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

Foreign firms list shares in the United States in order to raise capital at the lowest possible cost to finance growth opportunities and, when those opportunities disappear, a listing becomes less valuable.

In Why Do Foreign Firms Leave U.S. Equity Markets? (NBER Working Paper No. 14245), authors Craig Doidge, G. Andrew Karolyi,and Rene Stulz investigate Securities and Exchange Commission (SEC) deregistrations by foreign firms from the time the Sarbanes-Oxley Act (SOX) was passed in 2002 through 2008. Until the SEC adopted Exchange Act Rule 12h-6 in 2007 the deregistration process was extremely difficult for foreign firms. That may explain why over half of the authors' sample of 144 deregistrations that took place between 2002 and 2008 occurred after the rules were loosened in 2007. Before that, the firms that left were far smaller than the firms that stayed; that is not surprising, because the old rules required them to have fewer than 300 registered U.S. shareholders before they could leave. After the rule change, the size difference between firms that left and those who stayed disappeared. Easing these procedures led to a spike in deregistration activity in the second-half of 2007 that did not extend into 2008.

The authors observe that firms that deregister grow more slowly, need less capital, and experience poor stock return performance prior to deregistration compared to other U.S.-listed foreign firms that do not deregister. The deregistrations are generally associated with adverse stock-price reactions, they find, but these reactions were much weaker in 2007 than in other years.

The authors consider two explanations for these departures: the first is 'loss of competitiveness,' meaning that SOX and other regulatory developments made U.S. capital markets less competitive with other markets in holding onto foreign cross-listings. The second is 'bonding,' whereby the controlling shareholders of foreign firms, who had credibly bonded themselves by being subject to U.S. laws and institutions, were able to raise capital cheaply, but when their firms were no longer growing, or no longer needed to raise new capital, they quit U.S. markets. If the first explanation were true, then the stocks of the deregistering firms would have been affected by various U.S. regulatory announcements. For example, when the SEC adopted the rule making it easier to leave U.S. equity markets, shareholders might well have boosted their purchases of shares of companies most likely to use the rule. But the authors find no evidence of that.

Overall, the evidence supports the bonding explanation rather than loss of competitiveness. Foreign firms list shares in the United States in order to raise capital at the lowest possible cost to finance growth opportunities and, when those opportunities disappear, a listing becomes less valuable. The authors write that 'deregistering firms are poor performers, have lower growth opportunities, and have a financing surplus, all characteristics that reduce the value of a cross-listing... If a firm is no longer expected to require outside finance because its growth opportunities have been taken advantage of or because they have disappeared, a [US] listing is no longer valuable for insiders.'

Looking at market reaction, the authors find that companies' stocks fell significantly when they announced they were deregistering before the rules were loosened, but did not fall significantly after the rule change. However, they also find that companies with better growth opportunities and larger financing deficits saw their stock prices fall much more significantly. That would be consistent with the bonding theory.

-- Laurent Belsie