Analysis of Cross Listing Benefits and Risks Associated - Example

ANALYSIS OF CROSS LISTING BENEFITS AND RISKS ASSOCIATED College Cross listing Companies decide to list their common shareson a different exchange market from their own primary and original stock exchange for different reasons and driven by different desires. This is what cross listing entails. Cross listing, therefore, refers to the listing of shares of a company on a different exchange market rather than its own home stock exchange (Edison & Warnock, 2003 p.34.). The essence of this essay is to elaborate on the risks and benefits of cross-listed firms. Prior to this, the paper will discuss on the importance of cross listing a company and some of the factors that determine cross listing of the company. Just as mentioned earlier, some companies can choose to list their exchanges on US based exchanges such as the New York Stock Exchange. Also, firms in the US could opt to cross list their firms in the European or Asian market. The conditions for approval of the company to participate in cross listing is that it has to meet the basic requirements just as other companies in the cross listing market. Some of these requirements include the total amount of share count, accounting policies, filing requirements for financial reports as well as business revenues (Edison & Warnock, 2003 p.35.) It also forms part of a strategy for firms to secondarily list their shares abroad thereby marketing themselves to potential investors. There are various ways of achieving cross listing. One is through direct listing whereby more firms perceive their benefits of listing their securities abroad. In such cases, the firms is on a stock exchange in its country of incorporation whereas the secondary listing is on exchange in another country. The other forms of cross listing are through depository receipts program and global registered firms. It’s quite observable that a cross listing is primarily practiced by companies that began as a small business and eventually turned out to be large markets (Edison, 2003 p.12). The underlying reason could be associated with the marketability that comes along with cross listing. Cross listing is also a way that domestic firms can gain access to lower cost of external credit. Cross listing is regional and its success is dependent on regional integration. Regional integration improves efficiency, synergies and economies of scale, attract foreign inflow of funds, and foster risk sharing, as well as portfolio diversification. This serves to expand the competitiveness of regional financing systems and at the same time minimizing the risks of financial instability (Edison, 2003 p.20). Similarly, it is worth noting that economic growth improves in integrated markets because of better allocation of capital to investment opportunities. In Africa, cross listing is primarily policy driven or market driven. A case scenario of government policy driven cross listing was when the government came up with the policy induced between Johannesburg Stock Exchange (JSE) and the Namibian Stock Exchange (NSX). A business driven cross listing is the example of West African triple cross listing. In this merger are Nigerian Stock Exchange (NSE) and Ghana Stock Exchange (GSE). Irrespective of regional cross listing it serves to benefit both the host and home countries (Karolyi, 1996 p.30). . 2. Importance of cross listing International cross listing aids in complementing other aspects of the firm’s strategic operations depending on the market share it intends to capture. These strategies could be implemented in countries where the firms have sizeable operations, sales, customers, and strategic partners. The suitability of these factors helps the firms in coming up with viable options for their listing routes. Further, according to Thomas, an international cross-listing often pre-dates substantial M&A activity in the host market, in part because cross-listing equity as an "acquisition currency. Alongside this fact, international cross listing is very relative. Some managers will opt to cross list while others will not and this decision can be studied regionally. According to the findings of Mittoo (1992) and Bancel and Mittoo (2001), Canadian managers point out that an increase in liquidity, prestige, and image are the most important sought after benefit arising from the listing in the United States, it is followed by "growth of shareholder base/appeal to foreign investors," "increased access to international capital markets as well as funding ability," better implementation of the global strategies and improved stock performance/stock liquidity." 12% of those who participated in the research believe that cross-listing actually attract benefits. 3. Benefits of cross listing 3.1Expansion of investor Cross listing in a foreign market increases the availability of the domestic market to a larger number of investors while in turn increasing the shareholder base and risk sharing which yield higher valuations of the securities concerned. According to Foster and Kaloyi, market value is increased by expanding the shareholder base and at the same time increasing its liquidity. This is a point that is emphasized by Canadian managers with their share base in NYSE with claims that it greatly helps to widen their shareholder base. The benefits that come with increased shareholder base are that it reduces the risk involved because it is shared among more shareholders. Which also serves to increase diversification that eventually translates to lower cost of funds. As such, it would be possible to conclude that cross listing is beneficial for reducing the cost of capital by evoking interest in foreign investors to start trading in both local and international markets. This interest is not just from the fact that the business cuts across but also from the commitment that high standards of governance will be the order of the day. Cross listing also tends to serve as a multiple of the business which will ensure that a wider investor base is covered and growing awareness of the securities concerned. 3.2 Market segmentation This is the most prevalent reason for cross listing, the chief reason being that it allows for investors to avoid cross border barriers to investment (Donald & Mei Zhang, 2008 p.58). . The barriers could emanate from regulation restrictions, information strains, such as uninformative accounting practices or rather the lack of information about the constraint. The status or prestige of an exchange market could be a reflection of the visibility of firms cross listing to the given position hence affecting their valuation later on. The market place should be visible from its overall size though in some cases given high inflows, a total size measure of employee serves as an accurate measure. In environments where numerous locations are competing for cross listing companies, market prestige needs to be subjected to further scrutiny. The importance of this being that it serves to improve the accuracy of decisions suppose they were to be based primarily on the nature of the markets concerned. An accurate assessment of the prestige of alternative destination markets for equity activity should benefit from taking a network-based approach thereby expanding the informational content of standard, one-dimensional aggregates to consider the entire matrix of location-to-location flows. Besides, taking this approach is validated in an environment such as that of the past two decades – with global markets growing steadily and with the expansion of many new, more liquid, and sophisticated business centers that adhere to better corporate governance principles and that can rightly compete for global financial activity. Based on a report by Lulu and Reed, cross listing of shares in a foreign market has become a relatively common phenomenon. It denotes that Karolyi (2006) reports of U.S. holdings of foreign equities sum up to approximately 12% of the asset base of U.S. investors in 2003. Karolyi (2006) also estimates that international listings go for approximately 10% of total listings on non-U.S., major exchanges. Based on this report it is evident that close to a third of all firms appearing in Data stream is listed in at least two markets. Given these statistics, it, therefore, becomes apparent that investors in different markets could potentially hold different information sets. This is beside the fact that they are bound to respond differently to different events especially when the situation at stake is of considerable effect to both the national and international markets. For example, given a case of overseas mergers and acquisitions, domestic traders could be more exposed to the information about the acquirer while, on the other hand, foreign investors would appear to be more abreast of information about the target market. 3.3 Liquidity Cross listing can be analyzed in terms of the liquidity nature of the investment portfolio concerned. The more liquid investment is, the less the cost of capital. It, therefore, forms a crucial component of the investors’ decisions to as it is factored in the market prices. Cross listing allows access to more investors which consequently translate to higher volume of trade. Besides, cross listings are in most cases associated with a boost in the voluminous capacity to trading. However, few studies go into the details as to whether the cross listing affects liquidity priced risks and whether the observed effect on expectations is given a plausible explanation by a reduction in liquidity risk premium concerned. Based on the World Bank study, liquidity in stock markets is a recipe for long-term economic growth since it eases firm’s accessibility to capital for investment. The report illustrates the findings of a study by Kadlec and McConnell (1994) that analyses the implication on return of bid-ask spread for firms that upgrade from NASDAQ to NYSE. The conclusions are that the firms that get a reduction in bid-ask spreads also exhibit an increase in prices; though the magnitude of the relation is sensible to the way the changes in the spread are measured (absolute or relative terms). Additionally, Baker, Khan and Edelman (1994) analyze the behavior of the returns of dual listed stocks and suggest that part of the particular is a reflection of liquidity risk. In the same report, Mittoo (2003) provides an examination of a particular case of Canadian cross listed stocks and finds that the result in returns is positively correlated with inconsistencies in liquidity after managing firm, industry, and market specific factors. Some studies have evaluated the role of systematic liquidity risk in expounding on expected returns and found a significant premium for illiquidity (a case example is Jun, Marathe and Shaky (2003), for the particular case of emerging markets). Owing to the fact that liquidity of markets is directly proportional to economic growth it also results into transaction costs for investors through gains in capital liquidity. However, cross listing may not be an obvious way to enhance liquidity due to the potential offsetting impact arising from the marketing fragmentation. This is to say that, in case of asymmetrical market information, liquidity is bound to suffer. Cross listing is, therefore, dynamic and can be destabilizing to the liquidity from local exchanges to international markets hence compelling consolidation among market centers. Despite this risk, improved liquidity still forms the basis for which investors choose to go for cross listing. 3.4 Increased visibility This is another chief reason for firms to go for cross listing. Local capital markets get attracted to cross lists to larger markets and indirectly provide a pool for larger investors. Increased visibility also serves to increase the local stock market to foreign investors through which they can sell their products. It is a way of communicating to investors that the firm is globally recognized, therefore, can compete from a universal platform. A cross listed business, therefore, becomes more credible through provision of information to the local capital market. This translates to making decisions that are more accurate and timely. As a matter of a fact, visibility of markets forms grounds for making decision to cross list. 3.5 Financial gains The major drive for any business organization is profit maximization without which the company ceases to exist. Cross listing is a means through which capital cost is lowered and enable markets to mint more cash from investors when they offer their stocks to the public. This is a consequence of market segmentation gains and diversification gains. 3.6 Information environment Information disclosure requirement tends to be more stringent in cross listing destination countries such as the US and the UK. The major assumption in cross listing is that information in the market is never symmetrical and that business incompetency will always exist. When a firm decides to cross listing in a more stringent scenario it acts as a signal to outside investors that they are of more value as compared to their counterparts. Firms that are outside the US are generally controlled by shareholders and based on the perspective of the shareholder comes the costs as well as the benefits associated with it. Little is known about direct evidence tying the relationship between a firm’s information environment and cross-listing. This is because we cannot directly measure a firm’s information environment. However, evidence so far points to a positive relationship between the information environments and cross-listing, the association is not clear-cut for several reasons. First, high-quality disclosure could theoretically eliminate or substitute for the collection of private information, leading to less firm-specific return volatility (Kim & Verrecchia, 2001:35) and Tong (2004)]. When firms already have high analyst coverage, Botosan (1997) is of the opinion that that increased disclosure is not necessarily associated with a reduced cost of capital. Lang and Lundholm (1996) note that added firm disclosure can actually level the playing field for analysts. Extra firm information, publicly available to all market players, potentially diminishes analyst’s competitive advantage, which in turn reduces incentives to cover the firm. Suppose intensive trading on private information underlies firm-specific return variation, than stocks for which public information, which is considered of greater importance, will be less volatile because more information is now flowing outside via lower-frequency accounting releases. 3.7 Corporate governance Corporate governance is the process through which companies and organizations are controlled and directed. It can also imply a relationship between various participants in determining the trend and performance of corporations in the process of running its affairs. The primary members include the shareholders, the management as well as the board of directors. Cross listing enables companies to choose the level of regulation including protection that it can provide to its customers. As a matter of fact, the company involved will commit itself to the rules and regulations as indicated in the corporate governance requirements. For instance, suppose that a company cross lists its equity in the New York Stock Exchange, the company will develop on its governance through various means. First, it will be subjected corporate regulations and governance laws that are used in the US, in which their requirements are more stringent. Secondly, it will be subject to the review of financial institutions like underwriters, auditors, values and/or debt rating agencies. This will of course be coincided with a high level of disclosure requirements. Thirdly, the fact that it is across listed implies that it will undergo increases future analysis hence implication that future projections will be more accurate Kadlec & Mcconnell, 1994 p.46). 3.8 Bonding Cross listing comes with the benefit of bonding. This refers to costs of liabilities that an agent or entrepreneur will have to incur to assure investors that they will deliver on their promises as stipulated in the memorandum of understanding. This allows markets to sell their securities at higher prices (Kadlec & Mcconnell, 1994 p.56). . According to the bonding hypothesis, cross listings help capital markets improve on their corporate governance and at the same time protect minority interests through reduction in agency of costs and controlling shareholders. Bonding can be done through submission to reputational intermediaries in then target jurisdiction such as securities analyst, investment bankers, and auditors. Improvement in governance stimulates investors’ incentives to collect private information and work towards improving on the stock market’s nature of information. This hypothesis constrains insiders of the cross listed markets from trading on private information, especially if the login information is tighter than national insider trading rules. Bonding also serves to communicate to potential investors that they are more than just willing to abide by higher standards than they would do in their home market. Disclosure and monitoring associated with cross listing is a bonding technique that can be used to control shareholders for less expropriation of market resources (Kadlec & Mcconnell, 1994 p.57). 3.9 Increased analyst coverage More analyst coverage and more accurate earnings forecast are indications of improved information coverage. Based on the analyst coverage hypothesis, an increase in trading activities resulting from cross listings induces entry of analysts. Besides, cross listing serves to bring to light the cross listed companies to more investors which attract more analysts and more media coverage. Generally, cross listing is also beneficial for the firm and country of the secondary listing. In addition to growing liquidity in the stock market, cross listing also provides diversified portfolio that intensifies investor base. It improves the levels at which people are employed by using gains that are achieved from the country’s operation expansions of the secondary listing. This is through capital accumulation which can be used for investment purposes. Moreover, it improves the cross listed firm’s business reputation and listed firms which are listed nationally. This is through a network formed from which information is dispersed. It helps in reducing interest rates spreads and debt security debts through number of investors increase in the stock market. However, this reduces the investors’ concentration in the money market. It also leads to an increase in the accuracy and the availability of information to the public and ensures information asymmetries are kept low. Most importantly, it enhances corporate governance, and market transparency and quality. 3.10 Marketing motivations Owing to the fact that cross listings create a bigger market demand for the market’s products as well as securities, it indirectly serves to boost the marketing motivation of the firms concerned. This is achieved through the fact that firms choose to bond hence sending a signal to potential investors of their commitment to deliver nothing else apart from results. With cross listing comes positive publicity in the international market that ultimately translates to higher need. 4. Risks of cross listing Cross listing does not just affect cross listing markets but also affects countries in which these cross listed markets are located. Cross listing might demand changes in the primary market so as to coordinate better with the law of cross listed jurisdiction. Suppose cross listed countries attempt to impose laws on cross listing markets, and these laws contravene the law of their home countries, it tends to reduce cross listing and by extension digging into the benefits that come along with international market cross listings. The resultant effect is a decline in investment in the primary market since investors will lose confidence in the market performance. This eventually trickles down to the residents of the country since they will have to bear the brunt of unemployment opportunities. In as much as cross listing provides a wider base for investors to exploit profit opportunities, they are still subject to marketing dynamics, or rather market conditions. There is loss of control in management, the associated cost, loss of privacy and an upsurge in reporting and disclosures. These problems can come as a whole in a sequence. With poor management comes poor governance therefore affecting the market in terms of the costs to be incurred and irregularities in the informative nature of the market. One factor that greatly affects foreign exchange market of equity of shares is the interest rates. Investment and interest rates are inversely related and so a rise in one part causes a decline in another part. This calls for intermediate measures that serve to counteract the effect of the time lag. A vital implication of such models is that when shares of a cross-listing firm experience changes are seen in its local and global market risk characteristics and its cost of capital. To illustrate this, a number of empirical studies were carried out and carefully segregated into those that evaluated on U.S. firms listing abroad and non-U.S. firms listing in the America . On another instance, the results were distinctly different. Typically, these research evaluated changes all the total risk or systematic market risks but with different returns-generating models, in event-time around the listing date. For U.S. firms listing in the international scene (Howe and Madura, 1990; Varela and Lee, 1993b; Damodoran et al., 1993; However, Madura and Tucker, 1994; and Lau et al., 1994), stock return volatilities changed very little and home market betas actually increased slightly. Not many studies have examined changes in risks for non-U.S. firms listing in NYSE. There are definitely costs and disadvantages that come along with a foreign listing, the first being with listing fees. These costs can be divided into: ‘initial listing fee, which has to be paid once, and the ‘annual fee, which has to be paid annually. The annual fee is a surety for the company to maintain its listing on the stock exchange market. The ‘listing fees depend on the number of shares which the company issue and vary on each different stock exchange. There exists a ceiling as to the number of maximum shares that an individual can acquire in a given market. Also, the original and annual listing fees form a small portion of the total costs: commissions payable to the ‘book runner, accountants and lawyers fees and the expense of preparing annually and other reports in the foreign languages. To keep and attract new shareholders, companies have to organize road show campaigns and presentations so that they can maintain their loyalty to the company, not just in the short term but also in the long run. This helps eliminating the flow back of shares to the primary country. Karolyi (1996) researches on the economic implications of the decision to list the companys shares on a foreign exchange. Karolyi (1996) focuses on the valuation and liquidity. The consequences of the listing decision, the effects of listing on the companys global risk exposure and the costs of equity capital. The research consists of 40 studies with the significant findings given as the impact on the stock price around a cross listing is initially favorable after the listing date, however the post-listing period is likely to be to be associated with highly variable Performances, which depends on the home and listing market, the companys capitalization and capital formation needs and other company-specific factors. Following the company’s listing on a foreign stock exchange, the company’s presence and experience in the field has led to an increase in the volume of trading. The liquidity of the company has gone up, but this also depends again on the place of market and the foreign ownership scope restrictions that are found in the home market. Furthermore, many firms will experience a reduced exposure the risk in the domestic market. This leads in a reduction of capital cost, despite the fact that the above mentioned research did not find any significant results on average. Some conclusions can be made from the studies that have been conducted. One of the conclusions is that American Depository Receipts can cause diversification globally and this can help in managing requirements from stringent disclosure in NYSE. 5. Study of various cross listing research Based on findings of NYSE Euro index, it has been found that companies that cross list their shares in the United States have significantly greater valuations than those that do not. The study further links corporate governance with financial performance. For those companies that have been listed in the NYSE, the premium is on an average of 31.2% which is twice larger than the ordinary premium. This is a point that is supported by Andrew Karolyi who posits that cross listing will always have a significant impact on the a firm’s financial performance. However, based on other studies, this may not always be the case. According to a report by Zou & Fu 2011 p.87), cross listing may not always satisfy the investors’ expectations which is a long term better performance. To confirm this point, the report states that a 2007 joint study took a re-examination of the long run stock performance exhibited by Canadian firms which are listed in NYSE from 1900 to 2005. Just as confirmed previously, this report also confirms that cross listing also comes with benefits such as lower cost of capital, increased growth opportunities, less agency costs and a strong improvement in visibility. Alongside these benefits also comes better informational environment that leads to better stock value. The report finalizes by stating that a number of U.S. accounts tend to be restricted from buying international securities. For example, in case a Toronto Stock Exchange (TSX) company has equities on U.S. market on OTCQX, those investors suddenly become very accessible. According to Kadlec and Mcconnell (1994), researchers the benefits that come along with cross listing are only helpful prior to cross listing but are likely to become less important afterwards. Given their observation on the firms that have been cross listed, they came to realize that there was an abnormality in the performance of the firms of 22% before cross listing but later on the performance experiences a free fall before flattening later on. It is no doubt that cross listing benefits outweigh the risks associated with it. The more a firm cross lists, the better its chances of improving its business returns. My personal opinion is that more firms should go for cross listing. It attracts a wider client base therefore a bigger network. Bibliography (2012). Index to Emerging Markets Finance & Trade. Emerging Markets Finance and Trade. 48, 129-135. DONALD LIEN, & MEI ZHANG. (2008). A Survey of Emerging Derivatives Markets. Emerging Markets Finance and Trade. 44, 39-69. EDISON, H. 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