How Would the Stock Exchange Monitoring Role Affect the Performance of U.S. Firms: Evidence From Cross‐Listed Firms in the United States

• Author: Enas A. Hassan
• Published date: 01 May 2017
• Date: 01 May 2017
• DOI: http://doi.org/10.1002/jcaf.22274

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© 2017 Wiley Periodicals, Inc.

Published online in Wiley Online Library (wileyonlinelibrary.com).

DOI 10.1002/jcaf.22274

How Would the Stock Exchange

Monitoring Role Affect the

Performance of U.S. Firms:

Evidence From Cross-Listed

Firms in the United States

Enas A. Hassan

INTRODUCTION

This article

examines the effect

of stock exchange

monitoring on a

firm’s performance.

A large volume of

literature in finan-

cial economics

explores how stock

exchanges perform

their unique roles

and how firm-stock

exchange relation-

ships affect a

firm’s business

(e.g., L. D. Brown &

Caylor, 2009; Frost,

Gordon, & Hayes,

2006; Krishnamurti,

Sequeira, &

Fangjian, 2003).

Despite a num-

ber of theoretical

discussions on stock

exchange monitoring,

however, little empiri-

cal evidence has been

done on whether stock

exchange monitoring

is successful (Holm-

strom & Tirole, 1993).

Further, those studies

that do examine this

issue explore lim-

ited aspects of stock

exchange governance

functions, such as

market depth (liquidity)

(Cumming, Johan, &

Li, 2011) and the

governance and trad-

ing system structure

(e.g., Krishnamurti

et al., 2003; La Porta,

Lopez-De-Silanes, &

Shleifer, 2006). Thus,

the main objective

of this study is to

Stock exchanges perform governance activities, among

these activities, monitoring is considered as one of the

stock exchanges most distinctive and important activi-

ties, since it increases shareholders’ ability to evaluate

managerial performance, and put in place effective

managerial incentive schemes; yet little research atten-

tion has focused on the effects of stock exchanges as an

external mechanism on firm performance. This article

provides empirical evidence on whether stock exchange

monitoring is successful. Using a comprehensive mea-

sure comprising a range of stock exchange monitoring

factors suggested by prior literature as important deter-

minants of stock exchange monitoring role, the results

indicate that the strength of stock exchange monitoring

is positively associated with firm performance as mea-

sured by return on assets, return on equity and Tobin’s

Q. A more comprehensive analysis provides additional

evidence suggests that U.S. firms are more likely to be

influenced by U.S. stock exchanges monitoring than

their non-U.S. counterparts and the incremental legal

bonding benefit provided by the Sarbanes-Oxley Act

(SOX) for U.S. firms was exceeded by SOX’s incremental

costs. Finally, the findings of this study highlight a num-

ber of implications for academics, the SEC and other

international standard setters, securities regulators, and

stock exchange operators. © 2017 Wiley Periodicals, Inc.

Refereed (Double-Blind

Peer Reviewed)

The Journal of Corporate Accounting & Finance / May/June 2017 21

© 2017 Wiley Periodicals, Inc. DOI 10.1002/jcaf

empirically examine the effec-

tiveness of stock exchange

monitoring by using firm per-

formance. Further, instead of

considering just a single mea-

sure of governance, this study

expands extant literature by

developing a comprehensive

measure of stock exchange

monitoring comprising a range

of stock exchange monitor-

ing factors suggested by prior

literature as important determi-

nants of stock exchange moni-

toring role.

Stock exchanges perform

governance activities such as

setting listing requirements and

monitoring listed companies.

Among these activities, moni-

toring is considered as one of

the stock exchange’s most dis-

tinctive and important activities

(Frost et al., 2006). In general,

the purpose of stock exchange

monitoring is to increase share-

holders’ ability to evaluate

managerial performance, and

put in place effective manage-

rial incentive schemes (Bush-

mana & Smith, 2001; Lambert,

2001). Consequently, stock

exchanges have advantages in

performing a monitoring func-

tion. This is because (a) stock

exchanges impose governance

and disclosure rules that govern

the release of private informa-

tion, which reduces information

asymmetry between managers

and investors and increases

investor confidence; and (b)

they provide investors with

insights into firms to assess

managerial actions (Cumming

et al., 2011; Holmstrom &

Tirole, 1993; Humphery-Jenner,

2012).

Using 51,411 firm-year

observations between 2001

and 2010, results indicate that

there is a positive association

between the strength of stock

exchange monitoring and

firm performance, implying

that stock exchange plays an

important role in corporate

governance. These results

are not in line with, but also

add to the findings of Fang

et al. (2009), as it confirms

similar results while using

a comprehensive measure

rather than an individual mea-

sure (liquidity). Additional

analyses examine whether the

association, suggested by the

main results, continues to be

evident in the non-U.S. stock

exchanges. The result indicates

that U.S. firms’ performances

are more likely to be influ-

enced by U.S. stock exchange

monitoring than non-U.S.

stock exchanges. Further

analysis examines the main

association in the context of

non-U.S. firms, shows that

non-U.S. firms are less likely

to be influenced by U.S. stock

exchange monitoring than are

U.S. firms. Finally, the main

analysis expands to examine

the impact of the Sarbanes-

Oxley Act (SOX) on the

monitoring role of U.S. stock

exchanges. The results indi-

cate that SOX crowds out the

impact of stock exchange as a

monitor on firm performance.

A few recent studies are

closely related to this paper.

La Porta, Lopez-De-Silanes,

Shleifer, & Vishny (2000) show

that securities law, shareholder

protection, matters in improv-

ing firm performance. Fang

and colleagues’ (2009) results

indicate that firms with liquid

stocks have better perfor-

mance. While the findings in

these studies suggest that stock

exchange governance is related

to operating performance,

they provide little evidence

regarding the importance of

stock exchange monitoring

role in particular. Thus, unlike

prior research on the United

States, this paper, using a com-

prehensive measure of stock

exchange monitoring, contrib-

utes to the ongoing research

on the corporate governance

role of the stock exchange as

an external monitor in mitigat-

ing agency problems leading

to improved firm performance.

Further, the results of this

study may be of interest to the

Securities and Exchange Com-

mission (SEC), as it provides

implications for the likely

impact of stock exchange

monitoring on the corporate

governance as the focus has

shifted from attracting domes-

tic issuers to attracting larger

international companies. Con-

cerning competition among

stock exchanges, the finding of

this study may also encourage

regulators in other countries

to adopt effective policies with

a view to improving legislative

frameworks for corporate gov-

ernance.

This article proceeds as

follows: the next section dis-

cusses the theoretical frame-

work. The third section reviews

related literature and develops

hypotheses. The fourth, fifth,

and sixth sections present the

variable construction, sample

selection, and research design.

The seventh section discusses

main and additional empiri-

cal results. The eighth section

presents results of robustness

tests. Finally, the ninth section

concludes the paper.

THEORETICAL FRAMEWORK

Scholars have widely

applied agency theory (AT)

to the study of corporate

governance as a monitoring

and control mechanism used

to curb agent opportunism

and minimize informational