U.S. capital market has long been an attractive destination to foreign companies. Cross-listing by foreign firms on U.S. exchanges has been associated with major benefits such as increase in value, easier access to external finance, and lower cost of capital. A recent deregulation by SEC in 2007, Rule 12h-6, may have significant impact on the benefits of cross-listing and the attractiveness of U.S. capital market to foreign firms. Our study explores the long-term consequences of this deregulation and its implication for U.S. capital market.
The main drivers of the benefits enjoyed by cross-listed foreign firms is a subject of passionate debate. On one hand, researchers argue that the strict legal and disclosure rules of US market allow foreign companies to signal a credible commitment to better corporate governance and thus appeal to investors. On the other hand, we question the impact of U.S. regulations and attribute the benefits of cross-listing to factors such as higher visibility, larger shareholder base, and increased analyst following after cross-listing. Amid this backdrop, the passage of SEC Rule 12h-6 on March 21, 2007, aimed at easing the regulation requirements for cross-listed foreign firms, proved to be a contentious issue among researchers and regulators. Prior to Rule 12h-6’s passage, stringent deregistration requirements made it almost impossible for cross-listed firms to deregister from U.S. exchanges and avoid the disclosure requirements of SEC. The new rule significantly relaxed the deregistration requirements, allowing the cross listed firms to leave at any time they wish.
To explore the impact of Rule 12h-6, we first examine whether the passage of the new rule affects investors’ perception of corporate governance and agency problems of the cross-listed firms. To measure the market perception of private benefits of control, the study uses the voting premium of duel-class firms. The voting premium is measured as the price difference between high voting and low voting shares of the same dual-class firm; a stronger protection of minority shareholder should lead to a lower premium as the private benefits of control become less valuable. Using data of 880 dual-class firms from 19 countries (including 154 cross-listed firms), we find that while the voting premium of cross-listed foreign firms on major U.S. exchanges was about 40% lower than non-cross-listed firms from the same country before 2007, the average difference has reduced to only 20% in the 2007 to 2012 period. We also find that the decrease in voting premium for cross-listed firms is more significant for firms from weak investor protection countries. This evidence suggests that investors’ concern for corporate governance of cross-listed has significantly increased since 2007.
Next we investigate how Rule 12h-6 affects the capital raising capabilities of cross-listed firms. Cross-listing allows foreign firms to improve their access to the capital market by either directly allowing firms to obtain better access to U.S. markets or by enhancing the reputation of the firm in its home market. If Rule 12h-6 has indeed weakened the market perception of cross-listed firms’ commitment to U.S. regulations, then we expect to see a change in the equity issuance pattern for cross-listed firms following the passage of the rule, particularly in non-U.S. markets where firms benefit from the certification effect of listing on the U.S. market. Tracking the seasoned equity offering patterns of 15460 firms from 42 countries (including 621 cross-listed firms on major U.S. exchanges) from 1996 to 2012, we find that compared to non-cross-listed firms, cross-listed firms raised more equity before 2007; however, the equity raising activity declined significantly since 2007, and that the decline is mostly driven by decreased activity in the home markets. The analyses further reveal that the decline in equity issuance in home market is particularly large for cross-listed firms from low investor protection countries, while equity issuance by firms from high investor protection countries barely changed.
Lastly, we look at the value premium enjoyed by cross-listed firms compared to non-cross-listed firms. Higher value relative to non-cross-listed firms in the same country has been a major benefit enjoyed by foreign firms coming to U.S. exchanges; a reduction in such premium will have significant implications on the costs and benefits of cross-listing. Using the same 15460 firms, the study shows that the value premium of cross-listed firms have dropped from an average of 29% before 2007 to a little over 8% in the post Rule 12h-6 period (2007-2012). Similar to earlier results, we find the decline in premium is most significant for firms from weak investor protection countries, while the decline is insignificant for firms from strong investor protection.
Overall, the study shows that the cross-listing benefits have significantly diminished since 2007; and, one of the main drivers is the increasing concern about minority shareholders’ protection in cross-listed firms following the passage of Rule 12h-6. These concerns are also supported by the findings in a separate study where the same authors show that the investment efficiency and performance of cross-listed firms relative to non-cross-listed have declined post 2007. Convincing the market that cross-listed companies remain committed to the superior corporate governance of the U.S. is a major challenge for the management of these firms.
The preceding post comes to us from Chinmoy Ghosh, the Gladstein Professor of Business and Innovation at the University of Connecticut School of Business, and Fan He, Associate Professor of Finance at the Central Connecticut State University. The post is based on their recent article, which is entitled “The Diminishing Benefits of U.S. Cross-Listing: Economic Consequences of SEC Rule 12h-6” and available here.