Gravity in International Finance: Evidence From Fees on Equity Transactions

Milsom, L., Pazitka, V., Roland, I. and Wójcik, D.

We shed light on the impact of institutional quality and information barriers on trade in financial services using a novel panel data set on revenue earned on domestic and crossborder equity securities underwriting transactions. Our data set covers 91,511 transactions across 122 countries of origin and 145 countries of destination for the period 2000-2015. The granularity of our data set enables us to estimate theory-consistent gravity equations, avoiding the methodological caveats that apply to most of the existing literature on gravity in international finance. First, we find that institutional quality in the exporting country, proxied by the rule of law, is an important determinant of financial services trade. In addition, we provide support for the "bonding hypothesis" (Coffee, 1999) in the literature on the determinants of foreign listings. Foreign firms can increase their valuation by bonding themselves to high-quality institutions through cross-listing. In line with this hypothesis, we find that institutional quality matters primarily for transactions where the underwriter is located in the country of the stock exchange where the shares are listed. Second, we focus on the role of multinational business networks in breaking down information frictions. Specifically, we control for several measures of "connectivity" based on banks' parent-subsidiary networks and syndication ties across banks. We find evidence supporting our hypothesis. In all our estimations, we control for the classical determinants of trade in the gravity framework, including distance. Interestingly, we find that the inclusion of our institutional and informational variables leaves a very limited role for physical distance - supporting the consensus in the literature on gravity in international finance that the role of distance reflects institutional and information frictions.