Over the past few years there has been a lot of concern that the US has become less competitive in attracting listings by foreign firm (for example, see Zingales 2007). A popular explanation is that the Sarbanes-Oxley Act of 2002 (SOX) has made it more costly for foreign firms to have a US listing – so much so, it is argued, that fewer foreign firms now choose to cross-list in the US and firms already listed want to leave US equity markets.
Foreign firms that list on US exchanges, such as the NYSE and NASDAQ, have to register with the Securities and Exchange Commission and as a result, become subject to US securities laws. Since 2002, these firms have also been subject to Sarbanes-Oxley. Until recently, foreign firms could easily delist their shares from a US exchange, but they faced extremely tough obstacles in deregistering their shares and, without deregistration, were still subject to US securities laws.
All of this changed when Exchange Act Rule 12h-6 was unanimously adopted by the Securities and Exchange Commission on 21 March 2007. This rule makes it easier for foreign firms to deregister by means of a straightforward capital-markets test based on the extent of trading activity of their securities in US markets. Now, it is much more realistic for them to consider taking the step of deregistration. Indeed, within six months following the passage of Rule 12h-6, 59 foreign firms filed for deregistration for the first time from US equity markets.
Two competing theories
Why did these firms choose to deregister and what are the consequences for their shareholders? There are two competing theories.
- The “loss of competitiveness” theory, advocated by the Committee on Capital Markets Regulation.
This argues that the spike in deregistrations “represents pent-up demand to leave” which is a “reflection of the unattractiveness of the US public equity market.”
- The “bonding theory” proposes that firms choose to leave because it is no longer in the best interests of their controlling stakeholders to stay, and they drove the decision to come in the first place.
The idea is that corporate insiders of foreign firms pursue a US listing to subject themselves to US laws and institutions in order to assure minority shareholders that they are less likely to be exploited. Cross-listing has a cost for corporate insiders. They face more restrictions in consuming private benefits at the expense of minority shareholders. It also has a benefit; they can finance growth opportunities on better terms. Insiders at a firm with no foreseeable need for external capital gain no benefit from having their firm cross-listed unless they intend to sell their stake. By terminating registration in the US, insiders at a firm with enough cash flow to finance its growth opportunities can extract more private benefits from their firm.
Each of these theories has direct and distinct implications for which foreign firms choose to deregister from US markets and for the shareholder wealth consequences of such decisions.
Loss of competitiveness theory: Firms that deregister were adversely affected by the Sarbanes-Oxley Act so that a US listing became a burden rather than a benefit for them.
- Shareholders of foreign firms, in general, and of deregistering firms, in particular, were hurt by Sarbanes-Oxley – abnormal stock-price reactions around Sarbanes-Oxley announcements should be negative.
- Shareholders benefit from the introduction of Rule 12h-6 and from firms’ deregistration announcements – abnormal stock price reactions should be positive.
Bonding theory: Firms deregister when it benefits their insiders.
- Firms that deregister have poor growth opportunities and have performed poorly.
- Shareholders of firms that deregister are hurt by deregistration since it increases corporate insiders’ discretion to extract private benefits – abnormal stock price reactions should be negative.
- Deregistration hurts shareholders more when firms have higher growth opportunities.
In a recent paper, we examined the 59 firms that deregistered in the six months after Rule 12h-6 was adopted.1 Our analysis shows that deregistering firms have poor growth opportunities and experienced poor stock return performance over a number of years before deregistration. Compared to other foreign firms cross-listed on US exchanges, deregistering firms also have a significantly lower “cross-listing premium”, the valuation difference between cross-listed firms and their home-market counterparts, and this lower cross-listing premium cannot be explained by an adverse impact of Sarbanes-Oxley.
When we examined the stock-price reactions of deregistering firms around major events surrounding the passage of Sarbanes-Oxley, we found no evidence that these firms were affected adversely by the legislation compared to other foreign firms cross-listed on US exchanges. In fact, there is no clear evidence to suggest that foreign firms with US exchange listings were affected adversely by Sarbanes-Oxley at all. The average stock-price reactions of deregistering firms to the announcements of Rule 12h-6 are insignificantly different from zero as is the average stock-price reaction to firms’ deregistration announcements. However, the average reaction to deregistration announcements is negative and the proportion of firms with a negative stock-price reaction is significantly greater than 50%. Finally, firms with better growth opportunities have a significantly worse stock-price reaction around the deregistration announcements.
So, then, why do they leave?
None of this evidence is directly supportive of the loss of competitiveness theory. There is no reliable evidence that firms with US exchange listings were hurt by Sarbanes-Oxley, that the legislation had a more adverse impact on deregistering firms, or that firms gain from deregistration.
Conversely, some of this evidence is supportive of the bonding theory. Deregistering firms have lower growth opportunities, worse return performance, and there is some (though admittedly weaker) evidence to support the view that shareholders lose when firms deregister, especially shareholders of firms with better growth opportunities.
Overall, the evidence supports the hypothesis that foreign firms list shares in the US in order to raise capital at the lowest possible cost to finance growth opportunities and that, when those opportunities disappear, a US listing becomes less valuable to corporate insiders, so such firms are more likely to deregister and go home.
Zingales, Luigi, 2007, Is the US capital market losing its competitive edge? Journal of Economic Perspectives, forthcoming.