Nowadays, the growing globalisation and accessibility to
financial markets all around the world make the geography less and less
relevant: restrictions for international capital movements disappear, trading
costs decrease, stocks exchanges merge or enter into alliances, and so on. The
purpose of a foreign cross-listing may be the presence in a wider, more
efficient and more innovative financial market than its incorporation country
one. We may give the example of Russian and Indian companies which are listed
in their domestic financial place, but also often in London or in New York.
Influences on the shares
First of all, a foreign cross-listing increases the trading
volumes and therefore improves the overall liquidity. In efficient markets,
greater liquidity should be translated into lower cost of capital, since
liquidity is valued by investors. Y. Amihud and H. Mendelson12
stated that "the theory of corporate finance has been based on the idea that a
company's market value is determined mainly by just two variables: the
company's expected after-tax operating cash flows or earnings, and the risk
associated with producing them." The two authors also argued that "there is
another important factor affecting a company's value: the liquidity of its own
securities, debt as well as equity". For instance, since 2008 more and more
companies initially listed on the Londoner fast growing market AIM (Alternative
Investment Market) have initiated cross-listings on Euronext Alternext in order
to offset the lack of liquidity on their primary stock exchange and to benefit
from a second European market in the Eurozone, the world's second main
currency. This was the goal of IPOs of British companies Proventec and Accsys:
"European investors are not comfortable dealing in the AIM market. There aren't
many market makers handling our shares, there aren't many market makers
handling most AIM shares 11.3 we do not want to knock AIM but want to provide
better liquidity for our European investors", Proventec's CEO
said13.
12
Y. Amihud and H. Mendelson, 2008, "Liquidity, the Value of the
Firm, and Corporate Finance", Journal Applied Corporate Finance
13 See Appendix 2: Article by Jon Mainwaring, The
Independent published on Sunday, 10 February 2008, "AIM companies bid for dual
listings on Euronext to boost liquidity"
Then, the reduction of transaction costs should also improve
the volumes and the liquidity, by encouraging investors to perform more
buy/sell operations. However, in his study14 published in 2001, J.
Hamet highlighted that cross-listings may affect the equilibrium of the
markets. Indeed, Hamet's rationale suggests that trades in each listing place
may risk to become more limited, not facilitating the pricing discovery
process.
Moreover, in part I.3.b. Corporate Governance Motivations, we
have already dealt with the influence of the shareholding diversification for
the corporate governance. However, according to R. Merton, it is also possible
to establish the positive impact of the shareholder basis widening on the stock
price. R. Merton15 stated "when the shareholder base broadens,
risks' sharing improves, bringing about a positive impact on stock prices. [..]
Smaller shareholder base is associated with lower firm value".
Finally, we may imagine that a foreign cross-listing in
markets having different time zones may reduce the volatility of the stock. In
this perspective, P. Lowengrub and M. Melvin16 arrived at the
conclusion that pricing errors are reduced because "it facilitates the process
of assessing a stock's value at the beginning of the trading session. At the
opening of the trading, prices are less volatile for shares that traded
overnight on another exchange than for those that did not".
Influences on the cost of capital
Through a foreign cross-listing, there are different ways to
influence a company's financing.
Firstly, we may consider a positive influence on the cost of
capital thanks to a better access to capital markets. Indeed, empirical
studies17 showed that the cost of equity generally declines after a
foreign cross-listing. This decline may be explained by the access to easier
and more competitive financing conditions
14 J. Hamet, 2001, "La cotation des titres d'une
entreprise française sur un marché étranger et ses
conséquences pour l'actionnaire", PUF
15 R. Merton, 1987, "A simple Model of Capital Market
Equilibrium with Incomplete Information", Journal of Finance 72, No.3
16 P. Lowengrub and M. Melvin, 2006, "Before and
After International Cross-Listings: An Intraday Examination of Volume and
Volatility"
17
A. Karolyi, 1998; R. Stulz, 1999; V. Errunza and D. Miller,
2000
(loans, issuance of shares, equity-linked or bonds
instruments), but also by the elements previously given in part I.3.b Corporate
Governance Motivations, i.e. a decrease of transaction costs for investors, a
higher reliability and quality of information provided to investors, as well as
a better investor protection. For instance, a higher reliability and quality of
information may reduce the investor's cost for researching information and the
risk related to a company, therefore allowing the company to obtain lower cost
of funding, R. Stulz18.
Secondly, the increase of the company's geographical customer
basis helps to lower the company's beta R (see Appendix 1) which
impacts downwards the cost of capital, R. Stulz18, P. Martin and H.
Rey19, D. Lombardo and M. Pagano20.
Influences on the valuation
As a matter of fact, it is well established that the cost of
funding has an influence on the company's valuation.
In its study, L. Zingales21 measured the
difference between market value and book value, with the conclusion that
"shares of foreign companies listed both in the company's home market and on a
U.S. stock market traditionally trade at a higher valuation as a percentage of
book value than domestic peers that aren't cross-listed. A cross-listed company
traded at 150% of book value and a similar company from the same country listed
only on their home market traded at 120% of book value, the valuation premium
would be 30 percentage points. [..] The premium for listing on both U.S. and
foreign markets averaged 51 percentage points from 1997 to 2001. It dropped to
31 percentage points between 2002 and 2005". As a consequence, we may deduct
that investors would pay more for a company listed in the United States, mainly
for the reasons given previously in this research.
The influence of the corporate governance on company's
valuation had already been highlighted by the work of P. Hostak, E. Karaoglu,
T. Lys and Y. Yang22, who noticed that "compared to foreign firms
that maintained their ADRs, foreign firms which voluntarily delisted have
weaker corporate governance, had a less negative
18 R. Stulz, 1999, "Globalization of Equity Markets
and the Cost of Capital"
19 P. Martin and H. Rey, 1999, "Financial Integration
and Asset Returns"
20 D. Lombardo and M. Pagano, 1999, "Law and Equity
Markets: A Simple Model"
21 L. Zingales, 2006, "Is the U.S. capital market
losing its competitive edge?"
22
P. Hostak,, E. Karaoglu, T. Lys and Y. Yang, 2007, "An
Examination of the Impact of the SarbanesOxley Act on the Attractiveness of US
Capital Markets for Foreign Firms"
stock market reaction when SOX was passed, and suffered a
significant price decline in their home-markets when they announced their
intention to delist."
Over the years, some financial places have managed to become
the center of gravity for some sectors: Nasdaq has become a natural stock
exchange for investors and funds specialized in technology-IT-biotech, whereas
the places of London, Toronto and Sydney own a real expertise in Mining and Oil
& Gas sectors. Such evidence has already been showed by A. Blass and Y.
Yafeh23 with the demonstration that Dutch and Israeli companies
performing a listing in the United States are "young, fast growing,
overwhelmingly high-tech oriented and highquality innovative".
Furthermore, not being listed in a place specialized in its
sector, may contribute to a lower the liquidity, and therefore the company's
stock underperformance in comparison to its sector.
Being foreign cross-listed may also help the company to gain
in price-to-earnings ratio (P/E). Indeed, it is well established that the
difference of the average P/E between stock exchanges (see exhibit #10) may
offer substantial gap, and therefore lead to important difference in market
capitalisation for companies evolving in the same sector.
#10: Historical Average P/E of the World Main Stock
Exchanges
(Period 2000-2007)24
61.8 59.8
31.9
24.1 22.6 21.1 20.9 20.2 19.2 17.9 16.7 16.4 14.9 14.1 13.2
23 A. Blass and Y. Yafeh, 1999, "Vagabond Shoes
Longing to Stray: Why Foreign Firms List in the United States"
24
Sources: World Federation of Exchanges, Bloomberg,
ThomsonReuters Datastream
As we can see in the exhibit #10, there are major differences
of valuation between stock exchanges. For instance, the Nasdaq offers a 7-years
average P/E of 59.8 whereas the Nyse and Euronext Paris offer respectively 20.2
and 14.9. By taking advantage of this mispricing (low domestic P/E in
comparison to foreign P/E), a company may initiate a foreign cross-listing on a
stock exchange where its peers benefit from relative higher P/E.
#11: 2007 P/E Comparison of Foreign Companies Foreign
Cross-Listed
on American Stock Exchanges
