Cross-listings and the new world of international capital: another look at the efficiency and extraterritoriality of securities law.

Author:Guseva, Yuliya
Position:V. Quintessence of the Current Policies: Justification and Evidence through VII. Conclusion, with footnotes, p. 459-501
 
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  1. QUINTESSENCE OF THE CURRENT POLICIES: JUSTIFICATION AND EVIDENCE

    1. Policy Justifications: Theory and Practice

      This Section focuses on the policy assessment and determines whether the above-discussed approach is appealing to foreign issuers. To put it another way, does this incremental deregulation work for the U.S. market and support its competitiveness? Are there any efficiency losses? Does every rational issuer (or the majority of FPI) desire to cross-list in a jurisdiction marked by such deregulatory deference and is this policy uniformly efficient across various categories of issuers?

      Cumulatively, the above-discussed judicial and regulatory changes would be justified from a policy perspective (1) if the actions of the policymakers and courts reduced the prohibitive law-related costs and a possible negative externality, all associated with potential overregulation through a secondary listing jurisdiction; (2) if the benefits of cross-listings were unaffected by the lower law-related costs; and (3) if the deregulatory undercurrents and reforms benefited if not all, then at least the majority of FPI.

      The best way to support the first proposition is to demonstrate that the policies in question have stanched (in a meaningful way) the outflow of foreign registrants and listed ADRs. Unfortunately, this is not borne out by the statistics on de-registrations. The number of reporting issuers registered with the SEC has been dwindling: from 1310 companies registered in 2000 (221) to only 965 companies registered as of December 31, 2011. (222) The growth of de-registrations has been continuous and relatively steady between 2001 and 2011. (223) Moreover, in 2011, London overtook the United States as a main DR IPO capital raising location. (224)

      It is of course possible that U.S. markets are becoming comparatively less competitive or efficient along several law-related and non-legal dimensions, or that the "economic and geographic factors matter more" (225) than the SEC's initiatives and judicial standards. The impact of any national securities law reforms would therefore be blurred. Variables contributing to the outflow could range from the removal of legal impediments restricting foreign investments (226) to the simultaneous remarkable growth of several financial centers introducing better trading technologies and improving liquidity of trading. (227)

      Indeed, issuers are now able to trade on liquid foreign markets with improved transparency, liquidity, (228) and, possibly, cross-listing premiums comparable to those of U.S. exchanges. (229) By the same token, the growing confidence in foreign markets might have also affected the ADR trading volume, which has been recently shrinking vis-a-vis domestic share trading. (230) Finally, on the demand side, investors can diversify firm-specific and nation-specific risks globally and enjoy the benefits of this new, more integrated market where the effect of national legal institutions is weaker than before. (231)

      At the same time, even if financial globalization has reduced the value of national regulations as a variable in listing decisions, (232) law is still an important product contributing to the appeal of the package of goods that a country offers to the international market. (233) On the supply side, foreign issuers, meaning their managers or controlling shareholders, may still run a comparative cost-benefit analysis, balancing the pure financial costs of future registration in a multitude of suitable jurisdictions against the explicit economic and implicit legal "bonding" benefits associated with certain venues. Hence, a steady outflow of registrants may also point at potentially misbalanced regulatory policies.

      It is possible that the market could be either "under-deregulated" or vice versa. As the "[c]ost benefit analysis in the area of financial regulation is notoriously difficult ... there is no compelling evidence that the United States is currently striking the correct balance" (234) within the trichotomy of reporting, litigation, and enforcement. Therefore, even if the outflow is primarily caused by international economic developments, there still can be law-generated efficiency losses.

      The second explanation of the current policies is that a decrease in the cost factors would lead to a positive change in the difference between costs and benefits, thus making a cross-listing more efficient, proportionally increasing its value added, and incentivizing an FPI to open ADR programs. This conclusion is apparently predicated on the assumption that the costs and benefits are independent or that their possible interdependence is weak. Yet many scholars would note that this proposition might run afoul of the Law and Finance theory, a formidable body of modern scholarship. (235)

      The very development, depth, size, and liquidity of capital markets are thought to be associated with public enforcement, the private right of action in securities litigation, the ease and efficiency of the private litigation system in general, and the strictness of law implementation. (236) Moreover, there seems to be a positive association between disclosure, on the one hand, and liquidity, returns, trading volume, and the cost of capital, on the other. (237) Finally, the benefits of issuers and investors are mutual since better protection of minority shareholders and property rights is correlated with a higher valuation of corporate assets, (238) better corporate governance, (239) and a more efficient allocation of resources towards firms with high growth potential. (240)

      A cross-listing foreign issuer may seek to tap precisely into these law-related resources. The informativeness and accuracy of its stock prices will also be directly improved by the strength of local legal institutions (241) bolstered by institutional market underpinnings, more accurate analyst coverage, high-quality accountings standards, and certification by reputable auditors. (242) Thus improved transparency and the capital market discipline of another jurisdiction with high-quality regulations may incentivize better corporate governance and simultaneously ensure the safety of investments in the cross-listed issuer. The prospective and retrospective, i.e., remedial, disciplining effects of U.S. law also provide comfort to investors and assure them that despite their limited oversight of foreign management, insiders will be less likely to abscond with the investors' capital, (243) particularly in times of economic crises or severe recessions, when expropriation of corporate assets is a particularly serious concern. (244) Cumulatively, these factors may improve demand for an issuer's stock, (245) while keeping the management in check and, thus, theoretically increasing the cross-listing benefits and lowering an FPI's cost of capital. (246)

      Consequently, knowing that investors value these benefits, issuers are incentivized to "bond" to a higher quality legal regime. (247) This decision demonstrates their existing quality and also has a forward-looking connotation: "[c]hoosing a litigation-friendly regime may signal to investors that the firm's prospects are good," (248) its cash flow is abundant, investment projects are healthy, and the management believes the stock prices are not going to fall, which as a matter of common knowledge often leads to more securities litigation, and that investors will be satisfied with a handsome return on their investments. (249) Hence, the cross-listing "premium" as the sum of economic and law-related benefits, may be partially a function of the costs and robustness of reporting, litigation and enforcement rules. In this way, a simultaneous decrease of both (through either deregulation and international harmonization or minimization of judicial review) may, in theory, proportionally reduce the actual cross-listing benefits, at least for certain categories of issuers.

      The third justification, that the current deregulatory policy should be materially beneficial to the majority of issuers, is undermined by the same uncertainty. A related dilemma is that the U.S. law reforms are potentially not beneficial to all FPI and, instead, their effect is bifurcated. There is some negative stock price reaction to deregulatory events for cross-listed securities of issuers from countries with weak disclosure, investor protection, and corporate governance standards, (250) and a positive one for companies from "developed" jurisdictions. (251) In addition, the ADR trading volume, associated with a higher premium, is much lower for the "developed" stratum. (252)

    2. A Generalized Decision-Making Model

      The results of the reforms are, therefore, mixed and do not lend support to the partial deregulation taking place within the dichotomy of pro- and anti-regulatory policy choices. Based on the foregoing analysis, it is also possible that policymakers have generally misevaluated the cross-listing incentives of foreign managers. Hence, this subsection places the above-described uncertainties into the format of a decision-making model, taking into account the secondary nature of the U.S. regulatory and liability regime for a typical foreign issuer. The model synthesizes a typical set of factors that an average manager (or another control person) is likely to incorporate in her decision making. (253)

      The analysis assumes that a cross-listing decision is driven by a number of considerations representing a host of short-term and long-term strategic benefits such as better valuation, capital raising opportunities, M&A or marketing plans, better corporate governance mechanisms or respective signaling, and others, and denotes all these variables a "premium." (254) As discussed above, many of these considerations are strongly affected by the quality of securities law.

      Logically, in the process of making a cross-listing decision, each control person needs to conduct a cost-benefit analysis in order to determine...

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