What Makes Foreign Firms Attractive to U.S. Investors?
While other studies have established that foreign firms are increasingly attractive for U.S. institutional investors as they conform to U.S. accounting principles, this study establishes that the premium on transparency applies to all U.S. portfolio investors and to a much larger universe of foreign equities than has been captured in earlier studies.
U.S. investors exhibit a strong "home bias" for stocks in their country but the keys reasons for this -- and the countervailing factors that make foreign stocks attractive -- are less clear. Among the four main explanations favoring home equities -- familiarity, moderate transaction costs, strong legal protections, and transparency - the last factor appears to be the most important. Foreign firms significantly boost U.S. investor interest when they enhance their informational transparency, especially by cross-listing on a U.S. exchange, which requires more rigorous accounting and other mandated disclosures.
In Look at Me Now: What Attracts U.S. Shareholders? (NBER Working Paper No. 12500), co-authors John Ammer, Sara Holland, David C. Smith, and Francis Warnock suggest that foreign firms can double (or more) U.S. holdings of their stock when they cross-list on an U.S. exchange, either in a direct listing or through American Depositary Receipts (ADRs) on the New York Stock Exchange, American Stock Exchange, or the NASDAQ.
In a 1997 sample of 12,236 foreign-domiciled, publicly traded firms, just 498 were cross-listed. In these firms, U.S. investors held an (equal-weighted) average of 17.5 percent of market capitalization (26.3 percent of market float) as compared to an average stake of 2.9 percent (5.6 percent of market float) of the 11,738 foreign firms that were not cross-listed. The large difference between the two groups is the basis for what the authors call the "cross-listing effect," which they calculate results in U.S. holdings increasing by 8 to 11 percent of foreign firms' market capitalization. The researchers caution that not every firm could achieve this cross-listing-effect magnitude - indeed, a smaller increase should be anticipated for firms that already have relatively transparent accounting practices - but the evidence suggests that this surge in U.S. holdings could be expected in at least several hundred firms not already cross-listed.
While other studies have established that foreign firms are increasingly attractive for U.S. institutional investors as they conform to U.S. accounting principles, this study establishes that the premium on transparency applies to all U.S. portfolio investors and to a much larger universe of foreign equities than has been captured in earlier studies. It also suggests that, while transparency and legal protections are often correlated, the pattern of investor holdings highlights how much more weight is accorded informational transparency than formal legal protections. In practice, U.S. securities law enforcement does not extend to cross-listed companies but is seen as complementing, not substituting, for shareholder protection provided by other countries' legal systems. Indeed, protection for small shareholders should be more effective in an environment of greater transparency.
The current study's broader dataset yields evidence of U.S. holdings in over 70 percent of non-U.S. publicly traded foreign firms (up from about 5 percent in earlier studies) with significant variations on national and firm levels. U.S. investors own nearly a quarter of Argentina's market capitalization, roughly 20 percent in the Netherlands, Finland, Ireland, Hungary, and Mexico, but less than 5 percent in China, Taiwan, Greece, and Colombia. In the aggregate, Americans held just 9 percent of market capitalization in 46 countries. At the firm level, the holdings are relatively dispersed in roughly three-quarters of the sample 12,236 firms, ranging from very small to developing country trans-nationals. Of a total market capitalization (end of 1997) of US$11,080 billion, U.S. investors' US$1,020 billion stake represented 88 percent of total U.S. foreign equity holdings.
The pattern of ownership suggests how much more weight informational transparency is given than formal legal protections. An increase of 20 points in a country's national accounting quality index (CIFAR score) -equivalent to moving from an Austrian to a Swedish firm -- increases U.S. investment by 25 percent of typical holdings for a non-cross-listed firm, holding everything else constant. A similar increase in U.S. investment occurs when there is an increase in firm-level accounting quality, rising from a value of 2 to 4.
Other factors highlighting the importance of information quality include: the preference for larger firms (thought to provide more reliable information because of their capacity to generate quality information, and more regulatory, press, and after-listing securities analysts' attention); those producing information in English; those with diffusely held shares (diluting the influence of insiders); and dividend-paying firms (suggesting less danger of expropriation). There is also a tendency to avoid financial firms that are considered less transparent than non-financial firms. At the same time, U.S. holdings do not appear to be affected by either familiarity or costs. U.S. investors hold about the same proportion of foreign stocks traded over-the-counter (OTC) in the United States as they hold in peers not traded in the United States. Indeed, U.S. investors acquire a majority of their shares in cross-listed firms directly in the firm's home market, rather than through purchases of ADRs. Thus, the availability of foreign shares trading in the United States is, by itself, neither a necessary nor a sufficient explanation for the cross-listing effect.
The implications seem evident: firms can attract more foreign investment by voluntarily increasing disclosure, and governments can stimulate capital in-flows by promoting and enforcing those disclosures. Still, the evidence suggests that, to date, the key motive for cross listing has not been to expand the shareholder base; rather, the decision to cross-list is more likely when there is already a large base of U.S shareholders. In this light, cross listing is a means of servicing existing shareholder clientele. Indeed, there is evidence that foreign firms cross-listing in the United States are the types of firms that U.S. investors are likely to hold anyway, whether they are cross-listed or not
-- Ken Stier
