We investigate why the Chinese government chooses to perform share issue privatization (SIP) of its state-owned enterprises (SOEs) in Hong Kong, despite the benefit of facilitating the domestic stock market development if performing SIP in China (Subrahmanyam and Titman, 1999) and the higher cost to list in Hong Kong. We address this issue by arguing that the positive effect of SIPs on the development of the domestic market may have limitations, especially when the domestic market is not well developed and cannot absorb rapid and large-scale SIP activities. To maintain domestic market order, it may be optimal to carry out SIP in overseas markets. Furthermore, by listing shares in developed overseas markets, SOEs from the less developed countries could leverage on the overseas markets’ better accounting, governance, and legal standards. By examining a sample of 92 Chinese firms listed in Hong Kong and the relevant control samples of purely domestically listed Chinese firms during the period of 1993–2006, we find supporting evidence for both arguments.

We study the impact of mainland Chinese listings in Hong Kong on the quality and development of the Hong Kong equity market. At the macro-level, we find that the increasing presence of mainland Chinese stocks in Hong Kong increases the size, trading volume, and its link with the China and world markets but reduces the overall volatility of the Hong Kong stock market. At the firm level, the increase affects the market quality, resulting in lower turnover rate, higher Amihud illiquidity ratio, and higher spread for non-mainland Chinese firms. Furthermore, such an increase in presence causes Hong Kong stocks to move in a more synchronized way and reduces these firms investment sensitivity to stock price movement, implying deterioration in the information environment. As a whole, the increasing presence of Chinese companies in Hong Kong brings benefits to the Hong Kong market, yet not without cost.