The declining benefits of listing in the US

The WSJ reports an interesting finding in a report by the U of C's Luigi Zingales to be released Thursday by Committee on Capital Markets Regulation, the group supported by Henry Paulson studying the effect of U.S. capital markets regulation on the competitiveness of US markets. It shows that the premium for cross-listing a foreign country's shares in the U.S. dropped from 51% compared to equivalent non-cross-listed firms from the same country during 1997-2001, to 31% during 2002 – 2005. The premium fell most sharply for companies from countries with high governance standards.

Zingales says, "These results suggest that the changes in the U.S. regulatory environment post-SOX decreased the benefit of a U.S. cross-listing, particularly for countries that have good governance standards." He blames, among other things, SOX, and increased corporate criminal prosecutions and shareholder litigation.

For my own theory on all these, see my papers Cross-Listing and Regulatory Competition, (2005), and International Implications of Sarbanes-Oxley: Raising the Rent on U.S. Law. I gather the evidence supporting the hypothesis that firms from weaker governance regimes "bond" their disclosures by listing in the U.S. But if you raise the price of something without also raising the value, the demand will fall, and that applies to bonding. I hypothesize that SOX, by meddling in the internal governance as well as disclosures of foreign firms, raised price more than value. The result would be declining cross-listings in the U.S., a phenomenon we have observed.

The Zingales paper indicates that emerging market companies from countries with lower governance standards are more willing to pay the price for additional bonding because they need it more. This is consistent with a paper by my U of I colleague Paul Vaaler and his co-author Burkhard Schrage, Legal System and Rule of Law Effects on US Cross-Listing to Bond by Emerging-Market Firms,  presented this fall at the U of I's Corporate Colloquium. Here's an excerpt from their abstract:

We document evidence of cross-listing to bond with stronger legal systems and rule of law by more than 700 firms from 23 emergingmarket countries cross-listing their securities on US financial markets from 1996-2002. We find that: 1) US cross-listing levels are lower for firms from Common Law countries providing stronger investor protection, but only in Common Law countries with weaker rule of law; and 2) US cross-listing levels are higher for firms from Civil Law countries providing weaker investor protection, but only in Civil Law countries with stronger rule of law. Emerging-market firms exhibit behavior consistent with bonding hypothesis considerations and cross-list as a commitment to a more rigorous corporate governance regime, but the behavior is contingent and depends on examination of both legal system and rule of law effects individually and in interaction.

Andrei Shleifer wondered whether the decline in the premium might be due to "improvements in corporate governance and the quality of stock markets abroad." Possibly, but not necessarily the whole decline.

Zingales says that since firms whose cross-listing premia are decreasing resemble U.S. firms, the latter probably also have suffered. It would be interesting if we knew whether the decline in the cross-listing premium differed according to firm characteristics – that is, whether the decline was greater for smaller, high-risk companies. That might help explain the flight of these firms to London's AIM market as well as trends toward going private and going dark in the U.S. And, yes, we should worry about losing these higher risk firms.

Of course no data on the effects of SOX are going to be conclusive.  There may be multiple causes of phenomena like decreased cross-listings and decreased premia.  The Zingales data tends to answer those who say that the IPO flight to London is due to lower underwriting fees(though why ARE those fees lower?). It has always seemed to me that the theory on the effects of SOX is as important as the data.  As I have been arguing since SOX was passed -- before there were any data on effects -- there is no reason to think that the SOX reforms were necessary or cost-justified. If you expect the sun to rise at 6:00, that light in the east at that time is probably not a flying saucer. 

Comments

[save_the_rustbelt]

Proposal:

1) repeal Sox

2) have the SEC appoint board members to public companies (after all, they are PUBLIC companies)

See, easy.

[Robert Schwartz]

Save: Was that an attempt at humor?

[Kate Litvak]

And you didn't cite me??? I have the same results too! Market-to-book is down because market is down and book didn't move. That's exactly what I found, like, two years ago.

First Zingales, then Larry. Oh man. Everybody is ignoring me... I am heartbroken. Boooo.

[Larry E. Ribstein]

Kate Litvak, The Effect of the Sarbanes-Oxley Act on Non-U.S. Companies Cross-Listed in the U.S.,
http://ssrn.com/abstract=876624

[Kate Litvak]

Larry is a gentleman.

If only the authors of the report did the same!