The local market perception of firm risks during cross‐listing events

• Author: Kathryn Schumann‐Foster,Hui Sono,Elias Semaan
• Date: 01 May 2020
• Published date: 01 May 2020
• DOI: http://doi.org/10.1111/fire.12204

DOI: 10.1111/fire.12204

ORIGINAL ARTICLE

The local market perception of firm risks during

cross-listing events

Kathryn Schumann-Foster Elias Semaan Hui Sono

Department of Finance and Business Law,

College of Business, James Madison University,

Harrisonburg, Virginia

Correspondence

KathrynSchumann-Foster, Department of

Financeand Business Law, College of Business,

JamesMadison University, Harrisonburg, VA

22807.

Email:schumakm@jmu.edu

Abstract

We examine the local investors’perceptions on the relative idiosyn-

cratic risks around cross-listing events. Wefind that increases in rel-

ative firm-specific risks around the listing date are temporary and

small for Level I American depositary receipts (ADRs) while Level

III ADRs have the most variations. For exchange-listed ADRs from

emerging markets,there is a significant decrease in the relative firm-

specific risk in the year prior to listing, which increases during the

cross-listing, while there are only significant increases in relative

firm-specific risks for developed marketfirms. We interpret these as

evidencesof negative relationship between firm opaqueness and rel-

ative firm-specific risks.

KEYWORDS

ADR programs, cross-listing, emerging markets,idiosyncratic risks

JEL CLASSIFICATIONS

G15, G32

1INTRODUCTION

How do local investors perceive relative firm-specific risks when foreign firms decide to cross-list in the U.S.markets?

Prior research demonstrates that firm risks change around the cross-listing event (e.g., Fernandes & Ferreira,2008;

Foerster& Karolyi, 1999; Howe & Madura, 1990). However, the question of how and why this change occurs is still the

subject of some academic debate. Several theories have emerged to explainthese changes including market segmen-

tation, trading activities, and firm information environment changes (Barclay,Litzenberger, & Warner, 1990; Howe &

Madura, 1990; Jayaraman, Shastri, & Tandon, 1993; Jin & Myers, 2006). Empirical tests of these ideas have involved

measuring risk changes around cross-listing using several different measures, including abnormal returns, beta,

R-squared, total return volatility,and firm-specific volatility.1

Researchers who point to the changes in a firm’s information environment as a potential reason for changes in

firm risk around cross-listing argue that the level of opacity impacts firm-specific variance. Prior studies that examine

1Toname a few, Alexander,Eun, and Janakiraman (1988), Chan, Christie, and Schultz (1995), Errunza and Miller (2000), Fernandes and Ferreira (2008), Foer-

sterand Karolyi (1993, 1999), Howe and Kelm (1987), Karolyi (1998), Ko, Lee, and Yun (1997), Miller (1999), Sarkissian and Schill (2008).

Financial Review.2020;55:221–246. wileyonlinelibrary.com/journal/fire c

2019 The Eastern Finance Association 221

222 SCHUMANN-FOSTER ET AL.

R-squared changes find that opaque firms tend to have higher R-squares as firms reveal less firm-specific information

(Hutton, Marcus, & Tehranian,2009; Jin & Myers, 2006). Other studies find that the level of development of the home

market relates to abnormal returns and global idiosyncratic risks around cross-listing (Fernandes & Ferreira,2008;

Miller, 1999). Weexplore the local investors’ perception on the changes of firm-specific risks during cross-listing and

whether it varies over time by forms of listing or the home market development.When a foreign firm decides to for-

mally list on a foreign exchange, the firm needs to reach a certain level of transparency as established bythe listing

disclosure requirements. The increased transparency through cross-listing may be accompanied by increased relative

firm-specific risks. We expectthe firms going through formal exchange listing will exhibit the most variation in relative

firm-specific risks (to total risks). We also expect firms in more opaque countries, such as those coming from emerg-

ing markets, will have to overcome a larger degree of opaqueness than those coming from developedmarkets when

cross-listing in the United States; and hence larger increases in relative firm-specific risks.

Based on these expectations, we focus on changes in firm-specific risks from the local market investors’ perspec-

tive during the year prior and after the cross-listing. We explore any shifts in a firm’s risk structure from a local mar-

ket investor’s perspective.To the home market, the firm’s positioning within its industry is expected to stay level with

cross-listing because it is not an immediate fundamental change in terms of new business products or value creation

strategies. However,because a cross-listing does make one firm stand out relative to its peers, the home market may

perceive the firm differently than before. This motivates us to explorethe change in information environment relative

to the local home market, that is, the localmarket perceptions of relative firm-specific risks during cross-listing.

Empirical research of the timing of any changes in relative firm-specific risks from the local market perspective,

as well as any differences between American depositary receipt (ADR) programs and the country of origin, is still rela-

tivelyunexplored in the literature. To address these questions, we employa dynamic step-by-step approach to examine

changes in firm-specific volatility around cross-listing events using the perspective of the local market.This approach

allows us to examine changes during several periods before, during, and after cross-listing events to see if there are

significant differences in relative firm-specific volatility between ADR levels and developed or emerging home mar-

kets. Tothe best of our knowledge, this paper is the first to employ this methodology in the study of firm-specific risk

changes around cross-listings.

We examine a sample of foreign firms that haveADR programs, at some point, between January 1986 and January

2014, and measure and decompose risks using the home market share prices. Wefind that there are large differences

in relative firm-specific volatility during the cross-listing event period. Our results indicate that there are significant

changes in volatility during both the yearbefore and the year following the cross-listing event. The largest fluctuations

over time in relative idiosyncratic risk are seen for LevelIII ADR programs (∼6.5%) and lowest are in Level I programs

(∼1.5%).

When we break this sample down between developed and emerging home market firms, we find that relative

idiosyncratic risk is significantly different for firms from different economically developed markets,particularly in the

case of Level II and LevelIII programs. We observe an increase in relative idiosyncratic risks from the period spanning

152 days to 52 days prior the cross-listing to the period spanning 51 days prior to 50 days after the cross-listing for

the emerging markets.This is consistent with our expectations that as a foreign firm from a more opaque environment,

such as emerging markets,announces the intention to cross-list on a major U.S. exchange, the resulting increase in firm

transparency will be accompanied by increases in relative firm-specific risk during the period around the cross-listing.

The increase in relative idiosyncraticrisks for developed market firms begins much earlier in the pre-cross-listing peri-

ods. A plausible explanation is that firms from developed markets are already at a higher level of transparencyprior

to cross-listing as required by their home market regulatory and listing standards. In firms from developed markets,

we find that relative idiosyncraticrisk increases approximately 5% in the months preceding cross-listing and decreases

1 year after cross-listing.2

2Therelative idiosyncratic risks settle approximately 1.8% lower for Level II and 2.9% lower for Level III.