Why Are Foreign Firms Listed In The U.S. Worth More?

Summary of working paper 8538
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A U.S. listing probably decreases the controlling shareholders' ability to extract private benefits from control.

By analyzing factors largely overlooked in traditional explanations, Craig Doidge, G. Andrew Karolyi, and NBER Research Associate René Stulz offer a new perspective on the question Why Are Foreign Firms Listed in the U.S. Worth More? (NBER Working Paper No. 8538). The authors note that listing a foreign firm's shares on U.S. markets is widely perceived as beneficial (cheaper cost of capital, increased shareholder base, greater liquidity, enhanced prestige). And indeed, foreign firms listed in the United States have a significantly higher valuation than foreign firms not listed in the United States, so that there is a listing premium. Why then do fewer than 10 percent of large foreign companies choose such listings? Are the firms that list here worth more in the first place, so that there is no added benefit to a listing? Or is it that managers and controlling shareholders of firms unlisted in the United States would not benefit from such listings, even when other shareholders might?

Earlier studies indicate that large foreign firms typically are controlled by large shareholders, mostly families. The controlling-shareholder does not always have incentives to increase the value of the firm's equity capitalization and therefore can impose costs on the other shareholders. Instead, the controlling-shareholder might find it more advantageous to obtain private benefits from control, such as appointing family members to managerial positions when outsiders could do better, entering advantageous deals with other corporations he owns, or making investments of dubious value. The authors' study suggests that cross-listed firms are firms where the costs imposed on minority shareholders by controlling shareholders are low compared to other firms. Controlling shareholders who impose low costs on minority shareholders have the most to gain and the least to lose by listing in the United States: they have lower private benefits from control to protect and greater growth opportunities via improved access to capital markets. Firms where controlling shareholders impose high costs on minority shareholders evidently see a U.S. listing as a threat to the private benefits accruing to those private controlling shareholders.

In other words, a U.S. listing probably decreases the controlling shareholders' ability to extract private benefits from control. But this is not an issue for controlling shareholders of firms whose interests are already sufficiently aligned with those of minority shareholders. In addition, a U.S. listing presumably reduces a firm's cost of outside finance because of the controlling shareholders' compliance with the greater disclosure required by U.S. regulations and the greater protection afforded investors in the United States.

Doidge, Karolyi, and Stulz gather data on the value of foreign firms from Worldscope, an online information service of the Primark division of the Thomson Financial Group. This data is then linked to national rankings established in various studies in terms of investor protection, capital market accessibility, accounting standards, and aggregate market liquidity. Using information from 1997 and focusing on companies with assets of at least $100 million, the authors build a database of nearly 5,000 firms from 40 countries. Of these firms, 714 were cross-listed in the United States.

The authors then confirm that firms with high growth opportunities are those in which the controlling shareholders have incentives to limit extraction of private benefits from their control. More of the cash flows of these firms accrues to the providers of capital, so that growth opportunities are valued more highly for such firms. Further, these firms find a U.S. listing advantageous because it opens up broader capital markets and helps them to convince outsiders that their controlling shareholders' consumption of private benefits from control is limited. The increased valuation of growth opportunities for these firms should be even greater, the authors add, if they are located in countries with poorer protection rights, where controlling shareholders could expropriate more.

Moreover, the run-up in a stock's price that customarily precedes a U.S. listing is further evidence in support of the authors' theory. Such a run-up, they point out, is consistent with firms acquiring growth opportunities and with controlling shareholders committing to imposing fewer costs on minority shareholders before the listing. Finally, one would expect private benefits from control to be more constrained in those firms that raise capital publicly through an exchange listing, because the U.S. listing has the strongest effect on improving protection of minority shareholders.

Next the authors address the concern that their results might be sensitive to the particular year they chose to examine. To this end, they reconstruct their entire database for 1995, applying the same criteria and data sources. The number of firms available for examination is slightly smaller here than it was in the 1997 study. Despite this, the new computation results in markedly similar findings for 1995 and 1997.

Doige, Karolyi, and Stulz acknowledge that their study leaves some issues unresolved. For example, questions remain about self-selection; that is, firms may cross-list chiefly because they have performed well. The authors attempt to control for self-selection, but they allow that their study still might omit significant variables. In any event, they say, while the hypothesis that firms list after having done well can explain why cross-listed firms are worth more, it cannot explain why the cross-listing premium is related to investor protection in an individual firm's country. Yet another issue worthy of additional study is the proposition that the greater valuation of cross-listed companies might simply reflect the overall U.S. bull market of the 1990s. But the authors believe that the evidence nonetheless reveals an authentic premium accrues from cross-listing.

-- Matt Nesvisky