Master Thesis. European cross-listings in the U.S.: Deregistration reasons and deregistration consequences

Master Thesis European cross-listings in the U.S.: Deregistration reasons and deregistration consequences R.A.J. Wels December 2010 1

Master Thesis European cross-listings in the U.S.: Deregistration reasons and deregistration consequences Author: Robin, R.A.J., Wels (administration number: 931369) Graduation date: December 16, 2010 Faculty: Economie en Bedrijfswetenschappen Department: Accounting and Accountancy Mentor: C.A.C. Beuselinck 2

Table of contents 1. Introduction... 4 2 Cross listing... 6 2.1 The effects of cross listing, why do firms cross-list?... 6 2.1.1 Corporate Governance and bonding... 8 2.1.2 Changes in the information environment of cross listing firms... 9 2.1.3 Multi market trading and liquidity... 10 2.1.4 The role of capital markets... 11 3 Historical events for U.S. cross listed firms... 13 3.1 Sarbanes Oxley Act... 13 3.2 Adoption of IFRS... 14 3.3 Rule 12G-4 & Rule 12H-6... 15 4. Registration and deregistration requirements by SEC... 16 4.1 Registration requirements set by SEC... 16 4.2 Deregistration requirements set by SEC... 17 5. Delisting reasons of previously U.S. cross listed firms... 18 6. Delisting consequences for the information environment... 23 7. Hypothesis development... 25 8. Data and Methodology... 29 8.1 Regression model... 35 9. Results... 37 10. Summary and conclusion... 42 Appendix... 44 Appendix 1... 44 References... 45 3

1. Introduction In this study I examine delisting among non-u.s. (United States) firms, which are cross-listed in the U.S. and its relation to the information environment of these non-u.s. firms. Prior literature suggests that the information environment plays a critical role in cross listing decisions but little is known how delisting may affect the information environment of these firms. In fact, there is little direct empirical evidence on the relation between cross listing and the information environment of the firm, even less about the relation of delistings and the information environment. With the globalization of financial markets boundaries in trading become vague and may seem to be inexistent. However, one phenomenon that got increasingly important over the last decade is cross listing. Cross listing can be described as trading shares on a foreign market outside a firms home market. In prior literature several hypotheses can be found as to why firms tend to cross list their shares on the U.S. capital markets. Merton (1987) formulated the liquidity hypothesis, also referred to as the investor recognition hypothesis, in which he states that firms cross list shares in order to increase their liquidity due to a larger investment base which leads to a greater investor visibility. Another hypothesis, the bonding hypothesis, stems from the fact that foreign firms that cross list in the U.S. subject themselves to U.S. laws and institutions and this ultimately generates benefits. By subjecting themselves to U.S. laws and institutions foreign firms credibly bond themselves to avoid, for instance, agency problems which may decrease the wealth of minority shareholders. The benefits of cross listing find their origin within the above mentioned hypotheses. Prior literature suggest that firms cross list because the benefits gained by this type of listing, in general, out way the costs incurred. Cross listed firms tend to have a lower cost of capital because they bond themselves to more credible reporting when cross listed in the U.S. (Karolyi, 2005; Lang et al, 2002; Witmer, 2005; and Doidge et al, 2009). Thus, more enhanced reporting leads to a lower cost of capital since the investor bares less risk and eventual leads to a lower risk premium. Also, from the liquidity hypothesis perspective, since firms are deciding to trade their shares in the U.S., which holds one of the world largest capital markets, these firms will probably notice an increase in analyst following due to the large investor base on the U.S. capital markets (Karolyi, 2005; Baker et al, 2002). 4

As prior literature shows, numerous studies examine why foreign firms cross list on overseas exchanges but it would be more of interest to examine why foreign firms are delisting from these exchanges which were once chosen by these firms as being beneficial. The reason for investigating delistings and its effect on the information environment stems from the fact that recently there has been an increase in the number of foreign firm delisting in the U.S. A growing concern regarding this observation is that the U.S. stock exchange has become less attractive to foreign firms. A recent study by Doidge et al (2009) examines why foreign firms leave the U.S. equity markets. They find that deregistering firms grow more slowly, need less capital, and experience poor stock return performance prior to deregistration compared to other foreign firms listed in the U.S. that do not deregister. This study also provides a good insight into what drives these firms to eventually decide to deregister their stock from the exchanges in the U.S.. However, this study fails to examine the effects of delisting on the firms information environment. The goal of my study is to extend the paper by Doidge et al. by relating delisting to the information environment of these foreign firms, in particular European firms, measured via analyst coverage. Also, I selected an IFRS (International Financial Reporting Standards) affected sample, which to the best of my knowledge, will be unique. Also, since little is known about what drives delistings I screen the reasons for delisting since this has not been the focus in prior literature. My study will be a first attempt to give insight in what drives delisting. As stated earlier, I additionally study the effects of delistings via analyst coverage. The remainder of the paper is structured as follows. Section 2 will provide an overview of cross listing. Section 3 continues with a short overview of historical events between 2002 till 2008. Section 4 will cover the deregistration process and requirements set by the SEC (Securities and Exchange Commission). Section 5 will outline the reasons why firms delist from U.S. capital markets, section 4 will outline the effects of delisting on the firms information environment. Section 6 will outline the consequences of delisting for the information environment. Section 7 will cover the hypotheses development. Section 8 will discuss the data and methodology of this research. In section 9 the results will be presented and finally, in section 10 my findings and conclusions will be presented. 5

2 Cross listing 2.1 The effects of cross listing, why do firms cross-list? The globalization of financial markets is a very interesting topic in academic literature and has resulted in an increasing number of firms choosing to cross-list their stock on exchanges outside their own domestic market. However international cross listings around the world have been decreasing for the last few years. According to Karolyi (2005) this is due to a combination of global macroeconomic, political, regulatory and institutional factors. In a study by Karolyi (2005), which focus is particular on the U.S. capital market as the host market, a large growth is visible in the number of foreign listings on several major stock exchanges (i.e. NASDAQ, NYSE). The number of non-u.s. firm listings was in 2003 the double of the 1990 figure, namely over 2.000 foreign listings. Also the number of countries has been increasingly diversified over the years and according to Karolyi (2005) the number of countries has increased from 30 to 83 countries. Cross listing is therefore an interesting phenomenon and in prior literature reasons can be found why firms leave capital markets, especially in the U.S. since this is by far the most important market to trade on because it has a huge investor base and investor visibility may be higher than on other capital markets. However in prior literature the main focus is about the perceived benefits cross listing may bring. These kind of researches fail to account for governance problems, dominant shareholders and public investors which can arise directly from globalization and which can limit these perceived benefits (Karolyi, 2005). Also when a firm cross-lists its shares on a foreign exchange, the impact on i.e. its cost of capital may be influenced less by barriers that were put in place by new legal environment that protects minority investors more effectively (Karolyi, 2005). Stulz (1999) defines several important mechanisms (6 in total) typically used to monitor management and these are the ones that become increasingly important by globalization in terms of cross-listing. They also motivate firms to make a decision whether to cross-list or not. 6

1. Independent Board of Directors. The board is the most direct mechanism to monitor management, which plays an important role of disciplining managers if performance proves inadequate. For firms to succeed in global markets, investors must have confidence that the use of funds provided will be monitored; this is a particularly significant challenge for firms from segmented economies. Too often, boards of such companies are less than active and raise independent of management. 2. Certification in the capital market. The capital markets, and especially the investment bankers hired to play a certification role for firms selling securities to the markets, also provide an important monitoring function. Once again, companies from less developed markets seeking capital in global markets will rely on the certification of the most highly reputed investment banks to secure lowest cost access. 3. Legal Protections of Minority Investors. The legal system plays two monitoring roles. It limits the ability of management or controlling shareholders to expropriate resources from public investors and it provides a mechanism for investors to exercise their rights. To the extent that firms cross-list shares in new markets with superior legal protections, they may be able to raise capital at a lower capital cost. 4. Stringent Disclosure Requirements. Public disclosure of information by firms is required by laws and regulations and failure to provide adequate information makes it expensive to raise capital. Cross-listing on a market with a stricter regulatory environment is one way for companies to commit themselves to ongoing and more rigorous disclosure. 5. Active shareholders. Large shareholders, such as institutions, have the resources to invest in better monitoring. To the extent that cross-listing in a new market makes it easier to attract institutional investorsespecially foreign and thus outside blockholders - the better arm s length monitoring can yield lower capital costs. 6. The Market for Corporate Control. The market for corporate control, in terms of takeovers and leveraged buy-outs, can fill a monitoring role when internal systems fail. Firms that cross-list into markets with more active takeover markets present themselves with greater competition for control which benefits existing shareholders directly. Source :Quoted from Karolyi, 2005, The World of Cross Listing and Cross Listings of the World: Challenging Conventional Wisdom 7

2.1.1 Corporate Governance and bonding 1 The ability of management or controlling shareholders to gain private benefits from the firm has been an important aspect of corporate governance since it is a important source of potential agency conflicts with the public shareholder. Firms can raise external financing to the extent that it can commit to pay a return to the investors and not extract it for the controlling shareholders or managers personal use. The relation between private benefits and external financing implies that there are costs as well as benefits when resources are extracted from the shareholders. The value of having access to external capital may be large relative to the size of the private benefits when the firm has superior investment opportunities that require external financing (Karolyi, 2005). In such cases, controlling shareholders and managers will probably want to bond themselves to not take these private benefits in order to ensure access to the capital market. Prior literature shows that a useful way to bond managers is to cross list on exchanges that imposes more stringent legal and regulatory costs than the firm s home market, for example U.S. exchanges. In a research by Coffee (2002) he emphasizes legal bonding mechanisms of U.S. listing in three ways: 1) the listing firm falls under the SEC regime and therefore under its enforcement power, 2) investors get the opportunity to make low-cost and effective actions, which are not available in the home market, 3) With U.S. capital market entry the firm commits itself to provide fuller financial information according to the requirements set by the SEC. Coffee also states that not only the enforcement by SEC plays a major role when listing in the U.S. also the role of intermediaries is very important. For example, auditors, debt agencies and buy- & sell side analysts provide additional scrutiny or monitoring that is unavailable in the home market. 1 Karolyi, 2005, The World of Cross Listing and Cross Listings of the World: Challenging Conventional Wisdom 8

2.1.2 Changes in the information environment of cross listing firms 2 A number of researchers have stated that the information disclosure plays an important role in U.S. listing decisions. According to Karolyi (2005) they suggest that valuation changes around the time of listing and valuation differences between U.S. firms that choose to list on overseas markets and those that do not, has less to do with investment barriers but has more to do with the change of the information flows. Saudagran and Biddle (1992,1995) find a negative relation between the influence of enforced accounting standards, listing and regulatory requirements and voluntary disclosure. However during the 1990 s the number of listings on the U.S. stock exchanges grew. This event motivated researchers to investigate why firms would choose to list their shares on markets with higher level of information disclosure and why investors want to value these firms higher (cross listing premium). According to Merton (1987) this was due to market incompleteness or information asymmetry. Moel (1999) extends this research by relating disclosure levels to firm-and country specific factors. He states that firms with higher firmspecific volatility operate in a low quality and low information trading environment. On the other hand, larger firms will disclose more information. A study by Huddart et al (1999) shows how listing decisions on overseas exchanges guide decisions of traders seeking liquidity across different foreign markets. He states that exchanges compete against each other by lowering the trading costs and raising their disclosure requirements. However evidence that proves the contrary has been presented by Chemmanur and Fulghieri (2005). They conclude that firms benefit from listing on exchanges with a good reputation or enforces more stringent disclosure requirements only if investors can produce information about the firm at low costs. Their regression model implies that cross listing by foreign firms on high reputation exchanges with stricter disclosure requirements should be followed by increased analyst coverage since producing information is a motivation for firms to eventually cross-list on foreign exchanges. An event study by Baker et al (2002) noted that listing costs are higher for the NYSE than the LSE (London Stock Exchange). They also show that the visibility on U.S. exchanges is higher and therefore listings on the U.S. stock markets, NYSE in particular, are associated with a higher analyst following. Overall, firms that choose to list their shares on U.S. stock exchange 2 Karolyi, 2005, The World of Cross Listing and Cross Listings of the World: Challenging Conventional Wisdom 9

will notice an increase in analyst following. Karolyi (2005) also notice the positive effect in analyst coverage. However they also note that analyst forecast accuracy increases, resulting in higher valuations and therefore more volatile share price reactions around earnings announcement. The findings of Lang et al (2003) support the statements made in prior literature namely they show that U.S. listed firms are more profitable and trade at higher multiples and they are less vulnerable to earnings management, due to better monitoring. Also, listings on U.S. markets are associated with significant improvements in the information environment of firms which includes, increase in media and analyst coverage, which are related to a higher firm valuation. 2.1.3 Multi market trading and liquidity 3 The globalization of financial markets have lead to the fact that more firms are cross-listing their shares on overseas markets. As we saw earlier, cross listing also changes the firm s information environment and liquidity changes may be related to this change in information environment. Whether and how market intermediaries, like analysts, investment bankers, institutional investors, take an interest in monitoring management or the controlling shareholders of these firms may stem from the liquidity that arises in the new market for their shares (Karolyi, 2005). Price discovery for example is very important when trading on stock exchanges. Price discovery is defined as the search for an equilibrium price (Karolyi, 2005). Several studies have investigated the price discovery for U.S. firms and European firms on U.S. markets. According to Grammig et al (2004), which studied three U.S. listed German stocks, the XETRA prices dominate NYSE prices and exchange rate effects in price discovery. Another European study by Menkveld et al (2003) extends the analysis to incorporate information from U.S. trading during the overnight. They investigate stock like Aegon, Ahold and KLM and find important price and quote activity around the NYSE opening of these stocks (Karolyi, 2005). Since price discovery seems to be related to the actual trading activity on competing markets it is important for firms as to where to list their stock. A study by Pulatkonak and Sofiance (1999) investigates global trading data of 254 non U.S. stock which are listed on the NYSE. They find that 34 percent of the trading takes place on the NYSE. When taking firm and country characteristics into account 3 Karolyi, 2005, The World of Cross Listing and Cross Listings of the World: Challenging Conventional Wisdom 10

they explain 64 percent of the variation and the time-zone characteristic stands out. This implies that companies with home markets trading around the same time-zone as the U.S. are likely to be more active on U.S. markets (Karolyi 2005). 2.1.4 The role of capital markets 4 In a study by Fanto and Karmel (1997) they find that the increase access to new capital is the most important reason why firms tend to cross list on overseas markets. Also, in prior literature several studies find that firms from underdeveloped markets are opting for a listing in the U.S. in order to increase firm value. According to Karolyi (2005), it is the greater liquidity and efficiency of the U.S. market that makes a listing valuable for firms that need to raise extra or new capital. Karolyi (2005) also states that it is important to understand the role of global capital markets as a monitoring device for firms that list on overseas markets. Three of the six monitoring mechanisms, which I stated earlier, are focused on the capital market intermediaries According to Karolyi (2005), (1) investment bankers as a certification device for firms that raise capital, (2) active shareholders, including institutional investors, as outside monitors, (3) the market for corporate control. Investment bankers as a certification mechanism are needed because when a firm wants to trade their securities they need to be certified. Firms from underdeveloped markets gain access to a broader range of investment banks. As long as the prospects are good, they can choose to issue securities with an investment bank which has a stronger reputation than the investment banks on their home market. Trading the securities with the help of a investment bank with a strong reputation may lead to positive information about the firm and increase firm value. Active share holders and institutional investors will be playing a greater role when firms cross list on overseas markets. One of the primary goals of cross listing is to increase the investor base and this means that larger institutional investors will perform more costly monitoring which in turn may lead to greater firm value due to enhanced monitoring by these intermediaries (Karolyi, 2005). The market for corporate control stems from the takeover market. The takeover market is an important monitoring mechanism when internal governance systems fail. Takeover are 4 Karolyi, 2005, The World of Cross Listing and Cross Listings of the World: Challenging Conventional Wisdom 11

however effectively and legally, prohibited in most countries. Cross listing shares in countries where there is such an active takeover markets gives incentives to investors to remove underperforming managers. This leads to greater competition for control among investors (Karolyi, 2005). Below you will find an illustration which clearly shows the reasons why firms choose to crosslist their shares on foreign capital markets and how it influences firm value. Figure 1 The impact of cross-listing (source: promotion research Vincent Chertier, 2008) 12

3 Historical events for U.S. cross listed firms As stated earlier, this study covers the period from 2002 till 2008 and during this timeframe a lot of events can be identified that may influence listing decisions of foreign firms to list on stock exchanges in the U.S.. These events include: (1) The passage of the Sarbanes Oxley Act (SOX) (2002), (2) the adoption of the International Financial Reporting Standards (IFRS) in Europe (2005), (3) the new Exchange Act Rule 12h-6, which made deregistration for foreign firms easier in the US (2007) and finally (4) the waiving of the reconciliation requirement by the SEC (2008). Figure 2 Timeline of historical events 3.1 Sarbanes Oxley Act The enactment of SOX in July 2002 was the result of large financial scandals, Enron and WorldCom, in the U.S. The main objective of the SOX Act is to restore investors confidence which includes the accuracy and reliability of corporate disclosure. However Piotroski and Srinivasan (2008) find evidence that listing decisions for large foreign firms between the LSE and NYSE did not change after the passage of SOX. For small foreign firms they find a decrease in the likelihood of choosing a U.S. listing and this is consistent with the statement that these firms are less able to absorb the cost of compliance imposed by SOX. Another study by Hostak et al (2009) shows that since the passage of the SOX Act an increasing number of voluntary delistings and deregistration of foreign firms is visible. On the other hand the SOX Act also notes some advantages and this holds for firms from badly regulated countries. For these firms the benefits are higher than the cost for receiving a better credit rating by complying to regulations in a highly regulated U.S. (Litvak, 2007). 13

3.2 Adoption of IFRS Another important business reform is the adoption of IFRS in 2005. The globalization of business and finance has led more than 12.000 companies in more than 100 countries to adopt IFRS (AICPA backgrounder, undated) From 2005 onwards European listed companies must prepare their consolidated financial statement in accordance with IFRS. The growing acceptance of IFRS as a basis for U.S. financial reporting means a fundamental change for the U.S. accounting profession. Nowadays approximately 113 countries require or allow the use of IFRS for the preparation of financial statements by publicly held companies (AICPA backgrounder, undated). Growing interest in global acceptance of one standard comes from all capital market participants. An explanation for this can be the fact that home-bias is reduced among the investors because the financial statements are presented in a form which is recognizable for (foreign) investors and therefore willing to make cross-border investment, as according to Kang and Stulz (2007). In the U.S. the SEC has been taking steps to allow public U.S. firms to use IFRS and it may be mandatory in the future. The SEC already proposed a roadmap with key milestones for adopting IFRS and one of its milestones has already been completed in 2009 namely that IFRS statements can be filed with the SEC without a reconciliation to U.S. GAAP (Generally Accepted Accounting Principles). Nowadays the FASB (Financial Accounting Standards Board) in the U.S. and IASB (International Accounting Standards Board) in Europe are working together intensively to make IFRS mandatory in the U.S. as early as 2014. The goal is to develop high quality and globally accepted accounting principles embodied in IFRS as issued by the IASB. As a result of this, and stated earlier, the U.S. GAAP reconciliation is no longer required in foreign issuer filings with the SEC when the financial statements are in accordance with IFRS, as stated above. However according to Leuz (2010) there are still considerable differences in the enforcement systems across countries, which are unlikely to converge in the near future. One can think of who enforces the rules (contracting parties, independent third party, public enforces), how compliance is monitored and what penalties and sanctions are available in case of a violation (monetary, non-monatory, criminal penalties ) (Leuz, 2010). The implication is that since many countries have adopted the IFRS standards, enforcement will play a larger role in the reporting process of firms. 14

3.3 Rule 12G-4 & Rule 12H-6 More business reforms occurred in 2007 when Rule 12G-4 was reviewed and has led to eased conditions. Subsequently, a new rule was enacted and effective on June 4, 2007, namely Rule 12H-6 which makes it easier for listed foreign firm to delist their stock which falls under Section 12G of the Exchange Act. Each U.S. exchange sets its own delisting standards and these are considerably less burdensome than those that govern deregistration from SEC reporting obligation (Doidge et al (2009)). Macey, O Hara and Pompilio (2004) classify delisting standards into two broad categories, namely profit related and reputation related standards. The profit standards are put in place to eliminate firms that are, from the exchange point of view, unprofitable and therefore the exchange uses minimum criteria for those firms to enter the exchange. The criteria are based on market capitalization, price per share, number of publiclyheld shares, number of registered shareholders and trading volume. The reputation related standards are set to maintain the exchange reputation of self-regulatory organization (Chemmanur and Fulghieri, 2003) and allow the exchange to delist firms that go bankrupt, or fail to meet the exchange s corporate goverance standards. The main aspect of the new rule is that firms can use a benchmark of less than 5% of average worldwide trading volume taking place on the U.S. capital markets. The trading volume must not be greater than this 5% (Doidge et al, 2009). According to Greene and Underhill (2008) it was very difficult for foreign firms to deregister when trading volume was low in the U.S. for these firms. After going through the annual reports of the 65 firms in my research sample, by far, most of the firms noted low trading volume as the main cause for delisting. Also, the spike in 2007 which Doidge noted in his study can also be confirmed for European firm sample. 15

4. Registration and deregistration requirements by SEC 4.1 Registration requirements set by SEC 5 I will provide an overview of the deregistration processes as described by Witmer (2005), Leuz et al (2004) and Marosi and Massoud (2004) since they provided a good overview of the deregistration process that needs to be followed in order to deregister from U.S. stock exchanges. In general there are three different rules required for registration with the SEC. First for any company that has it shares listed in a national securities exchange is required to register these securities under Section 12(b) of the Securities Exchange Act of 1934. As a second requirement, companies with more than 300 shareholders and greater than $10 million in total assets must also be registered with the SEC. Failing the requirement of $10 million in total assets, the threshold for the number of shareholders will be increased to 500. To register under these 2 requirements, foreign companies must file form 20F with the SEC. However there is still the possibility for companies to voluntarily register with the SEC under rule 12(g). Third, if companies want to sell their securities on U.S. capital markets they also need to register under the 1933 Securities Act. The forms foreign firms need to use for registration include the F-1,F-2, F-3, F-4 and F-6. The forms are also applicable to perform so called shelf registration under Rule 415 of the 1933 Act. Therefore, it is possible for firms to be registered with the SEC and without trading any securities in the U.S. Once registered, the foreign firms fall under the regime of the SEC and file annual reports pursuant to sections 13 and 15(d) of the 1934 Act. While U.S. based firms must file a form 10-K, foreign firms need to file a form 20-F or 40-F. According to Licht (2003) these last two forms are less stringent because the form 20-F must be filed within 6 months of the firm s fiscal year end and the 10-K filing must be registered within 90 days. Foreign issuers may also report aggregate director remuneration, stock options and ownership of voting securities. Also, foreign companies do not need to disclose transactions with insiders. 5 Overview of registration process as described by Witmer (2005), Why do firm cross-(de)list? An examination of the determinants and effects of cross-delisting 16

Since 1993, U.S. domestic firms are required to file most SEC forms electronically via the SEC EDGAR system. In 2002 foreign issuers were also mandated to file their forms with the SEC system. The SEC estimated that 20% of the foreign issuers were voluntarily filing with the SEC in 2001. However, there was some resistance from foreign issuers since this electronic way of filing forms with the SEC increased the cost of translation and submitting. These costs and disclosure requirements, associated with the EDGAR filing, in addition to the enactment of the SOX act may make U.S. listing less attractive to foreign issuers (Witmer, 2005). 4.2 Deregistration requirements set by SEC 6 Issuers can apply voluntarily for deregistration using form 15F. Form 15 includes information such as the class of securities being deregistered, the class of any securities that still require a duty to file, the filer s address and the number of shareholders in the U.S.. Any security class of a company can be deregistered if it no longer meets the requirements of Section 12 (g). This requirements set out that if there are less than 300 U.S. residents shareholders than a firm may deregister under Section 12(g). An alternative is that if the company s total assets in each of the three previous fiscal years are less than $10 million, the security class may be deregistered if there are less than 500 U.S. residents shareholder. This rule is stricter for foreign firms than for domestic filers because they can be delisted based on the number shareholders and not on the number of beneficial shareholders. Foreign firms may have to incur increased costs in order to determine the residence of all their shareholders in every country. Recently, a rule has been proposed to relax these requirements and allow well-known foreign filers to delist based on the share of trading volume in the U.S. and share of public float held by U.S. residents. This rule may have led to the fact that according to figure 3 a lot of firms from my research sample stated that low trading volume was the cause for delisting. For foreign issuers it is also possible to receive exemption from registration under Section 12 (g) of the 1934 Act. In exchange for avoiding registration, Rule 12g3-2(b) states that the foreign issuer must provide the SEC with any public information that is required by the 6 Overview of deregistration process as described by Witmer (2005), Why do firm cross-(de)list? An examination of the determinants and effects of cross-delisting 17

issuers home country or stock exchange, or any information distributed to its security holders. The SEC publishes a list of the foreign issuers that claim an exemption under this rule. Leuz et al (2004) and Marosi and Massoud (2004) examine the deregistration of domestic companies in the U.S.. Both researches find large negative abnormal returns at the deregistration announcement, which goes together with a sharp drop in liquidity. Moreover, Leuz et al (1994) identifies characteristics which are also in line with Doidge et al (2009) namely, fewer growth opportunities, fewer institutional shareholders and lower stock returns (resulting in low trading volume). Once a firm deregisters, it is no longer eligible for trading on most exchanges. Deregistered firms may also not trade on NASDAQ OTC markets and deregistering firms either go private or trade on Pink Sheets following deregistration. 5. Delisting reasons of previously U.S. cross listed firms Delisting reasons are not widespread in prior literature since most studies focus on why firms cross list on overseas markets. However, it is important to know what drives these once cross listed firms to make the decision to eventually delist from the stock exchange. Delisting a firm from U.S. capital markets can be very costly since most of the benefits the firm received in the past when they cross listed are no longer there. However, firms are well aware of the consequences delisting might bring but do have good reasons for making the decision to delist. From the stock exchange point of view firms can delist if they do not meet the requirements set by the exchange. So failing the requirements of the stock exchange on which a firm is listed will result in delisting the shares. However, according to Macey et al (2004) the exchanges exercise a lot of discretion in applying these requirements. They find that several firms traded their shares for months or years after failing to meet the delisting requirements set by the exchange. Also, firms may be delisted if they fail to meet the exchange s corporate governance standards. Several studies find that firms delist from U.S. stock exchanges due to a low trading volume of current outstanding shares (Doidge et al, 2009; Karolyi, 2005: Lang et al 2002). This is in accordance with a study by Baker et al (2002) stating that firms trading on U.S. stock 18

exchanges have a noticeably larger investor base following the firm due to greater visibility. A logical consequences is that delisted firms will have less analyst following because they return to their home markets. Another reason why firms may delist is from a competition perspective. When a firm cross list on the U.S. stock exchange it bonds itself to more stringent disclosure requirements, meaning more credible reporting and eventually more analyst following the firm. However, from a bonding perspective this can be seen as a benefit but from a competition point of view it may not. Due to more stringent disclosure a firm may need to disclose key financial data which can harm its position among the competition. However, a firm in this situation cannot just choose to not disclose this information because due to more analyst following the firm (more scrutiny) not reporting this kind of information may impact firm value negatively. Accounting standards also play a role in the decision to delist. Since the widespread adoption of the International Financial Accounting Standards (IFRS) and the enforcement of these standards by the European Union (E.U.), IFRS is rapidly making its way to be one of the most popular accounting standards. A logical consequence is that more investors are familiar with the IFRS standards, therefore increasing investor visibility (increase analyst following), and this will lower the cost of information for the investor. Foreign firms list their shares in the U.S. in order to raise capital at the lowest possible cost to finance growth opportunities but if these opportunities disappear, listing becomes less valuable. Also, if IFRS becomes the international standard it doesn t matter on which market firms trade since investors are familiar with IFRS based reports and investors will be active more globally. Therefore, companies which are dual-listed may not benefit from being listed on U.S. capital markets and therefore may terminate their foreign listing and concentrate their trading activities on home markets. Doidge et al (2009), which investigate why firms leave U.S. equity markets, also find evidence that firms are returning to their home markets. Poor stock returns, caused by low trading volume, is the main reason for firms to terminate U.S. listing. In figure 4 the reasons for delisting for the firms in my research sample can be viewed. There are four main categories in which I was able to categorize the reasons found in the 65 annual reports. 19

The first category, cost of listing, contains firms (3) which indicated that listing in the U.S. was too costly to maintain the listing and therefore terminated their listing within the 2002-2008 timeframe. Also, a couple of firms (2) indicated that cost reduction was the cause for delisting and another group of firms (4) indicated that the SOX compliance costs were the reason for terminating their listing. The second category, liquidity issues, mainly consist of firms (19) which indicated that low trading volume caused delisting in these cases. Other firms indicated that the value of being cross listed was no longer there and therefore terminated the listing. The third catergory, return to home market, is relatively straight forward. Firms within this category indicated that globalization of financial markets (4) was the main reason and others (4) simply had no more business in the U.S. so the need for being listed was no longer there. The fourth category, regulatory changes, contains firms which state that IFRS and Rule 12h changes are the cause for delisting. Figure 3 Delistings in the U.S. per country (n=65) 20

35 30 Reasons for delisting 28 (43%) 25 20 18 (28%) 15 10 9 (14%) 10 (15%) 5 0 Cost of listing Liquidity issues Return to home market Regulatory changes Figure 4 Reasons for delisting, condensed research sample (n=65) Leuz et al (2008) investigate why firms go dark and find evidence that going dark is due to poor future prospects, distress and increased compliance costs after the enactment of SOX. So regulatory changes to reporting requirements may also impact firms since these changes can impose substantial costs on firms, especially the smaller firms (Bushee and Leuz, 2005). SOX is of particular importance because evidence found in prior literature states that SOX imposes a substantial cost increase for listed firms in order to comply with the SEC reporting requirements, as well as the cost of retaining outside auditors, directors and lawyers A study by Hostak et al (2009) shows that since the passage of the SOX Act an increasing number of voluntary delistings and deregistration of foreign firms is visible. Foreign firms are still publicly traded in their home markets after terminating their registrations, the associated costs i.e. loss of liquidity are likely to be smaller than those of U.S. firms which must either comply to SOX, go private, or trade on OTC markets. Therefore voluntary delisting decisions are less of an issue for dual listed firms and supportive evidence is found by Doidge et al (2009) since there is a significant increase in the number of deregistrants visible in the year 2007, when Rule 12h-6 was adopted. Alongside these factors, there are also indirect costs that can impose great pressure on resources of listed firms. For example, the market characteristics may change which requires the firm to disclose information that may be valuable to competitors. Also the pressure on management to meet or 21

beat short-term earnings expectations has increased in recent years and could increase indirect reporting costs (Graham et al, 2005). As stated earlier, since most of the firms in my research sample adopted the IFRS standards enforcement on country level is going to play a greater role. However, according to Leuz (2010) enforcement brings, alongside its benefits, several costs. Operating a mandatory reporting regime and providing the necessary enforcement can be quite costly. Regulatory solutions can face many problems and are far from perfect (Stigler, 1971, Peltzman et al 1989). Leuz (2010), one problem is that regulators are often not as well informed about the relevant cost-benefit tradeoff as firms. Much of the reporting regulation in developed countries is focused on publicly traded firms. In general, regulating at country level generates larger benefits from standardization and exploits networks externalities. This is one of the reasons behind the push towards IFRS (Weahrisch, 2001). Regulating at lower levels allow far more fine-tuning to firm needs and investors and hence avoids the problem of a one-size-fits-all approach (Leuz, 2010 and Bushee and Leuz, 2005). Regulation at lower level can increase the competition among several regulatory regimes (Mahoney, 1997; Choi and Guzman, 1998 and Romano, 1998 and 2001). Competition between regulatory regimes can raise the issue that a firm, often by managers and not by shareholders, chooses the regulatory regime and that agency problems can bias this decision. These issues become even more complicated in international markets. According to Stulz (2009) the regulations of various countries interact with each other. The liberalization and globalization of financial markets has given firms more ways to respond to home-country regulation, to attract capital from foreign investors and opt into stricter regulatory regimes (Leuz, 2010). 22

6. Delisting consequences for the information environment A study of Baker et al (2002) for example looks at investor visibility from a different perspective namely by listings on the New York Stock Exchange (NYSE) and the London Stock Exchange (LSE). They find evidence that international firms listed on the New York Stock Exchange (NYSE) or the London Stock Exchange (LSE) experience a significant increase in visibility when looking at analyst following and media attention. Associated with the increase in analyst following is the decline in cost of equity after listing. This effect is consistent with the investor recognition hypothesis develop by Merton (1987) and is found to be stronger for NYSE listed firms instead of LSE listed firms. It shows that analyst following is a good measure to capture the information environment. However, when a firm delists from the U.S. capital market the consequence of this action may be that a firm is less recognizable for the investor since it will return to the home market where the investor is not active. Therefore, firms that delist from U.S. stock exchanges may notice a decrease in analyst following because delisting affects analyst following negatively. According to Lang et al (2002), cross listing provides a commitment to increased disclosure because a firm is subject to greater regulatory and investors scrutiny, disclosure requirements and potential legal exposure. Therefore cross listing is far more complicated than just increasing disclosure in the home market because once cross listed a firm cannot easily terminate their commitment if bad news arises which they prefer not to disclose. According to Lang et al (2002), delisting is very costly from a reputational standpoint, because firms that delist risk alienating its international investor base. Also, this effect would be applicable to agency problems namely investors anticipate better incentive alignment for firms that bond themselves to a stricter regulatory regime by cross listing in the U.S., which means better investor protection. As stated earlier, increased analyst following around cross listing can influence the firm s information environment as they seem to complement each other. However, Lang and Lundholm (1996) note that extra disclosure may lead to increased analyst following it could also reduce the competitive advantages among analysts, which in turn leads to less incentives for the analyst to follow the firm. Also, Botosan (1997) finds that increased disclosure is not associated with the reduction in cost of capital suggesting that analysts and disclosure are substitutes. Another interesting study by Chang et al (2000) concluded that firms from code law countries tend to have more analysts following than common law country firms. This finding could lead to the fact 23

that analyst following could decrease for firms that cross list in the U.S.. Since I do control for the legal background of a country I cannot test whether this will influence my data. However, this finding shows that analyst following can not only be influenced by delisting of a firm but also by cross listing. Therefore it is difficult to make sound conclusions whether delisting per se can influence analyst following and is remains an empirical issue. However, based on prior literature analyst following is negatively related with delisting and my data also supports this finding. The negative relation between delisting and analyst following can also be explained for a analyst forecast accuracy point of view. Cross listed firms change their local GAAP reporting when they list on the U.S. stock markets and Lang et al (2003) suggest that firms change in ways that make earnings more volatile and more similar to U.S. firms. Therefore, non-u.s. analysts might find it harder to predict earnings following a movement toward U.S. GAAP because of greater familiarity with local GAAP (Lang et al, 2002). Witmer (2005) find evidence which are in accordance with the liquidity and awareness theories as firms are more likely to delist when they have a lower percentage of turnover in the U.S.. This finding is supported by my research due to the fact that among the European firms in my sample, low trading volume is the main reason for delisting. Witmer (2005) also finds that delisting returns are more negative when a firm has a higher percentage of turnover in the U.S. prior to delisting. This is important for firms that are considering to delist because home market stock return is affected by the relative amount of trading in the U.S. versus the home market. 24

7. Hypothesis development Several studies look into the phenomenon of cross-listing (Lang and Raedy 2002; Reese and Weisbach 2001; Baker et al 2002). Empirical evidence shows that cross-listing firms have better growth opportunities and may result in more benefits for the shareholders when they cross-list on different capital markets (Reese and Weisbach, 2002; Doidge et al, 2004 and 2009; and Hail and Leuz (2009). One of the effects that comes with cross listing is the cross-listing premium. Doidge, Karolyi and Stulz (2004) find that there is a large valuation premium visible for firms worldwide that cross list on U.S. capital markets. They conclude that the premium is higher for countries with weaker investor protection, the premium is related to the future growth opportunities and the premium is greater for ADR listing than OTC (Over The Counter) and SEC Rule 144a private placements. This cross listing premium can last for a long period of time, even for firms that may have cross-listed a couple of years earlier. Research of Doidge et al. investigates SEC deregistration by foreign firms in the time the SOX act was passed in 2002 through 2008. In this research it is stated that deregistering firms grow more slowly, need less capital and experience poor stock returns. However these findings are based on a research sample that covers worldwide firms which deregistered in 2002 through 2008. My study will investigate deregistration reasons and consequences for European firms, which I derived from the research sample of Doidge et al (2009). In my empirical analyses, I will extend Doidge research by investigating the European firms only but in more detail with respect to the qualitative factors that delisting firms name in their delisting documents, press releases and annual reports. Furthermore, I will particularly be looking at the effects on the information environment around the deregistration event captured by analyst following and firm size. Also several firm specific variables will be used to capture the characteristics that may affect investors decisions, in example EPS (earnings per share), Firm size, trading volume and price-to-book ratio ( here after P/B ratio). Also accounting standards are of influence on the investors decisions but since my sample only consists of European firms, most firms adopted IFRS and therefore it would be less relevant to include. However, since most of the firms are adopting the same standards enforcement may have an effect as earlier stated by Leuz. Prior literature suggests that firms receive numerous economic benefits from committing to strict reporting and disclosure 25

requirements. These benefits include less information asymmetry and higher liquidity (Easley et al, 2002; Leuz and Verrecchia, 2000), a larger investor base (Merton, 1987 and a lower cost of capital (Coffee, 1999; Doidge et al, 2004; Karolyi, 2006). While strict reporting requirements can bare substantial costs, evidence suggests that the benefits of SEC reporting exceed the costs for most listed companies. Covrig et al (2007) for example find evidence that foreign mutual fund ownership is higher for IFRS firms compared to firms that use local standards. Foreign mutual funds therefore have a stronger preference for firms that use IFRS standards. This increased preference is likely to benefit IFRS users because (1) the access to a larger investment capital should increase share liquidity and thereby make it easier for firms to finance projects that may be beneficial. (2) Chan, Covrig and Ng (2006) state that increased mutual fund investments is associated with a lower cost of capital suggesting that attracting foreign investments via IFRS generates a lower cost of capital. In prior literature surprisingly little direct evidence on the relation between cross listing and a firm s information environment can be found and even less evidence can be found which relates delisting in respect to analyst following. According to Lang et al (2002 this is because it is difficult to measure directly a firm s information environment. Bailey et al (2002) use price volatility and volume reaction to earnings announcement to capture changes in the information environment. Baker et al (2002) test whether visibility changes around cross listing using measures as analyst following and media coverage. A study by Healy et al (1999) uses analyst forecast as a proxy for the information environment. In my research I will use analyst following to capture the information environment and therefore this will be the dependent variable in my regression. The phenomenon cross listing has become increasingly important because during the past two decades, the globalization in capital markets has accelerated and broadened the scope of firms to increase ownership and trade their shares on capital markets all around the world. This globalization has led to the fact that an increasing number of firms chose to list their shares abroad on capital markets that were of interest and started to trade outside their domestic market. As a result, competition on major capital markets around the world has increased significantly to attract listings and trading volumes. During the 1990 s the number of foreign firms with shares cross-listed and trading among major exchanges outside their domestic market reached a number of 4.700 (Karolyi, 2005). This number includes firms from developed economies as well as firms 26