Cross List In The U.S. example essay topic

COMPETITION AMONG SECURITIES MARKETS: A Path Dependent Perspective (By John C. Coffee, Jr.) I. THE MECHANISMS OF COMPETITION: Exchanges and other market centers have natural incentives to compete and attract order flow from rivals, but they cannot determine by themselves the trading venue. Rather, trading location is the product of decisions made by at least three different actors: 1. - issuers, who determine where to list; 2. - liquidity traders, who determine where to trade; and 3. - financial intermediaries, including brokers and dealers, who determine where to route trades and where to trade, themselves, as market makers (or their equivalents). Competition among market centers thus hinges on a variety of different decisions by each of the foregoing actors: 1. - issuers can cross-list on multiple exchanges; 2. - financial intermediaries can move between markets, opting for whichever offers them the best trading environment; 3. - liquidity traders can opt for one market over another; and 4. - exchanges can form networks and / or merge in order to foreclose rivals. Potentially, nothing is stable. II. WHY DO FIRMS CROSS-LIST?

: The Competing Explanations. To this point, it has been argued that cross-listing is the dynamic and de-stabilizing force that will move liquidity from local exchanges to international "super-markets", thereby impelling a consolidation among market centers. But this explanation leads to an obvious further question: what motivates firms to cross-list? The answer may seem obvious: firms can increase their value through cross-listing.

The evidence here is relatively clear. But there answer only leads to a further question: why do stock prices increase when firms cross-list? Here, there are two competing explanations, one old and one new. The traditional explanation was that cross-listing broke down market segmentation's and allowed the firm to reach trapped pools of liquidity.

A variation on this basic theory has suggested that, as cross-listing increases the shareholder base, the firm's risk is shared among more shareholders, which reduces the firm's cost of capital. For a time, the empirical evidence seemed to confirm this explanation because abnormal returns incurred by cross-listing firms seemed to rise and then decline post-listing. Until recently, little evidence suggested that a dual listing actually increased firm value. Essentially, the bonding hypothesis posits that cross-listing on a United States stock exchange (including Nasdaq) commits the listing firm to respect minority investor rights and to provide fuller disclosure. Listing on a U.S. exchange does so both because (i) the listing firm becomes subject to the enforcement powers of the SEC; (ii) investors acquire the ability to exercise effective and low-cost legal remedies (such as a class action) that are not available in the firm's home jurisdiction; and ( ) the entry into the U.S. markets commits the firm (at least when it lists on an exchange or Nasdaq) to provide fuller financial information and to reconcile its financial statements to U.S. GAAP accounting principles.

The premise of this hypothesis follows from the work of La Porta, Lopez-de-Silane's, Shleifer & Vishnu ("LLS&V"), who have shown in a series of important studies that immense differences exist between the capital markets of common law countries and those of civil law countries, with capital markets in the former jurisdictions being much deeper and apparently significantly more able to support dispersed ownership and a separation of ownership and control. LLS&V have attributed these differences to the greater protections that common law legal systems provide minority shareholders. Ultimately, neither the segmentation nor the bonding hypothesis requires the rejection of the other. They are to a degree complementary. But which explanation better fits the data? Four different types of evidence better support the bonding hypothesis than the segmentation hypothesis. a.

The Market Reaction to Cross-listings: An initial source of evidence consists of studies of the stock market's reaction to a U.S. cross listing by a foreign firm. Although there are numerous such studies, most do not consider the possibility that a U.S. cross-listing serves to protect and assure minority investors, and only one study has carefully focused on the market reaction around the announcement date, rather than the often much later date of the actual listing. The Miller Study found positive abnormal returns on the announcement of a prospective U.S. listing, without any subsequent post-listing dissipation of those returns. Alone, this is significant because proponents of the segmentation hypothesis have long interpreted their theory to predict that post-listing expected returns would decline because investors would accept a reduced rate of return with greater liquidity. More importantly, the Miller study also found that the stock price performance of foreign firms that established a depository receipt facility depended heavily on whether they also listed on an exchange or Nasdaq. Those that did not experienced only modest positive abnormal returns, while, in sharp contrast, those that also listed on the NYSE or Nasdaq experienced much larger positive abnormal returns, which were in fact more than double those of the firms that did not list.

Finally, foreign firms that only did private placements under Rule 144 A in the U.S. market and then listed on PORTAL, a special electronic market restricted to large institutional investors, had the smallest abnormal returns. b. The Cross-Listing Premium: A second source of data involves a comparison of the foreign firms that do cross-list in the U.S. versus those that do not. A 2001 study by Dodge, Karolyn and Stull focused not on stock price reaction but on the valuations of foreign firms that cross-list in the United States in comparison to a control group that did not so cross-list. Using the Worldscope database of firms, they find that "the firms listed in the U.S. have a Tobin's q ratio that exceeds the q ratio of firms from the same country that do not list in the U.S. by 16.5% on average". This valuation difference, which they call the "cross-listing premium", depends significantly on the particular form of listing chosen and is largest for exchange-listed firms, where it reaches 37%.

100 In the abstract, such a valuation disparity could reflect either segmentation or bonding. Because an exchange listing increases the firm's liquidity, it is fully consistent with the market segmentation hypothesis, but at the same time the bonding hypothesis is also supported because an exchange listing requires the issuer to reconcile its financial statements to U.S. GAAP. c. Post-Listing Behavior: Common Law Firms Versus Civil Law Firms Although the foregoing stock price studies did not consciously seek to test the bonding hypothesis (and indeed may have been unaware of it), one study has made a deliberate effort to test this explanation by comparing firms incorporated in common law jurisdictions to civil law jurisdictions. The premise to this comparison is the well-known assertion made by LLS&V (and, more recently, by others) that the civil law provides inferior protection for minority shareholders. If this is true, it would also logically follow that firms incorporated in civil law jurisdictions would gain more from cross-listing in the United States. To test this hypothesis, William Reese, Jr. and Michael Weis bach examined the composition and post-listing behavior of foreign firms that cross-listed in the United States and concluded that the evidence tends to corroborate the bonding hypothesis.

Among their principal findings were the following: 1. Firms incorporated in countries with legal systems deriving from French civil law, which according to LS&V provides the weakest shareholder protections, were the most likely to cross-list in the United States; 2. Such French civil law firms are also the most likely to cross-list on securities exchanges, such as the NYSE and Nasdaq, while firms incorporated in English civil law jurisdictions are more likely to establish only Level I facilities and remain on the over-the-counter market; 3. Firms that cross-list in the United States significantly increase their equity offerings following a U.S. listing.

This would appear consistent with the hypothesis that a U.S. listing in some way protects minority shareholders; 4. The post-listing increase in equity offerings occurs both inside and outside the United States. The substantial increase in post-listing equity offerings outside the United States that they find cannot be explained in terms of a market segmentation hypothesis, but is consistent with a bonding explanation; and 5. The weaker the shareholder protections in the foreign firm's home jurisdiction, the greater the quantity of equity offered by the firm after the time of its U.S. listing. Finally, equity issuance's following cross listings tend to be inside the U.S. for "common law" firms with strong legal protections, but outside the U.S. for French civil law firms. This suggests that "common law" firms come to the U.S. to tap its capital markets, while "civil law" firms come more for bonding purposes. d.

Flow back and Market Share: That a foreign firm lists on the NYSE or Nasdaq does not imply that its common stock will principally trade there (as opposed to on its home country exchange). In general, the NYSE fraction of total global trading volume for foreign firms listed on the NYSE ranges from as low as 1 percent to more than 90 percent. In most cases, the allocation of trading between the NYSE and the home country exchange is constrained by an inherent limitation in the nature of the securities traded: the NYSE will the issuer's trade ADRs, while the home country exchange will trade the issuer's ordinary shares. This was not the case, however, when Daimler Benz AG merged in a share-for-share exchange with Chrysler Corporation in 1998. Rather, Daimler Benz carefully designed a new security - - a Global Registered Share - - that could trade and settle on both the NYSE and the Frankfurt Stock Exchange (and other exchanges). Freed from the usual constraints that restrict flow back, 95 percent of the trading in the Daimler Chrysler promptly flowed back to Frankfurt.

Yet, Daimler Benz had elaborately negotiated its listing on the NYSE only a few years earlier and had undergone the painful experience of converting its earnings from German to U.S. GAAP, which transition had turned a reported profit (under German principles) into a loss (under U.S. GAAP). In short, Daimler management saw a U.S. listing as important to it, but its shareholders still preferred to trade in Germany. Such evidence suggests that, although the U.S. listing was useful to Daimler, its value lay not in breaking down market segmentation or in improving liquidity, but in serving as a mechanism for bonding. Without a NYSE listing, Daimler could not have made a major U.S. acquisition for stock, because U.S. ders would not be satisfied with holding a foreign, risky and illiquid security in lieu of their former Chrysler shares. Still, the need to assure U.S. shareholders that they were protected against expropriation did not require that trading actually occur in the U.S., and it quickly migrated back to Germany. This phenomenon of "flow back" thus supports the bonding hypothesis, because it shows that the value of a U.S. listing may have little to do with improving liquidity. e.

Contrary Evidence and a Reinterpretation: The simple bonding story has its critics. One response has been that increased enforcement risk associated with a U.S. listing has been exaggerated. For example, one skeptic argues that SEC actions against foreign firms listed in the U.S. have been rare. Similarly, another U.S. study finds that between January, 1995 and June, 2001, the SEC took legal action against just five foreign firms with listed ADRS.

Private enforcement of the securities laws against foreign firms also appears to have been limited. The same study finds only a total of twenty-five private actions against foreign firms between the enactment of the earliest federal securities laws and July 31, 2001. This evidence is, however, far from dis positive.. THE CURRENT COMPETITIVE LANDSCAPE: Can foreign markets compete at bonding? Or is it a game that only the U.S. can play? The manner in which stock exchanges and other market centers might compete in the future will likely be affected by a variety of forces, of which only one is the possible desire of some non-U.S. issuers to assure minority investors of their credibility.

Other forces must also be factored into the balance, some of which are reviewed in this section. a. The Trend Towards Demutualization: Historically, securities exchanges in the U.S. and generally elsewhere have operated as nonprofit mutual or membership organizations. As such, they behaved more like sluggish monopolies than dynamic entrepreneurs. That pattern is, however, rapidly changing. The first exchange to de mutualize was the Stockholm Stock Exchange in 1993; it was quickly followed by the Helsinki Stock Exchange in 1995, the Copenhagen Stock Exchange in 1996, the Amsterdam Stock Exchange and the Borsa Italiana in 1997, and the Australian Stock Exchange in 1998. This year, each of the London Stock Exchange, the Deutsche Boers e, and Euronext N. V (itself the union of the Paris, Brussels, and Amsterdam stock exchanges) have completed their initial public offerings, and the Italian Bourse has announced similar plans. b.

The Shaky Status of Exchanges Transitional Economies: Of the twenty-six transition economies, stock markets have emerged or been created in twenty of them, beginning with the Prague Stock Exchange in 1992. Typically, the new exchange in these transitional economies simply listed the shares of all mass-privatized companies. This was the Czech model, but it produced disastrous results for the credibility of these new exchanges. Mass listing of all privatized companies produced a very large number of listings, but relatively thin trading in most of these stocks.

Il liquidity in turn invited market manipulation, and a series of scandals accompanied the early history of exchanges that followed this approach. Ownership of these firms quickly concentrated, leaving only a small minority float in the public market. In contrast, in a few transitional markets (most notably, Hungary and Poland), a different approach to privatization was followed, and fewer companies were listed. In these markets, the principal route to listing was through an initial public offering conducted through the exchange. While less stocks were listed, they enjoyed more liquid trading. c.

A Success Story? : The Ups and Downs of The Neuer Markt: The foregoing bleak description of the stock markets in transitional economies may suggest that the odds are stacked formidably high against any new entrant. But one counter-example may show that these odds can be overcome. Established in 1997 by its parent, the Deutsche Borse, the Neuer Markt swiftly became Europe's dominant market for growth firms, both in terms of number of listings and market capitalization. Indeed, in so doing, it has outdistanced both Nasdaq, which eventually was acquired by Nasdaq, and Nasdaq's own more limited efforts to enter the European market. IV.

HOW MARKETS WILL COMPETE: Rival Scenarios - To this point, it has been argued that world of securities markets is in flux: exchanges are privatizing; issuers are cross-listing; some markets may fail; and others may consolidate by any of several techniques. But will this new competition produce greater transparency and more rigorous listing standards (i. e., a race to the top) or greater laxity in order for exchanges to attract more listings or greater liquidity from dealers (i. e., the race to the bottom)? A case can be made for either scenario. a. The "Race to the Top" Scenario. The "Race to the Bottom" Scenario. c.

Combining the Scenarios: A Mixed World of High and Low Disclosure If some exchanges are likely to see an advantage in upgrading their disclosure standards (or in organizing a subsidiary market that does so), what specific reforms are most likely? The Neuer Markt's experience suggests that the following standards could become more common: 1. Quarterly reporting. This is already common in the case of foreign issuers reporting on SEC's Form 20-F, even though it is not required by that form; 2. IAS or US GAAP. Again, this seems a minimum requirement for any exchange seeking to promote itself as having high disclosure standards.

3. Management's Discussion and Analysis of Financial Conditions and Results of Operations ("MD&A") Disclosures. There is evidence that share pricing in the United States became more accurate following the introduction of the SEC's "MD&A" required disclosures, which require a company to identify and evaluate "known trends or any known demands, commitments, events or uncertainties" that are "reasonably likely to result in "material changes in the issuer's liquidity or any "known trends or uncertainties" that the issuer expects will have a material impact on results of operations. Investors in Rule 144 A transactions have come to expect such disclosures (although again they are not legally required), and an exchange could mandate them as a competitive strategy. d.

Other Competitors: Who Else Can Offer Bonding Services? To this point, it has been argued that (i) there is a demand for "bonding" services; (ii) exchanges can compete in offering such services; ( ) " " exchanges now have the entrepreneurial incentive to expand their range of services to compete for new listings by offering such services; and (iv) a sizable potential market exists in those companies incorporated in transitional economies where governance is weak and where the existing markets are unlikely in any event to be able to offer sufficient liquidity. There is, however, still a further element to the puzzle: who else besides traditional stock exchanges could offer bonding services? If others can do it better or cheaper, exchanges may find it unprofitable to compete on this playing field. The real difference between bonding through cross-listing and bonding through private, self help measures that the securities analyst verifies is that, in the latter case, the issuer does not subject itself to private litigation in the United States (and is also far less likely to be the target of SEC enforcement actions when it is not listed in the U.S. ). This difference poses the currently unanswerable question of whether bonding can occur in the absence of a strong enforcement mechanism.

Clearly, issuers would prefer to offer the promise of better disclosure - - without also incurring the heightened risk of litigation. But can issuers have one without the other? Those who believe that securities class actions achieve much will argue that it can, and those who disagree will note that this alternative means to bonding has never developed (even though it may be cheaper). Whether bonding requires exposure to litigation thus remains a currently unresolved possibility. CONCLUSIO " ON: Cross-listing has accelerated during the 1990's, while at the same time the costs of information technology have declined radically. Our understanding of the motives that drive it is far from complete.

Yet, precisely because cross-listing is costly on a variety of levels (both in terms of expense and legal risk), it cannot continue to be satisfactorily explained simply as simply a search for additional sources of capital in a segmented world. The key competitive decision for most exchanges involves in which direction to move: (1) toward the high disclosure, high transparency approach that both the NYSE historically and the Neuer Markt more recently have pursued, or (2) toward the low transparency, cost minimization approach that most European and Asian stock exchanges have traditionally followed. This article has suggested that different exchanges will move in different directions, because they have (or can attract) different clienteles of listed companies. How they will behave also depends on whether smaller exchanges can forge alliances both with each other and with international brokerage firms to integrate their operations.

Predicting which strategy will dominate is speculative because the relative costs and benefits of cross-listing versus broker linkage of global markets are likely to change over time. At present, most issuers wishing to secure greater analyst attention and investor recognition outside their home markets must cross-list and enter a larger securities market, but this pattern could easily change if global brokerage were to direct their securities analysts to search abroad for firms they wished to market to their institutional clients. For the short-run, exchanges may remain focused simply on making acquisitions or negotiating alliances in order to form regional (or world-wide) "super-markets". The urgency behind this process lies in the fact that those excluded from major alliances will be at a significant competitive disadvantage (much like the losers in the traditional game of musical chairs, they will be left out when the music stops). That fear seems greatest in a post-crash environment, and this in turn suggests that the race for the near future should be more towards the top.

In short, because multiple forms of regulatory competition are possible, the case for unfettered "issuer choice" becomes correspondingly weaker, because this form of regulatory competition alone dissipates the signal that other firms wish to send. Finally, precisely because exchanges do not today capture the full value of the bonding services that they provide to issuers (both because of flow back, E CNs and other means that divert trading away from exchanges), there is a case for regulatory oversight to protect and preserve the reputation al benefits of exchanges listing. The "race to the top" show.