Study On Firms Engaging In Cross Listing Practices

Published Date: 02 Nov 2017

Introduction

Cross listing is the listing of shares on two or more stock exchanges (Eiteman et al; 2010). In recent decades, technological progress and liberalization of capital flows have lowered the barriers that insulated domestic stock markets from each other. Firms can access foreign capital markets more easily (Pagano et al; 2002). This has led to an increase number of cross listing. This essay examines the benefits and costs of cross listing, summarises its implications with relation to investors, management and markets.

Why do firm engaging in Cross listing?

There are a number of reasons why firms may seek listings on multiple stock markets.

By listing on multiple stock markets, firms can achieve a higher valuation, improve visibility within a market, provide easier access for investors and achieve greater liquidity (Thornton, 2008). While cross listing brings many benefits for the listing firms, it also brings costs. These relate to enhanced disclosure requirements, registration costs with regulatory authorities, and listing fees (Karolyi; 1998). This section examines the effects of cross listing.

Effects on Capital

By listing on different stock exchanges, firm can obtain capital via wider sources. Firms are especially more likely to cross list when they are fast-growing, newly privatised or have already reached debt capacity. Ideally, firms should have high investment, growth rate, and leverage before cross listing (Pagano et al; 2002). Multi-national firms may find it easier to place their shares in foreign market because their established global reputation (Karolyi; 1998).

Effects on Share Price

Studies have shown that share prices increases in the home market at the announcement of cross listing and cost of capital decreases due to cross listing (D’Souza et al; 2008). Several explanations have been offered for this unusual share price movement. One possible explanation is that the increase in share price directly related to a diversification of global market risk exposures for the firm and thus an overall reduction in its cost of equity. In other words, cross listing reduces firm’s specific risks; this causes investors to change their expectations on risks and returns. Another explanation is that cross listing reduces transactions costs through an improvement in market liquidity following the foreign listing (Karolyi; 1998). This is called the liquidity effects. A market is considered to be liquid if transactions can be executed rapidly.

For Non-U.S. firms listing on U.S. market, Foerster and Karolyi (1998) suggested that the post-listing decline was not likely to be associated with liquidity effects. Switzer (1997) concurred this and found that pre-listing abnormal returns could occur as much as 90 days before the announcements. Moreover, Switzer identified a significant relationship between the market reaction around listing announcement dates and the proportion of total trading volume captured by U.S. exchanges after listing.

For U.S. firms listing abroad, researchers found that the trading volume in overseas market is typically very small relative to U.S. This suggests the economic impact of the price effects is likewise to be smaller. Earlier studies, such as Howe and Kelm’s research confirmed this suggestion. They studied 165 NYSE stocks listing in Canada or European between 1969 and 1982. They uncovered a statistically weak but surprisingly negative 12.5% annualized return during the first 40 days following listing. But other researchers found either slightly positive or neutral market reactions in the listing month (Karolyi; 1998).

Why do earlier studies show a post-listing price decline for some firms? Only a few empirical studies have examined this post-listing price decline. Alexander et al. (1988) proposed that the price decline for Non-U.S. companies listing in the U.S. is associated with the elimination of the investment barriers, since these price declines are more dramatic for companies from markets that are more likely to be segmented from the U.S. Foerster and Karolyi (1996) offered some evidence that these price declines are related not to country of origin but to the same factors that affect the positive pre-listing and listing week price increases. Dharan and Ikenberry (1995) show that the post-listing drift is not observed for large firms at all, but rather for smaller, less established firms, for which listing requirements are more likely to be binding.

Effects on Liquidity

By establishing a secondary market for shares, Cross listing can improve the liquidity of its shares. It helps foreign investors to acquire shares more easily. Researchers found that the increase in liquidity comes from two factors. First, overseas market often have trading hours that are different from the home market, so that cross listing has the effect of expanding the trading period for the stock within the 24-hour period. Second, the existence of an alternative trading location for stocks may lead to conjectures about liquidity and volatility patterns, depending on which market is able to attract more of the order flow (Karolyi; 1998).

Are firms motivated to cross list by the liquidity effect? Market surveys by Mittoo (1992) indicate that managers of overseas companies indeed cite increased trading liquidity (28% of respondents) as a primary factor in their decision to list in the U.S. For Non-U.S. companies listing in the U.S., extensive research on this question has been hampered by the unavailability of quality data on home market trading volume, bid-ask spreads and depth of quotes before and after listing (Karolyi; 1998).

Information

Information considerations are frequently claimed to be a key factor in firms' cross listing decisions. In theory, as firms submit themselves to tougher disclosure standards and stricter legal enforcement, firm will be more transparent and more information will flow on the market. However, Lang, Lins, and Miller point out that there is little direct empirical evidence on the informational effects of cross listings (Leuz; 2003).

Early empirical researches suggest a positive link between the information environment and cross listing, but the association is not clear-cut for three main reasons. First, the added reporting and disclosure requirements by regulators for cross listing could crowd out or substitute for the collection of private information, so that, on balance, a smaller amount of firm specific information would be incorporated into stock prices. Second, the analyst activity is not necessarily a good proxy for private information trading because analysts do not have significant firm specific information. Moreover, the increased analyst coverage fosters the production of industry and market wide information and dampens firm specific stock return variation. Overall, the impact of the cross listing on the information environment can vary across countries. The enhanced disclosure associated with the cross listing in the U.S. can produce different results depending on a country’s home environment. Ball (2001) argues that changing accounting standards systems alone is not enough to improve actual financial reporting and disclosure. A wide range of other changes in the country’s economic, legal, and political infrastructures is required to improve the actual quality of financial reporting, which in the end is determined by the actions of managers, regulators, and auditors (Fernandes et al; 2008).

Cost of Cross Listing

Cross listing involves with both direct cost and indirect cost. Direct cost refers to listings charges and fess for professional advice. Indirect cost refers to the cost of complying with the cross listing regulations. There are two main requirements. First, firms must qualify for listing according to standards set for overseas companies by the exchanges. Second, firms must arrange for an exact replication of settlement facilities as for domestic securities with a transfer agent and registrar. To register with the local securities commission, firms must furnish a complete reconciliation of financial accounts with local market standards, which often can be one of the biggest hurdles (Karolyi; 1998).

It is clear to see that cross listings can be quite costly to firms, so some firms prefer the alternative to cross listing: the Depositary Receipt (DR) programme. DRs are negotiable certificates issued by a bank to represent the underlying shares of stock, which are held in trust at a foreign custodian bank (Eiteman et al; 2010). DRs have two main advantages over cross listing. First, custody fees are avoided with DRs. Second, DRs follow a stricter rule, and trades fail very rarely. Thus, DRs are more cost efficient than cross listing (Karolyi; 1998).

Implications for Investors

Cross listing benefits investors, as investors can get higher returns, better shareholder protections and international diversification. However, investors must often face with cross border barriers, such as differential taxation rules, restrictions on foreign equity ownership, and the higher transaction costs. These barriers may segment different markets and reduce diversification gains (Karolyi; 1998).

Implications for Management

Before the management decide to cross list, management should evaluate the net gains or net loss of listing. In a survey by Bancel and Mitto (2001), out of a sample of 79 European firms, most firm managers perceive the increase in prestige and visibility, and growth in shareholders as the major benefits, and the costs of public relations and legal fees are the major costs. While 60% of managers believe that cross listing derives positive net benefits for the firm, about 30% perceive that costs outweigh the benefits. The survey shows the perceived net benefits are positively related to the increase in the total trading volume after foreign listing, the financial disclosure levels of the firm, and the dual listing on both the U.S. and European foreign exchanges. Without the influence of these factors, the perceived net benefits are negative.

Firms should monitor exchange rate changes closely; especially when cross listing is done in two countries with different currencies. If one currency fluctuates, firm may have difficulties issuing share in one market. As a result of the exchange rate risk, most firms suffer a home equity bias – most equity capital is raised in home market. This means liquidity at home market is higher than aboard, thus, firm should focus more on home market.

Evident shows after listing on a major stock exchange, corporate governance is improved, because poor performing CEOs from cross listed firms are more likely to be removed than CEOs from non-cross listed firms, this is particularly true in countries with weak investor protections (Lel et al; 2008). This means CEOs have to always act in the best interest of shareholders and have to work harder after cross listed.

Moreover, by complying varies disclosure requirements and trading regulations, the firm can reduce the possibility of being involved in a scandal. Firms are required to disclose their trading information at certain times of the year, thus reduces information asymmetries, and in turn, it can eliminate some mal-practices of the management, such as insider trading (La Porta et al; 2006).

Studies have found cross listed firms have comparative advantages to non-cross listed firms, cross listed firms tend to have stronger earnings performance, are valued by the market and are better able to take advantage of growth opportunities (Melvin et al; 2009). This suggests cross listing can be used as a tool to compete against business rivals.

Implications for Markets

Cross listing can increase liquidity, boost share price and reduce market information asymmetries. But what sort of market does firms look at when considering cross listing? Firms are more likely to cross list in more liquid and larger markets, and in markets where several companies from their industry are already cross listed. More over, the decision to cross list is also relying on foreign expertise coverage, foreign country characteristics (Pagano et al; 2002)

Liquidity

A market with greater liquidity can translate into a lower cost of capital for the company concerned, insofar as it is valued by investors and factored into market prices (Amihud et al; 1986). Therefore it is reasonable to expect that companies from relatively illiquid exchanges should be especially likely to cross list on more liquid exchanges.

Market Size

Large stock markets provide access to a larger pool of potential investors. Moreover, being listed on a large stock market may confer greater visibility and reputation upon a company (Pagano et al; 2002).

Business Sector

There is a positive correlation between the decision to list abroad and the degree of foreign operations, which suggests that future listings are likely to be driven primarily by the global business issues rather than by the financial issues of raising capital or enhancing stock liquidity (Bancel et al; 2001).

Firm’s decision to cross list is also correlate with the decision of other firms in the same industry. Firm managers tend to imitate their business rivals, if their rival firms are cross listed on a particular stock market, firm will likely to follow. Failure to follow might put the firm at a competitive disadvantage in the industry (Stoughton et al; 1999).

Foreign Expertise

By listing on a market with higher number of experts, it will reduce informational asymmetries, and therefore affect the availability of finance (Pagano et al; 2002)

Accounting standards

Recent studies have shown firms are likely to list in a market where the level of disclosure is lower, this is because although listing in a country with higher accounting standards allows the company to pre-commit to greater transparency and thereby reduce the monitoring costs of its shareholders and their required rate of return. But these benefits out-weight the cost barriers (Eiteman et al; 2010).

Legal variables

The degree of shareholder protection against the misbehaviour of companies' directors is largely determined by the law of the country of incorporation and by the way its courts interpret and enforce it. However, a cross-listing in a country with tougher standards of investor protection may affect some aspects of corporate governance, and thereby provide a way to overcome some agency problems between managers (or controlling shareholders) and non-controlling shareholders. Subjecting to a better jurisdiction should imply better reputation in the capital market, more abundant outside equity finance and possibly lower cost of capital. Moreover, if a cross-listing is a preliminary step in a strategy of expansions and acquisitions abroad, a company is likely to prefer a country where contracts are easily enforced and the bureaucracy is efficient (Pagano et al; 2002).

Cultural homogeneity

Companies may tend to cross list in countries that are culturally similar to their home country in terms of language and institutions, because this reduces costs of communication with foreign investors (Pagano et al; 2002).

Conclusion

This paper finds cross listing brings net benefit to firms. It increases equity capital finance, improves corporate governance and helps the firm to be more competitive. Firms are likely to cross list in markets of the developed countries, because these markets are large and more liquid, but since cross listing is associate with high cost, some firm may choose to use the depositary receipt programme, but still, cross listing has its challenges, such as the home market bias, most firms still can’t geographically diversify their shareholder base fully.

Investors should be happy to see firms cross listed, because generally speaking, this means share price increases and liquidity risk reduces. Plus firms have to obey the information disclosure requirements set by different regulators. As more information flow on the market, investors can make better investment decisions.