Discussion of the empirical evidence regarding the merit of companies cross-listing their shares on foreign equity markets

Table of Contents

1. Introduction

2. Critical Review of the Conventional Wisdom
2.1. Global Risk-Sharing
2.2. Access To More Developed Capital Markets
2.3. Information Disclosure
2.4. Bonding and Monitoring

3. A New Research Initiative: The cross-listing premium
3.1. The Model
3.2. Data and Hypothesises of the Model
3.3. Results

4. Conclusion

References

1. Introduction

Some non-American companies benefit from a US-listing and others do not even cross-list in the US. Several empirical studies show that foreign companies, which are listed in the US, are worth more. However, less than one out of 10 large public non-American companies float their shares in the US (Doidge et al., 2004). Why is cross-listing beneficial to some companies and not to others?

In 1997 more than 4,700 companies were internationally cross-listed. But, during the past several years this number decreased significantly by 50% to 2,300 (end of 2002) companies (Karolyi, 2004). Today more and more foreign companies acknowledge that they cannot cross-list in the US. Moreover, some companies admit that they are no longer even willing to cross-list, because of the high costs and strict requirements (Economist, 2005). Still, there must be a benefit for some to cross-list.

A number of studies point out that the benefits regarding cross-listing include a lower cost of capital, access to foreign capital markets, an extended global shareholder base, greater liquidity in the trading of shares, publicity, visibility and prestige. On the other hand, these companies face costs, which might erode the benefits. Typical costs associated with a US-listing are the SEC-reporting, reconciliation of financial statements with home and foreign standards, direct listing costs, compliance requirements, exposure to legal liabilities, taxes and various trading frictions as well as investment banking fees (Karolyi, 2004 and Doidge et al., 2004).

This essay aims to examine the empirical evidence regarding the merit of cross-listing shares on foreign equity markets, especially listing shares in the US. First, it critically reviews the conventional wisdom. Secondly, it examines the new approach of the cross-listing premium. Finally, it ends with a summary of this project and my own opinions.

2. Critical Review of the Conventional Wisdom

This chapter critically reviews the conventional wisdom by examining the global risk-sharing hypothesis; the better “access to more developed capital markets” notion; the information disclosure approach and the bonding and monitoring hypothesis.

2.1. Global Risk-Sharing

The global risk-sharing hypothesis delineates the fact that a company, which finds a way to reduce the costs for foreign investors to hold its shares, reduces its cost of capital, because the foreign investors share some of the company’s risk. It assumes that, if a company is located in a country, which is not fully integrated in the world capital markets, the company will normally face higher costs of capital. Only the local investors can bear the company’s risk, because it is cheaper to buy and hold these shares (Doidge et al., 2004).

In other words, if a company floats its shares in the US, it attracts more investors, because it makes its shares more available to foreign investors by reducing direct and indirect barriers of international investment. Hence, foreign investors find these shares more advantageous to hold (Karolyi and Stulz, 2002). An enlarged shareholder base reduces the risk premium which causes the share price to increase and the costs of capital to decline (Foerster and Karolyi, 1999). Therefore, a company can decrease its cost of capital decreases by listing its shares in the US (Karolyi 1998; Stulz 1999; Errunza and Miller 2000; Karolyi, 2004).

Doidge et al. (2004) state that the global risk-sharing hypothesis and its favourable impact on the cost of capital face some technical hitches. If the only reason of a cross-listing is a decrease of the risk premium, then all companies for which the risk premium would fall sufficiently to cover the transaction costs of listing would list in the US. Therefore, much more companies should cross-list than they actually do.

Lee (2003) developed an interesting notion (mentioned in Doidge et al., 2004). Lee proved that even if the number of cross-listings of one country increases, the abnormal return followed on the cross-listing announcement of the companies does not fall. Lee interprets this finding as evidence against the global risk-sharing hypothesis. This argument fits to the knowledge of the portfolio theory where at some point it does not make sense in terms of costs to add more shares to a portfolio to diversify risk.

2.2. Access To More Developed Capital Markets

Surveys by Mittoo (1992) and by Fanto and Karmel (1997) discovered that managers perceive the increased access to new capital as one of the most important motivations for pursuing cross-listings.

Lins et al. (2000) advanced this notion that foreign companies, listed in the US, gain value because of the more developed US capital markets. They can circumvent local underdeveloped capital markets through a cross-listing. The US capital markets offer greater liquidity and efficiency. Hence, these companies become less credit-constrained as a result of cross-listing. As a result, companies which ‘ … expect to have to raise funds would be more likely to list in the U.S. and firms that do not anticipate the need to raise funds would have no reason to list’ (Doidge et al., 2004).

On the other hand, Doidge et al. (2004) oppose this theory, because they prove that even companies from a market which is well integrated with the US market do also benefit from cross-listings in the US. They show that Swiss and Canadian firms gain most from a cross-listing of their shares, even though the Swiss and Canadian capital markets are substantially integrated in the world markets.

2.3. Information Disclosure

This hypothesis suggests that information disclosure plays an important role in the cross-listing decision and assumes that the US financial disclosure standards are among the highest in the world. As stated in Doidge et al. (2004) this hypothesis was developed by Cantale (1996), Fuerst (1998) and Moel (1999).

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