Corporate Governance and Cross-Listed Firms

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...80 percent of all cross-listed foreign firms opt out of at least one exchange governance rule.

Although many investors may assume that foreign companies that cross-list on U.S. stock exchanges adhere to those exchanges' corporate governance rules, in Opting Out of Good Governance, (NBER Working Paper No. 19953), C. Fritz Foley, Paul Goldsmith-Pinkham, Jonathan Greenstein, and Eric Zwick show that 80 percent of all cross-listed foreign firms opt out of at least one exchange governance rule. Smaller and more rapidly growing foreign companies are more likely to comply with exchange rules, presumably because this assists them in raising capital. The authors also find that the stock market values a dollar held inside a cross-listed firm from a weak-governance country less when the firm does not comply with exchange rules.

Many foreign companies want to be listed on U.S. exchanges to facilitate their access to capital. Such firms must comply with U.S. Securities and Exchange Commission (SEC) rules designed to protect investors, but U.S. stock exchanges also have their own distinct governance rules that apply to foreign firms. These firms can opt out of some of these exchange rules provided they disclose how their governance practices differ from them. Until recently, these disclosures were often difficult to obtain.

Beginning in 2008, the SEC required foreign cross-listed firms to list their deviations from exchange rules. The authors created a database by sifting through SEC Form 20-F filings and other available documents for 519 firms from 45 countries that cross list on the New York Stock Exchange, AMEX, or NASDAQ. They discover that 47 percent of cross-listed firms opt out of three or more categories of exchange requirements; 80 percent opt out of at least one. About 51 percent of firms opt out of board independence requirements, 55 percent opt out of board committee requirements, 41 percent opt out of audit committee requirements, 31 percent opt out of shareholder approval requirements for stock issuance, and 27 percent opt out of general good governance requirements. The authors find a correlation between opting out and weaker governance practices in general. For example, there are fewer independent board members at companies that choose to opt out of board independence rules, board committee rules, and audit committee rules.

The authors view complying with U.S. exchange listing rules as involving a tradeoff between "insiders' ability to consume private benefits when governance remains weak and ... managers' desire to raise capital when growth opportunities are attractive." They conclude that "the high share of foreign firms that opts out, especially foreign firms from countries with weak governance regulations, suggests that the costs of complying with strict governance requirements are too high for many insiders."

-- Jay Fitzgerald