Latin American Capital Markets

PRAGMATIC ISSUES IN CAPITAL MARKET DEVELOPMENT IN EMERGING ECONOMIES 497triation (or withholding) tax, capital gains tax, and income tax, all of which may becharged differentially to different groups of people, such as local investors, foreign investors,natural persons, legal entities, and nonresidents.Investors can easily migrate to foreign markets in response to the impositionof a tax. As summarized in Lee and Qin (2002), an example of this arose in Sweden,where a I percent round-trip equity transaction tax was imposed on Swedish brokerageservices in 1984; the tax was doubled to 2 percent in 1986, reduced back toI percent on January I, 1991, and finally removed on December I, 1991.The totaltrading volume in Swedish equities was adversely affected during this episode. It is estimatedthat 60 percent of the trading volume of the I I most actively traded Swedishshares migrated to London on the announcement of the mid-1986 tax increase, andthe proportion of total Swedish share volume traded in London rose from 48 percentin 1988 to 51 percent in 1989 and 52 percent in 19907 Campbell and Froot(1994) show that trading in Swedish shares by foreigners in Sweden was particularlydepressed during the late 1980s, since it was easier for foreign investors than for domesticinvestors to substitute their trading abroad.Competition for domestic stock exchanges in emerging markets can also ariseif local companies seek listings in or migrate to more established exchanges or tradein American Depository Receipts (ADRs).The way in which cross-listing of companiesinternationally affects the performance of their domestic markets is complicated. Foersterand Karolyi (2000) and Smith and Sofianos (1997) discuss how a company maychoose to list its shares on a foreign exchange, as well as a domestic one, because competitivepressure among the exchanges can narrow the dealing spreads on the domesticmarket and thereby raise trading activity. However Domowitz, Glen, and Madhavan(1998) show that cross-listing may not always lead to greater liquidity for acompany's shares, especially when the transmission of relevant information betweenthe markets is constrained in some way.Sanvicente (2000) argues that the listing by Brazilian companies of ADRs onthe New York Stock Exchange (NYSE) did not encourage orders to migrate to theNYSE. On the contrary, it appears to have increased domestic trading. In addition,Sanvicente notes that it was hard to predict whether ADR registration and listing ledto higher or lower volatility in the domestic market. He concludes that the establishmentof ADR programs appears to have had a positive effect on the domestic shareprices of Brazilian companies.7 Figures obtained from the Stockholm Stock Exchange. See Umlauf (1993).Copyright © by the Inter-American Development Bank. All rights reserved.For more information visit our website: www.iadb.org/pub