big 4 audit corporations were used are shown in Table 7, 1st and 2nd Column. The related outcomes indicate that in the sample group of low audit quality (audited by non-Big 4 audit companies), Treat×Post is significantly negative at the 1% level, whereas Treat×Post is insignificantly negative in the sample group of high audit quality (audited by Big 4 companies). Hence, after the connect program’s implementation, tunneling behavior of major shareholders of companies that do not choose Big 4 audit companies are more significantly inhibited.

Table 7
Heterogeneity: Audit Quality and Property Rights

	(1)	(2)	(3)	(4)
	Tunneling	Tunneling	Tunneling	Tunneling
	Big4	non-Big4	SOE	non-SOE
Treat×Post	-0.103	-0.118***	-0.128***	-0.125***
	(-1.21)	(-5.38)	(-3.22)	(-4.67)
Control	Yes	Yes	Yes	Yes
N	572	15547	5450	10097
Adj. R2	0.078	0.047	0.055	0.053
Firm	Yes	Yes	Yes	Yes
Year	Yes	Yes	Yes	Yes
Industry×Year	Yes	Yes	Yes	Yes
χ2 (test for differences between groups)	25.75		4.20
p-value	0.000		0.004

Effect of the property rights’ nature

The inconsistency in the intensity of market regulation and the degree of market competition experienced by non-SOEs and SOEs may contribute to variances in the constraints on tunneling. We partitioned the sample into SOE and non-SOE. Subsequently, the regression estimations are demonstrated in the 3rd and 4th Columns of Table 7. Treat×Post is substantially negative, with a 1% significance for both non-SOEs and SOEs. This indicates that the connect program’s implementation exerts a curbing impact on large shareholders’ tunneling behavior for both non-SOEs and SOEs. The inhibitory effect on tunneling behavior induced by the program’s implementation is more prominent in the SOEs. Meanwhile, non-SOEs are more competitive in the market and demonstrate higher requirements for internal corporate governance. Therefore, the intervention of foreign investors exhibits less effect in improving internal corporate governance and external supervision, and the inhibiting effect on tunneling is less prominent.

CONCLUSIONS

In this study, the influence of stock market liberalization on large shareholders’ tunneling behavior is analyzed using the exogenous shock of the SCP. Thus, a staggered DID model is built with a sample of A-share listed corporations on the SZSE and the SSE from 2007 to 2018. Reportedly, large shareholders’ tunneling behavior was significantly suppressed after SCP’s implementation. This inhibitory influence is more prominent in enterprises that did not engage Big 4 audit enterprises and SOEs. SCP plays an external governance role by enhancing equity checks and balances, increasing the selling pressure, and improving information transparency.

As an institutional innovation in the liberalization of China’s capital market, SCP’s effective implementation is of great significance to developing economies in terms of their smooth integration into the global capital market. Aligned with the aforementioned revelations, this research highlights three main policy implications. First, the regulatory authorities and listed enterprises should protect foreign shareholders’ legitimate interests and rights while actively guiding them to participate more effectively in corporate governance. Second, the governance of large shareholders’ tunneling behavior should be accentuated by strengthening equity checks and balances, equity structure optimization, and gradually diluting the shares of large shareholders by introducing foreign shareholders and other means. Third, the relevant authorities should further release institutional benefits by expanding the scope of participating stocks and relaxing the daily trading limit to attract more high-quality foreign capital to participate in developing China’s capital market. Building a higher level of a new open economic system necessitates exploring a capital market liberalization path that suits prevailing situations in China.

The relevant questions that are beyond the study scope are outlined as follows. First, despite the positive findings, the study results cannot address the broader questions of whether the program constitutes a cost-effective manner of realizing capital market development or whether it misallocates capital. Second, although this study has ascertained the role of equity checks and balances, selling pressure, and information transparency as plausible underlying mechanisms, more underlying mechanisms are yet to be exploited. Third, SCP plays multifaceted roles in corporate governance, and the question of how to effectively use this program and design proper mechanisms to optimize its output remains uncertain. In the future, further studies are needed to resolve these issues.

• The reviewers did not authorize disclosure of their identity and peer review report.
• Evaluated through a double-anonymized peer review.

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Edited by

• Associate Editor:
  Robert Aldo Iquiapaza

Publication Dates

• Publication in this collection
  29 Aug 2025
• Date of issue
  2025

History

• Received
  01 Jan 2024
• Accepted
  18 Mar 2025