Cross border listings

Existing regulation in local capital market like taxes, information asymmetry and foreign ownership restrictions usually act as barriers and prevent foreign investors entering those markets. In addition, local investors in segmented domestic capital markets in order to undertake the risk tighten to the local market usually require a risk premium. In order to counter these problem domestic firms can adopt policies such as listing in a foreign exchange in order to offset the negative effects of market segmentation and offer several other straightforward advantages that stem from lower transaction costs (Khurana et al., 2005). Further more, cross border listing serves as a mean for foreign investors to save any transaction costs associated with dealing in a foreign currency as well as to effectively bend any existing foreign exchange regulations since they are allowed to trade share in their own currency. Taken into account that cross-listing serves to lower barriers to foreign investment cross-border listing serves effectively in reducing the firms costs related to market segmentation and therefore lowers the cost of external financing (Alexander et al. cited in Khurana et al., 2005).

The ability to prevent shareholders or managers to acquire private benefits from their firms is an important aspect of corporate governance since it represents an important source of potential conflict with public shareholders. After all the rationale of raising external capital must be towards that it must be raised only after management's commitment to return this capital to investors and not to extract it for the controlling shareholders' personal use (Karolyi, 2006). Stulz (1999) as cited in Karolyi (2006), placed emphasis on the potential agency conflicts and information asymmetry problems that corporate managers or controlling shareholders would face with public shareholders in their effort to raise external capital. Agency conflicts could arise in the case where the set of actions of corporate managers or controlling shareholders are not aligned with the interests of public shareholders. On the other hand, information problems may arise if the management of the company, although having good information about future cash flows, is unable to credibly convince investors about the accuracy of these cash flows (Karolyi, 2006). Managers can alter those problems if they choose to bond themselves in a better governance regime by cross-listing in order to commit not to engage in illegal activities and as a result they can increase the firms’ value since they are able to raise external capital. Consequently, cross border listing effectively improves a company's corporate governance regime and this particularly true for such companies that come from countries with inadequate supervision and disclosure standards (Karolyi, 2006; Witmer, 2006,Pagano et al., 2002). In addition, firms that decide to list their shares on a more demanding exchange in terms of disclosure and corporate governance standards enjoy a better post listing profitability than those that cross list in other exchanges. Karolyi (1998) as cited in Pagano et al. (1999), after surveying several number of studies showed that the price reaction is significant for foreign listings in the US which is the country with the highest disclosure standards, whereas it is insignificant otherwise.

Merton (1987) as cited in Khurana et al. (2005) tries to explain the rationale behind a firm's decision to cross-list its shares by the investor recognition hypothesis. According to this hypothesis stock trading behaviour of investors is affected from the lack of information. Consequently, this behaviour affects the related share price since investors with incomplete information are reluctant to include those shares in their investment portfolios, requiring a risk premium in order to include those shares in their portfolios. Through cross listing firms can increase investor awareness and expand its potential investor base on their securities more easily than if it traded on a single market. Cross border listing enhances the credibility of a firm by providing information to the local capital market therefore the continue flow of information allow the capital market to make faster and more accurate decisions (Licht, 2004). Further more, listing a company's shares in a major and prestigious stock exchange like NYSE or LSE is accompanied with increased coverage and local media attention which in turn enhances visibility (Pagano et al., 2002). Supporting this argument, Baker et al., (1998) as cited in Witmer (2006), in their study looked how foreign firms’ visibility is affected after cross listing either on NYSE or LSE using two proxies for visibility: the firm's analyst following and media coverage. According to their findings an average of six more analysts follow the firm after a listing on NYSE and an average of three analysts following the firm after a LSE listing. In addition, they found an average increase in home media coverage by 37 and 11percent after NYSE and LSE cross-listing respectively.

In order for a market to be liquid transactions must be executed rapidly and with little impact on prices. Firms pursue cross border listings since it reduces transaction costs via an improvement in market liquidity following the foreign listing. The relationship between liquidity and cross listing lies upon the global competition for order flow (trading volume). Consequently, exchanges are forced to continuously look for ways to improve their trading processes in order to enhance market quality and maintain or attract order flow. The benefits that companies seek to gain through cross border listing come as a reduction in the firm's bid ask price resulting in an increase in firm's valuation, therefore this improved liquidity is more likely to attract more institutional investors. Low liquidity is perceived as a barrier for institutional investors that prevent them from holding the firms stock due to the high trading costs associated in holding this security (Witmer, 2006; Chouinard & D’Souza, 2003). Further more, the proportion of total trading volume that the new market captures along with the trading restrictions imposed on foreigners prior to listing are factors that affect the extent to which liquidity is enhanced. In addition, another factor favouring the enhancement of liquidity, especially for listing firms that come from emerging markets, is the existence of informational links between markets. If informational links for example were poor for listing firms that come from emerging markets cross-listing would actually reduce liquidity and increase volatility on the domestic market as informative trades were directed to other markets (Domowitz et al. 1998 cited in Chouinard & D’Souza, 2003).

Another benefit that cross border listing provides to foreign companies is the improved terms by which they can raise external capital either because credit constraints are relaxed, or because of the existence of the bonding effect due to which investor protection is increased. The benefits of cross listing are further increased in the case that either the firm or its shareholders due to financial constraints present in the home market serve as barriers to capital raising (Witmer, 2006; Pagano et al., 2002). In addition, evidence found in prior research of Reese and Weisbach (2002) as cited in Witmer (2006) demonstrated an increase in the capital raising as a result of the bonding hypothesis in that a firm's ability to raise capital in its own market is enhanced through cross listing. More over, firms perceive cross border listings as a mean to raise capital needed to finance future investment projects. Fast growing firms are the ones that are more likely to experience the benefits of the increased funding (Pagano et al., 2002).[1][2]

• Cross listing