International Cross-List and Visibility - Essay Example

Introduction This project will be completed in three separate parts. It focuses on important elements of international finance. The first part discusses the concept of cross-listing of shares by a company across two or more jurisdictions. It involves a critical review of the benefits and the costs of companies that cross-list. This is done through the critique of literature and academic sources on the topic, The second part of the report will be a case study of a selected multinational company. The company chosen for this study is Volkswagen. It will be done through the critique of their financial statements and other reports to identify elements and aspects of international finance that is relevant to the company. The final session will involve a critical review of foreign exchange and currency risks. It will be done by calculating significant aspects of risks and foreign exchange matters including hedging and other elements that are relevant to international finance. PART 1: CROSS-LISTING Globalisation and internationalisation are two very common themes that run through businesses today. More and more businesses find ways and means of expanding to other nations. There are various cross-border business transactions which help businesses to attain their objectives and strategies. There are three main reasons why businesses seek to undertake cross-border transactions and activities: 1. Greater participation in foreign countries and access opportunities in those jurisdictions. 2. Access to larger market and resources that helps them to attain results and 3. Access to capital in other countries to enable them to attain results and objectives (Baker and Riddick, 2013) Cross-Listing The quest to access capital in foreign nations come with the need for cross-listing. “Cross listing occurs when a security or good is simultaneously traded on more than one exchange” (Oran, 2010). Chen (2008) identifies that cross-listing involves the “listing of a companys common shares on a different exchange other than the primary or original stock exchange” (p49). This implies that a business that cross lists will sell it shares or securities one one stock exchange and sell it on another stock exchange at the same time. This means that the firm will have a presence in two or more stock markets. Thus for example, a Chinese Firm listed on the Shanghai Stock Exchange might want to enlist on the New York Stock Exchange as well. A business that enlists on different stock exchanges has to restructure its operations to comply with the stock exchange requirements of the local stock exchange. It involves changes in risks and retention of stocks and this could lead to abnormal returns (Oran, 2010). Baker and Riddick (2013) identify that cross-listing existed in the beginning of the 20th Century, but it increased significantly in the early part of the 21st Century. The US Stock Exchange, the London stock Exchange and the Alternative Investment Markets are the main pointers where most businesses enlist to access the foreign capital markets. Cross-listing comes with several benefits like involvement in financing activities, insider control and other valuation effects. However, it has some downsides as well. The rest of this section will examine the elements of cross-listing. It will commence by looking at the costs and challenges of cross-listing to businesses. The next section will involve a critical review of the benefits or advantages of listing on two international stock exchanges. Challenges & Costs of Cross-Listing There are various challenges and issues that come with the attempt to list on two or more international stock exchanges around the world. Standardization Issues The first issue and challenge that comes with enlisting your stocks on more than one stock exchange is the standardization of your books and accounts (Li et al, 2008). This is because cross-listing implies that a business will have to adhere to two different sets of rules and regulations. This is borne out of the fact that every stock exchange has its own supervisory rules. Thus, the firm might need to spend time and money to transpose the reports and accounts of the different stock exchanges in presenting unified accounts. Aside reporting issues, there are forecasting issues and problems. This is because it is difficult to forecast in both jurisdictions and there is a big likelihood that the forecasting tools and techniques that are invoked could provide inaccurate results. Li et al (2008) identify that the main method of preventing this is to use robust models like the Tobins Q which provides a more accurate method of evaluating trends across stock markets. Diseconomies of Scale Cross-listing favours larger firms than smaller firms. For most medium and small scale entities, cross listing can lead to extra overhead costs which could cause the business to incur more costs than normal (OConnor and Phylaktis, 2010). Thus, it could be a disincentive to effort if a smaller entity tries to enlist on different stock markets around the world. Spread of Benefits Most businesses undertake cross-listing in order to attain prestige. However, it is identified by Baker et al (2011) that cross-listing on some stock exchanges could bring less results than others. They cite famously, that the New York Stock Exchange provides the highest levels of returns. Other stock exchanges tend to come with issues and problems that make it less productive and less fruitful for the listing company. Higher Administrative Fees A company that is listed on more than one stock exchange around the world is likely to incur higher administrative costs (DeVilliers et al, 2013). This is because audit fees would have to be duplicated across the two jurisdictions. This causes more money to be dispersed. Also, the management of the group will have to spend more money and make more sacrifices. This is because the scope of their obligations are extended because of the fact that their activities straddle across two different nations around the world. Unnecessary Compliance Requirements Although most businesses around the world praise the compliance requirements and the robust nature of rules, there are many excessive demands and requirements that could be onerous for a firm. This is because any time the government of a nation comes up with directives for entities in the country, the listed companies are the first organizations that are targeted. Brewer and Felde (2013) cite the case of a moral action undertaken by the US government. This was the 2007 directive by the Security and Exchange Commission which published the names of firms that were trading in “terror-ridden states”. Although this motivation was justified in the need for transparency and promote effort to enhance ethical trading, it was extreme and such acts could go a long way to limit the benefits a firm gets from cross-listing on more than one stock exchange. Thus, one bad or onerous requirement can affect the business across board and this could cause irreparable damage to a firms image. In spite of the fact that compliance costs are high, Lin (2011) argues that the costs of cross-listing is much lower when compared to the benefits that accrues from cross listing. Hence, it is somewhat a positive venture to list on more than one market. And this explains why different companies continue to cross-list across the different stock markets around the world. Benefits of Cross-Listing This section of the essay will examine the benefits and the advantages of cross-listing across more than one stock exchange in the world. This include the different positives that listing on more than one market brings to a firm. Compliance and Regulation Benefits In the general sense, listing on a stock exchange comes with higher compliance regulations and standards. This is because the stock exchange is regulated by the government and the relevant authorities in the nation that it is located in. This is motivated by the fact that the stock exchange features businesses and entities that are funded by the share purchases of members of the public. Hence, the government of the nation has the obligation to ensure that shareholders rights are protected and shareholders are given the rightful treatment. Moreover, stock exchange rules are meant to to limit the power and authorities of the people charged with running the organization. This comes with specialized corporate governance rules which governs the conduct of listed companies. Thus, having to list on more than one stock exchange implies that a business operating in a foreign country will have additional rules and regulations. This is because the stock exchange rules will require the directors and persons charged with corporate governance to go beyond the normal to adhere to relevant rules and regulations about listing and operations. Evanoff (2009) identifies that there are regulations and assurances which governs areas like share issuance, accounting policies, filing requirements and financial reporting amongst other things. This means that the company will be held to a relatively higher level of accountability and transparency. This will ensure that the organizations are ran in good faith and there will be more ethical uprightness amongst the managers than ordinary entities. Additionally, a higher compliance standard will ensure that a business will have to remain a more faithful and more compliant entity in the host country than normal. This will provide a hedge against abuse and misuse of resources and power. This will keep the business functional and it will be able to adhere to other corporate governance standards easier than normal. Insurance and Protection by the Stock Exchange Cross-listing inevitably creates a system whereby a business gets some obligations that is more than normal. However, the fact that a business adheres to these high standards gives way to some rights which will otherwise be waived (Jiang et al, 2011). This is because a business will have to adhere to numerous standards and rules which comes with its own rights and privileges. In some jurisdictions, this include negotiable certifications and other local benefits which can help a business to attain better results and better security (Jiang et al, 2011). In other bailout activities that occur in a host country where an international business is listed, priority is given to public listed companies. This is because there is a guarantee and an assurance that such companies adhere to much higher standards and expectations. Hence, the business operates in a privileged manner, although it might be existing in a different country altogether. Goodwill of Locals & Capital Expansion Jiang et al (2011) identify that most businesses cross-list for business and profit motives. This is because there are opportunities in these jurisdictions which are always accessed if a business is listed in a foreign country. This benefit comes through the acquisition of the confidence and goodwill of the locals in the country that a foreign company is listed. The listing on a foreign countrys stock market gives a business an international profile and a positive image. The adherence to local standards, requirements and expectations make the locals more confident that the business is credible. Investors are not scared of the risk of the business folding up or disappearing. Hence, investors are able to comfortably invest in these companies in the host country that they operate in. Jiang et al (2011) observes that in most Western nations, Chinese businesses get to raise funds if they are listed on the countrys stock exchange. This is because the local investors are more confident about a listed company. Hence, these Chinese businesses end up expanding their capital base in order to launch into more challenging markets around the world. Reputation Enhancement and Stock Valuations Listing a business in a competitive country inevitably leads to higher valuation of the firms stocks. Listing in the New York Stock Exchange causes a firms stocks to soar almost the moment the announcement is made (Lin, 2009). This is because it is perceived that the standards for listing on the stock market in the United States is high. So most people assume that a business that manages to list there is successful. This boosts investor confidence and share prices go up. Also, there is a reduction in the cost of capital this is because the business gets more options in terms of seeking funding from third parties (Lin, 2009). This is supported by the fact that listing on a foreign countrys stock market causes relaxation of capital constraints, and increases the firms visibility (Lin, 2009). This creates a further enhancement of the companys image and promotes more interest in the business which shoots up the price of the stocks (Haihong, 2008). Another angle from which the increased stock price can be explained is the fact that the countrys citizens often believe that being listed provides stronger supervision and control. This is because it causes improved controls and promises better protection for investors (Shen et al, 2010). Thus, investors spend more and there is a higher demand which pushes the value of the firms shares up. Bianconi and Tan (2008) state that a firm gets higher valuations after listing. This is because the premiums in both the home country and the foreign country grows. There is a higher level of reputation and the companys share prices grows both at home and in the foreign country. Some explain it by stating that cross-listing comes with reputation-enhancement which leads to better results and better investment prospects. In an empirical study of cross-listed firms, it was identified that cross listing leads to “cross-listing discounts” which is a model that explains the benefits that a firm attains (Salva and Fresard, 2012). Salva and Fresard studied some US firms that were cross-listed over a period of 1989 to 2006 and it was discovered that they got 14% better performance and results than they would have attained if they had remained local. The double-listing created some sensitivity to stock prices and this lead to higher performance as per a study by Foucault and Fresard (2013). Better governance, enhanced image and proper practices is credited to this improved investment worth (Georgierva and Lee, 2008). The destination market shows more signs of growth in the value of stocks more than the home market (Dood, 2013). This is because in the destination market, the company is seen in a much more positive light than in the home market (Dodd, 2013). Information Benefits Another angle through which the benefits of cross-listing is examined is in the area of information flow. Since information about cross-listing is usually positive and enhances the image of the firm, most companies base their marketing campaign on the fact that they are cross-listed (Bris et al, 2011). Also, when a firm is on a stock market, its operations and competencies are seen by all and sundry (Fernandes and Ferreira, 2009). This is because a perfect market shows the things that occur in reality. Thus, a firm is guaranteed that whatever happens internally is shown externally on the stock markets as this will support the movements in the value of the stocks (Fernandes and Ferreira, 2008). International Benefits Cross-listing also supports a business in several ways. First of all, it increases visibility and credibility (Baker et al, 2011). This is because when a business is listed on two stock markets in distant lands, it can use its reputation and position to access important opportunities around the region. Thus, a British business that is listed on the Tokyo Stock exchange can use its credibility to establish branches in the whole Asian sub-region. On the other hand, a Japanese business listed on both the Tokyo Stock Exchange and New York Stock Exchange will get the benefit of gaining access and reach to expand throughout the Western hemisphere. Also, being on two or more stock exchanges decreases the cost of capital. This is because the listing will increase interest in the business share and the share value will go up. This means that the firm will continue to get capital to carry out its essential projects and activities. This will cause the business to grow and get enhanced in a positive way and manner Conclusion Cross listing provides some benefits and positives to a business. This include the fact that a cross-listed firm will get an enhanced image and also get a better reputation than normal. Cross-listing increases goodwill on both the home and host countries within which the firm operates. The enhanced reputation involves higher returns and better access to capital. On the downside, cross-listing favours larger businesses and entities. Smaller businesses go through harsher circumstances if they try to cross-list. Cross-listing leads to higher administrative costs and sometimes, very onerous compliance requirements that can prove to be a disincentive to effort. Most businesses delist after they attain their desired end on a foreign stock market (Jiang et al, 2011). PART 2: SOURCES OF FINANCE Finance involves the integration of capital into the operations of a given company. Finance involves providing money and resources for the organization to operate and fund other forms of operations. There are two main sources of finance, this include working capital and longer-term capital (Madura, 2008). Working capital is capital that a business invests into its operations. It uses working capital to pay for its trading activities and fund its growth. Longer-term capital is often invested into long-term assets like fixed asset. This boosts the the asset base of the company. The main distinction between long-term finance and short-term finance is that it involves capital that are acquired from external sources for periods that are more than 12 months (Lumby, 2011). Whereas sources of finance that are due in a period of less than 12 months appear as current liabilities, those above 12 months appear under long-term liabilities. Volkswagen as an international multinational automotive manufacturing company that has its headquarters in Germany. The company has a long-term history that goes back to the early parts of the 20th Century. Currently, Volkswagen operates as a global giant with many subsidiaries and business interests around the globe. From the 2012 financial statement of Volkswagen, it has several sources of long-term financing and long-term investment systems and options. In broad terms, Volkswagens sources of long term financing include the debt and equity. Equity The annual financial report of Volkswagen indicates that it has a subscribed capital base of €1,190,995,445. This forms the stock of equity and capital that the company has and the company. This include the worth of all the shares that have been issued to all the parties in the companys list of shareholders. Out of this total volume of subscribed capital, the companys shareholders included the following during the end of the period of accounts, December 2012: Investor Percentage of Shares Porsche Automobil Holding SE 30.00% Foreign Institutional Investors 25.00% Qatar Holdings 15.00% State of Lower Saxony 12.50% Rivate Shareholders/Others 10.00% German Institutional Investors 5.00% Porsche GmBH, Salzborg 2.50% At the end of the period, the DAX index, the primary stock exchange that the Volkswagen shares are listed had the following values for the shares of the company. This include: Share Type Cost per Share (€) Ordinary Shares 172.2 Preferred Share 172.15 Debt Equity creates control rights to the people who own hold shares. This is because in the legal sense, the various shareholders of the company are the owners of the company. Hence, they have a say in how the company is ran and how the company operates. These people take part in decision making and they support the company. In simple terms, they pool resources to build the company. On the other hand, a company might want to also get loans and other forms of financing from third party entities that will come at an interest. This is known as debt financing. The reward for equity is profits. However, the reward for debt financing is interest. Since holders of equity are owners of the company, they do not have a right to interest. And when the business falters and there are debt, holders of equity are likely to forfeit their profits and even capital. On the other hand, those who provide debt financing are legally entitled to repayment by the sale of a collateral used to secure the loan and if that is not enough, they can go further to claim an asset of the company. Shareholders do not have this right since they own the assets. However, since a company is a limited liability entity, the companys debts to third parties are put ahead of investors interests. According to Volkswagens 2012 financial statements, there are three main sources of debts that were acquired to help in its operations. This include: 1. Mandatory Convertible Five-Year Loan of €2.5 billion at 5.5% per annum taken from VW International Finance NV which is to expire in November 2015. 2. A Ten-Year US Market Bond of $6 billion that is at a rate of 7% taken in 2012. 3. A Chinese bond of CNY1 billion at 6% per annum for 8 years These three main sources of long-term finance form the crux and the fundamental long-term finance that was employed by Volkswagen. Rationale for Capital Structure The existing capital structure is fairly normal and similar to the system used by other competitors in the industry. First of all, the equity structure involves a fair balance of a stock of wealth that is necessary to provide a degree of stability in trading. This is because with that volume of capital, the firms shareholders could provide enough funds to support the operations of the company in return for a reasonable level of return on investment and dividend. The shareholder structure is fairly distributed amongst a series of owners who can play various roles in the company. This include the government of Lower Saxony, German institutional investors, moderate foreign shareholders and workers/managers of the company. Debt on the other hand provides some kind of working capital that can enable the firm to attain some specified results. In the case of the US bond that was acquired, it was meant to support the acquisition of a subsidiary in the United States. This subsidiary was to provide a strategic assembling of Volkswagens car units in North America and compete with the various car manufacturers in the country. Although VW was to pay a total of 7% or $42 million per annum for this bond, the competitive advantage that the US presence was to bring was a major advantage to the company. Also, the Chinese bond was to help in the marketing and promotion of Volkswagen in the Chinese market. China offers a long-term prospect with a large consumer base. Hence, the investment of this money at a rate of 6% was to boost the presence of VW in this new market. Calculation of the Cost of Capital There are various models that are used to calculate the cost of capital. This include amongst others, Capital Asset Pricing Model (CAPM) and Weighted Average Cost of Capital (WACC). For the purpose of this discussion, the WACC will be employed to examine the facts relating to the capital base of the company. WACC is calculated by the formula below: [Market Value of Firms Equity/(Market Value of Firms Equity + Debt)] X Cost of Equity PLUS [Market Value of Firms Debt/(Market Value of Firms Debt + Equity)] X Cost of Debt Calculation: [1991/(1991 + 7.16)] X 159.28 PLUS [7.16/(7.16 + 1991)] X 0.4621 [1991/1998.16]X 159.28 + [7.16/(1998.16)/ X 0.4621 (0.9964 X 159.28) + (0.0035833 X 0.4621) 158.707 + 0.0016558 Weighted Average Cost of Capital: €158.70866 The following details are relevant to Volkswagen Market Value of Firms Equity: €1991 billion Market Value of Firms Debt: €7.16 billion [2.5 + (6 X 0.75) + (1 X 0.16) = €7.16] Cost of Equity: €159.28 (@8% of Equity) Cost of Debt: €0.4621 [(2.5X 5.5%) + (4.5 X 7%) + (0.16 X 6%) . PART 3: HEDGING & FOREIGN CURRENCY RISK Question 3 Using your allocated MNCs home currency and the currency used by one of its subsidiaries give an example of transaction risk faced by the company in the last 12 months. You will find the information you need about exchange rates at the sites given below. You may find that you need to use cross rates to determine the exchange rates you need. http://www.fxstreet.com/rates-charts/forward-rates/ http://www.oanda.com/currency/historical-rates/ http://www.x-rates.com/historical/?from=SGD&amount=1.00&date=2005-03-01 Required: a) Give an example of a transaction the company undertook or might have undertaken in the last year. Using real exchange rates demonstrate the impact of exchange rate volatility on the amount the company expected to actually receive or pay. You must show clearly the sources of the data you have used. (5 marks) b) Clearly explain in your own words how a money market hedge and forward contract work and how they can be used to hedge a transaction. You should include a consideration of their benefits, costs and limitations in your answer. (10 marks) c) Using data for your two countries determine the result of using a money market hedge and a forward contract to hedge the transaction. (10 marks) (Total 25 marks) Marks will be given for the correct use of bid/offer or ask rates and suitable interest rates. You should include screen shots showing clearly all the data you have used. References Bakker, H. K., Nofsinger, J. R, and Weaver, D. J. (2011) “International Cross-List and Visibility” Journal of International Finance 12(2) pp231 – 242 Baker, H. K. and Riddick, L. A. (2013) International Finance: A Survey Oxford: Oxford University Press Bianconi, M. and Tan, L. (2008) “Cross-Listing Premium in the US and UK Distinction” SSRN Working Paper Series. Brewer, W. and Felde, M. (2013) “Wealth Effects of the Security Exchange Commissions Terror Tool” SSRN Working Paper Series Bris, A., Cantale, S., Hrnjic, E. and Nishtiotis, G. P. (2011) “The Value of Information in Cross-Listing” SSRN Working Paper Series. Chen, R. (2008) The Cross Listing Decision: Analysing the Sarbeans-Oxley Effects on the United States Santa Barbera: ProQuest DeVilliers, C., Hay, D. and Zang, Z. (2013) “Audit Fee Stickiness” SSRN Working Paper Series. Dodd, O. (2013) “The Valuation Effect of International Cross-Listing” The Business Review, Cambridge 21(1) pp59 - 666 Evanoff, D. A. (2009) Globalisation and Systematic Risk New York: World Scientific Fernandes, N. G. G. and Ferreira, M. A. (2009) “Does International Cross-Listing Improve the Information Environment?” SSRN Working Paper Series Foucault, T. and Fresard, L. (20130 “Cross-Listing, Investmetn, Susentitive to Stock Rise and Learning Hypothesis” SSRN Working Paper Series. Georgierva, D. and Lee, W. Y. (2008) “Impact of Sarbanes-Oxley Act on Gross Listing” SSRN Working Paper Series Haihong, H. (2008) “Are Changes in Cross-Listing in the US from the Pre-to-Post Sarbanes Oxley Period Associated with Shareholder Protection in Foreign Firms Home Countries?” Journal of International Accounting Research 7(2) p65 – 84 Jiang, Z., Tingting, Z. and Shengchao, K. (2011) “Cross Listing, Corporate Governance and Corporate Performance” Nankai Business Review International 2(3) pp275 – 288 Li, E. L., Sandeep, N. and Mujtaba, M. G. (2008) “Cross Listing: Information Environment and Market Value: Evidence from US Firms that Lists on Foreign Stock Exchanges” Journal of International Accounting Research 7(2) pp25 – 41 Lin, J. (2009) “The Effects of US GAAP Compliance on Non-US Firms: Cross Listing Decisions, Listing Choices and Their Variations” PhD Dissertation Knoxville: University of Tennessee Lin, J. (2011) “The Effects of US GAAP Compliance on Non-US Firms: Cross-Listing Decisions” International Journal of Economics and Finance 3(6) pp42 – 56 Lumby, S and Jones C ( 2011) Corporate Finance: Theory and Practice. 9th ed, London: Thompson Madura, J (2008) International Financial Management, Mason, OH: Cengage. OConnor, T. and Phylaktis, K. (2010) “Cross Listing Behaviour” SSRN Working Paper Series Oran, A. (2010) “The Effects of Non-US Firms in the NYSE” SSRN Working Paper Series. Salva, C and Fresard, L. (2012) “To What Extent Do Cross-Listed Firms Integrate into the US Environment” SSRN Working Paper Series Shen, H., Liao, L. and Liao, G. (2010) “Cross-Listing and Bonding Premium Evidence from Chinese Listed Companies” Front Business Research China 4(2) pp171 – 184 Read More