Corporate Governance

Why Do Foreign Firms Leave U.S. Equity Markets?

By Harvard Law School Program on Corporate Governance

In our paper, Why Do Firms Leave U.S. Equity Markets?, which is forthcoming in the Journal of Finance, we analyze a sample of firms that voluntarily deregister from the SEC and leave the U.S. equity markets over the period from 2002 through 2008. Because it was extremely difficult to deregister before March 21, 2007 when the SEC adopted its new Exchange Act Rule 12h-6, foreign firms that wished to deregister most likely did not do so because they were unable to meet the necessary requirements. When Rule 12h-6 came into effect, deregistration became substantially easier and the change in the rules was followed by a large spike in the number of deregistrations. We investigate why foreign firms deregister, how the Rule change affected firms’ deregistration decisions, and what the economic consequences are of the decisions to deregister.

Two theories offer predictions on which firms are likely to deregister and on the consequences of deregistration for minority shareholders. The first theory follows directly from the bonding theory of cross-listing that predicts corporate insiders value a listing when their firm has valuable growth opportunities that they can finance on better terms by committing to the laws and rules that govern U.S. markets. The listing comes at a cost to insiders since it limits their ability to extract private benefits from their controlling position. If a firm is no longer expected to require outside financing because its growth opportunities have been taken advantage of, or because they have disappeared, a listing is no longer valuable for insiders; the costs of a U.S. listing outweigh the benefits. Consequently, firms that deregister should be those with poor growth opportunities, with little need for external capital, and those which perform poorly. We find support for these predictions.

Deregistration should be advantageous for insiders, but not for minority shareholders, so that it should be accompanied by a negative abnormal return. Further, this negative return should be worse for firms with higher growth opportunities and those with a greater need for external capital. There is no evidence that deregistration benefits minority shareholder before or after the adoption of Rule 12h-6 and we find that stock-prices reactions are significantly negative before the adoption of the Rule. According to the bonding theory, the value of a cross-listing is higher for a firm if it is harder for the firm to deregister. Consequently, the adoption of new Exchange Act Rule 12h-6 should have had an adverse impact on cross-listed firms. Like Fernandes, Lel, and Miller (2010), we fail to find support for this prediction of the bonding theory for the overall rule change, although, consistent with their results, we find some evidence that firms from countries with weaker governance and disclosure have more negative stock-price reactions. Further, though firms with a greater financing deficit experience a worse abnormal return when they announce deregistration, the other firm characteristics that we use in our tests do not appear to be correlated with the deregistration abnormal return and no firm characteristic except for insider ownership is related to the announcement of the adoption of Rule 12h-6.

We call the second theory the loss of competitiveness theory. This theory predicts that the compliance costs of the Sarbanes-Oxley Act of 2002, and possibly other regulatory developments, reduced the net benefits of a U.S. listing so that, for some foreign firms, the value of a listing became negative and hence led these firms to choose to deregister. With this explanation, firms that reacted poorly to SOX would be the firms most likely to deregister, these firms should have benefitted from the Rule change, and they should benefit from deregistration. All these predictions from the loss of competitiveness theory hold even if there is a bonding benefit from cross-listing, so that the two theories are not mutually exclusive. We find no evidence that the stock-price reactions to SOX affect the deregistration decision. Moreover, there is no clear evidence either that foreign-listed firms reacted poorly to the announcement of SOX or that deregistering firms reacted any more poorly than non-deregistering firms. However, there is substantial cross-sectional variation in the stock-price reactions and a more promising way to understand the impact of SOX on cross-listed firms and deregistering firms is to study how SOX was beneficial for some firms but not others. We find that those firms with good growth opportunities and with poor governance provisions benefitted from SOX. Further, those firms that were affected more adversely by SOX were subsequently affected less adversely by the adoption of Rule 12h-6.

In summary, we find that the market generally reacts negatively to deregistration announcements and the deregistering firms are poor performers, have lower growth opportunities, and have a financing surplus, all characteristics that reduce the value of a U.S. cross-listing according to the bonding theory. Our strongest evidence is that firms that leave the U.S. do so because they do not foresee the need to raise funds externally. Indeed, the more funds a firm raises externally, the more negative is the market?s reaction to the firm?s decision to leave the U.S. markets. Overall, the impact of SOX on a foreign firm is not a major determinant of its decision to leave the U.S.

The full paper is available for download here.

Full post as published by The Harvard Law School Corporate Governance Blog on February 17, 2010 (boomark / email).