- Email: [email protected]
The impact of international listings on risk
Journal
of Banking
and Finance
THE IMPACT
14 (1990)
1133-1142.
North-Holland
OF INTERNATIONAL
LISTINGS
ON RISK
Implications for Capital Market Integration
John S. HOWE* Louisiana State Unioersity, Baton Rouge, LA 70803-6308,
USA
Jeff MADURA* Florida Atlantic University, Boca Raton, FL 33431, USA Received October
1989. final version
received
March
1990
In this paper, we examine the impact of international listing on common-stock risk. While previous research has used event study methodology, our research focuses on permanent shifts in risk. Different measures of risk are estimated to test for intertemporal shifts in risk attributable to an overseas listing. No signilicant shifts in risk from international listing are documented. The results are robust with respect to the location and year of listing. These findings suggest that: (1) markets are already reasonably well integrated; or (2) listing is an ineffective mechanism for reducing segmentation.
1. Introduction
A growing body of literature, both theoretical and empirical, has examined the issue of the segmentation of international capital markets. For example, Stulz (1981) models the pricing effects of barriers to international investment. The empirical evidence has generally shown at least some degree of segmentation [e.g., Errunza and Losq (1985), Jorion and Schwartz (1986)]. However, the topic remains controversial. Bodurtha (1989), employing a multi-factor model similar to that of Chen, Roll and Ross (1986), finds evidence consistent with integration rather than segmentation. The issue of the degree of capital market integration is relevant for the pricing of assets. Increasing attention has been paid in recent years to theories and tests of asset pricing models in an international context, such as the International Capital Asset Pricing Model and International Arbitrage Pricing Theory [see, e.g., Cho, Eun and Senbet (1986)]. These theories and the empirical tests thereof must make (sometimes implicit) assumptions about *Correspondence address: Department of Finance, Louisiana State University, Baton Rouge, LA 70803, USA. The authors would like to thank Alan L. Tucker and an anonymous referee for helpful comments. Any remaining errors are our own responsibility. 0378-4266/90/$03.50
J B.F
B
0
1990-Elsevier
Science
Publishers
B.V. (North-Holland)
1134
J.S. Howe and J. Madura,
Impact of international
listings on risk
the flow of capital across national boundaries and the degree of independence of different markets. Because capital market integration can influence pricing model specification, it has obvious implications for portfolio construction and investment management. Capital market integration is also an important topic for corporate finance [see Adler and Dumas (1983)j. If the markets of different countries are segmented, then corporate managers may be able to engage in investment and/or financing activities which serve to mitigate the effects of segmentation. Stapleton and Subrahmanyam (1977) suggest three categories of corporate financial policies which can reduce the negative effects associated with market segmentation: (1) direct foreign investment; (2) mergers with foreign firms; and (3) listing of the fum’s securities on foreign exchanges. In spite of the theoretical benefits of foreign listings when capital markets are at least mildly segmented, existing empirical studies find little or no evidence of net gains from dual listing. Howe and Kelm (1987), e.g., examine the stock price effects of American firms which listed their stock overseas. They find that first, second and third listings are associated with negative abnormal returns. Alexander, Eun and Janakiramanan (i988) use a sample of foreign firms which listed their stock in the U.S. While they find weak evidence of lower expected returns in the post-listing period, they do not find evidence of an increase in stock price that would presumably accompany a wealth-enhancing listing. Generally, evidence of significant benefits associated with an overseas listing has been lacking. This paper uses a different approach to measure the effects of overseas listings by U.S. corporations. Specifically, we explore whether the risk characteristics of the listing firms shares change as a result of the listing, in a manner consistent with a greater degree of market integration. We find no evidence of such changes. This finding is consistent with: (1) markets which are already reasonably well integrated; or (2) listing as an inegective mechanism for reducing se~entation. This paper is organized as follows. Section 2 reviews the relevant literature and section 3 outlines the methodology and data. The empirical findings are reported in section 4 and the paper ends with a summary and our conclusions. 2. Literature The potential benefits associated with international listings have been demonstrated in several models [Stapleton and Subrahmanyam (1977), Alexander, Eun and Janakiramanan (1987), Errunza and Losq (1985)]. The intuition behind these models is that, in the presence of partial or complete segmentation of capital markets, foreign listings can serve to lessen the degree of segmentation. These listings should therefore cause (theoretically) a
J.S. Howe and .I. Madura,
Impactof international
listings on risk
1135
change in equilibrium prices for the dual listed securities. Generally, listings are shown in these models to result in higher prices and/or lower expected returns. While changes in domestic listing location have been studied extensively, little empirical attention has been paid to international listings. In an early article, Stonehill and Dullum (1982) provide a detailed case study. The two most prominent studies are by Howe and Kelm (1987) and Alexander et al. (1988). Howe and Kelm examine a sample of U.S. firms undergoing their first, second and third overseas listings. The foreign exchanges involved are Paris, Frankfurt and Basel. Using standard event study analysis, they measure the abnormal returns in the 131 day period surrounding the announcement of the listing. They find this period to be associated with negative abnormal returns (about - 5.1% for the initial listing), suggesting a net cost to overseas listings. They speculate that uncertainty is increased for an internationally listed stock due to increased regulatory uncertainty, but offer no evidence to support this conjecture. Alexander et al. examine a sample of 34 foreign firms which listed their stocks in the United States. Thirteen of these were Canadian stocks, while the remaining 21 were American Depository Receipts (ADRs) of firms from Japan, Australia and other countries. They find positive abnormal returns in the pre-listing period, no abnormal returns in the listing period, and negative abnormal returns in the post-listing period. They argue that the timing of the abnormal returns is consistent with a reduction in the expected return on the sample stocks. However, they also note (p. 149), ‘. . .if a decline in the expected return on a stock does occur, there should be a large increase in the stock price.. . . However, . . . no such increase was observed here.’ In sum, there is little or no evidence documenting significant benefits to the shareholders of firms which list their stock on a foreign exchange. However, given the relative paucity of evidence, further empirical work is clearly justified.
3. Methodology and data 3.1. Methodology
The approach taken in this study starts from a simple premise: if capital markets are segmented and if listings are an effective mechanism for reducing the degree of segmentation, then an international listing should have an effect on the listing firm’s stock. Conversely, if markets are well integrated, listing should have no effect [as noted by Alexander et al. (1988, p. 136)]. In order to derive specific empirical hypotheses, we define a segmented market as having two salient characteristics. First, capital does not flow into or out of a
1136
J.S. Howe and J. Madura, Impact of international
listings on risk
perfectly segmented market. Second, an asset in a segmented market is priced in the context of that market. That is, the risk of an asset is measured relative to the systematic factor(s) present in that market. We focus in this paper on various risk characteristics and related measures in the pre- and post-listing periods. Five lines of empirical inquiry are pursued. First, we search for evidence of a change in ‘domestic beta,’ the beta of the stock measured with respect to the U.S. market index. An international listing which decreases segmentation will increase the influence of the foreign market on the listing firm’s stock returns. The influence of the domestic market will be correspondingly less pronounced. The null hypothesis is no change in domestic beta; the alternative hypothesis is a decline in domestic beta. The domestic betas for the sample firms are estimated in both a singleindex [bi in eq. (1)] and a two-index model [ci in eq. (2)]: (1) Ri = a: + CiR,, us + diR,,for + Ui,
(2)
where Ri is the return on stock i, R, us is the return on U.S. market index, and Rmsroris the return on country of listing (foreign) market index. Second, the ‘foreign betas’ of the sample firms are estimated. These betas are measured with respect to the market index for the country in which the listing occurred [di in eq. (2)]. If markets are sufficiently segmented, international listing will increase the sensitivity of the firm’s stock to market movements in the country of listing; i.e., the stock’s foreign beta would rise. In the absence of a high degree of segmentation, the listing will have no effect. Formally, the null hypothesis is no change in foreign beta before versus after international listing and the alternative hypothesis is an increase in foreign beta. Third, stock returns of the listing firms are examined for evidence of changes in standard deviation. If the domestic and foreign markets are not perfectly correlated, a ‘diversification effect’ should result from an international listing, causing a decrease in standard deviation. In contrast, an increase in standard deviation would be consistent with the Howe-Kelm conjecture of increased uncertainty as a result of listing. Thus, the null hypothesis is no change in standard deviation and the alternative hypothesis is two-sided. Changes in volatility are also of interest because they have important consequences for the pricing of related instruments such as options, warrants and convertible securities. Fourth, a complementary test of the listing-as-integration-mechanism hypothesis is to examine the R-squared of the univariate market model [eq. (l)] before and after listing. A decline in this measure would mean that less of the firm’s variability is attributable to the domestic market, suggesting an
J.S. Howe and J. Madura,
impact of international
listings on risk
1137
increase in integration. Likewise, an increase in the R-squared in eq. (2) would be consistent with greater integration. In each case, the null hypothesis is one of no difference in the pre- and post-listing periods. Last, we explore whether an overseas listing decreases the degree of information asymmetry. Information asymmetry might decline if the firm must abide by a different set of reporting standards or if the listing in some other way lowers the cost of acquiring information about the firm. Demsetz (1986) has suggested residual variance from the univariate market model (non-systematic risk) as a measure of information asymmetry. In the context of this study, we use the residual variance from the two-index model [eq. (2)] as an asymmetry proxy and look for changes in this variable, pre- versus post-listing. The null hypothesis is that there is no change in residual variance.
3.2. Data We identified the sample by writing to stock exchanges in Australia, Belgium, France, Germany, Japan, the Netherlands, Switzerland and the United Kingdom. Information about American firms’ listings was received from Germany, France, Japan and Switzerland. Listings after the first quarter of 1985 are excluded because a sixteen-quarter post-listing period is needed, as discussed below. Panel A of table 1 shows the distribution of listings by year and country. Thirteen international listings occurred in 1974, more than in any other year. The number of listings per year typically ranges from three to six. Over one-half the sample listings took place in Switzerland. Panel B shows the distribution of SIC codes for the sample firms. Companies from a variety of industries have engaged in overseas listing. Quarterly data are used in the study. ’ The 16 quarters prior to listing constitute the ‘pre-listing’ period; likewise, the 16 quarters after the listing constitute the ‘post-listing’ period. The number of quarters used to calculate betas should be sufficiently long to allow reliable estimates. However, because betas can be intertemporally unstable, the use of very long periods may disguise any true shift in betas attributable to the foreign listing. The choice of sixteen-quarter periods reflects this trade-off. Individual stock prices and dividends were taken from The Daily Stock Price Record. Data on the French, Japanese and West German market indices were compiled from the Wall Street Journal (WSJ). Because data on the Swiss market index were not available in the WSJ in some earlier years, The Economist was used as a data source for this index. ‘Quarterly 147-152).
data
are commonly
used to estimate
betas,
e.g., Moses
and
Cheney
(1989, pp.
1138
J.S. Howe and J. Madura, Impact of international listings on risk
I
Table Descriptive
statistics:
sample of international companies.
Panel A. Distribution Year
Germany
1 3
5 1 2 1 1 1
1
1
1
16
4
Panel SIC code
1
B. Distribution Number firms I 3
1 6
1 1 8 7 1 2 2 1 1 3 6 2
1 1
1 2 1 4 1
1 2 1 2 1
1 2 1 68
of
4
by U.S.
by year and country Switzerland
Total 1 4 4 6 4 13 1 5 6 3 6 4 3
1
I 1
2 1
Total
Total
Japan
I
1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984
10 13 16 20 21 26 28 29 30 32 33 34 35 36 37 38 42 48 49 53 58 60 61 62 63 67 78 79 80 89 Unknown
of listings
France
listings
2 6 3 5 2 5 3 5 2 3 1 2 3
I 4 3
44
68
by two digit SIC code Years in which occurred
listing
1980 1970, 74, 81 1977 1973(2), 76, 80, 83, 84 1983 1980 1972(2), 73, 74(2), 76, 78, 79 1969, 76, 77, 79(2), 81, 84 1974 1971, 80 1972, 82 1983 1977 1970, 71, 74 1970, 72, 74(2), 75, 76 1970, 72 1974 1974 1978 1974, 79 1983 1971, 74(2), 76 1977 1978 1973, 77 1974 1977, 79 1979 1984 1971, 81 1972
J.S. Howe and .I. Madura, Impact of international listings on risk
1139
Table 2 Comparison of pre- and post-listing betas using the singleindex model, Ri, I = ai + b,R,,,, + ei.
Entire sample Germany France Japan Switzerland
Average pre-listing beta (b,)
Average post-listing beta (bJ
1.11 1.41 1.35 1.19 0.91
0.98
1.05 1.25 0.96 0.93
t-statistic (difference) 1.32 1.80 0.22 0.72 0.33
4. Empirical results 4.1. Domestic
beta
The domestic beta is estimated initially from eq. (l), the univariate regression of the stock’s return on the U.S. market index. The findings are shown in table 2 for the entire sample and for the sample disaggregated by country of listing, estimated pre- and post-listing.’ Although in all cases the average domestic beta does decline, none of the changes is statistically significant.3 The 16 German-listing firms had the biggest decline, which is not quite significant at the 5% level. A second manner in which to estimate the domestic beta is with a twoindex model such as eq. (2). Here, the explanatory variables are the U.S. market index and the country-of-listing market index. The domestic beta is coefficient Ci from the equation; statistics on the average domestic beta are reported in panel A of table 3. The average domestic beta measures are strikingly similar to those found in table 2. This similarity suggests that collinearity between the two market indices is not a problem. In all cases, slight declines in the average beta are observed, none of which is significant. In sum, domestic betas do not seem to be affected by an international listing.
4.2. Foreign beta Panel B of table 3 shows the average foreign beta estimates. Foreign beta is here defined as the beta with respect to the market index of the country in ‘The results reported in table 2 use an equal-weighted domestic index. The outcomes are similar when a value-weighted index is used. ‘Throughout the paper, nonparametric tests of significance (sign and Wilcoxon signed rank tests) were also conducted. In all cases, conclusions about signiticance (or lack thereof) were unchanged.
1140
J.S. Howe and J. Madura,
impact
of international
listings on risk
Table 3 Comparison
of pre- and post-listing betas using the two-index model, Ri.,=aj+ciR,,vs+diR,,r.,+u,. Panel A. Domestic (U.S.) beta Average pre-listing
Entire sample Germany France Japan Switzerland
beta (c.1
Average post-listing beta (c,)
t-statistic (difference)
1.10 1.31 1.37 1.12 0.98
0.97 1.01 1.17 0.80 0.95
1.10 1.54 0.43 0.84 0.25
Panel B. Foreign (country of listing) beta Average pre-listing beta (d,) Entire sample Germany France Japan Switzerland
0.04 0.09 0.09 0.13 -0.01
Average post-listing beta (di) 0.04 0.07 0.07 0.70 - 0.03
t-statistic (difference) - 0.02 0.26 0.10 -1.88 0.15
which the foreign listing occurred. Again, the results are shown for the entire sample and for the individual countries. The foreign betas, both before and after listing, are quite small. Indeed, they are (on average) insignificantly different from zero, a finding similar to that of Jacquillat and Solnik (1978) for multinational corporations in general (irrespective of their listing status). Further, there is no evidence of changes in the foreign betas after listing. 4 Thus, listings do not affect a security’s sensitivity to the country-of-listing market. 4.3. Other measures We repeat our assessment of a listing impact, substituting total risk for systematic risk. A foreign listing could reduce a stock’s total risk, even if systematic risk is unaffected. Because Howe and Kelm (1987, p. 56) speculate that an overseas listing exposes the firm to increased regulatory uncertainty and therefore increased risk, a two-tailed test is appropriate. We test for a shift in total risk by comparing the pre- and post-listing standard deviation of stock returns. As noted earlier, this measure is also important for the valuation of securities convertible into common stock. The average pre-listing standard deviation of return is 15.5% (table 4). The 4Because of a small sample size, the observed increase in average beta for companies listing in Japan is not quite significant at the 5% level.
J.S. Howe and J. Madura, Impact
of international
listings on risk
1141
Table 4 Additional pre- and post-listing comparisons.
Standard deviation RZ single-index model R2 two-index model Residual variance
Pre-listing average
Post-listing average
0.155 0.375 0.426 0.017
0.144 0.382 0.43 1 0.015
t-statistic (difference) 1.19 - 0.20 -0.15 0.54
average post-listing standard deviation is 14.4%, which is not significantly lower (t= 1.19). This finding is robust across location of listing and does not support the idea of a shift in total risk associated with a dual listing. Table 4 also shows the average R-squared from eqs. (I) and (2). Indirect evidence of an integration effect would consist of a lower R-squared in the single-index model or higher R-squared in the two-index model due to the foreign listing. Neither effect is evident. Finally, table 4 also shows that the residual variance, a proxy for asymmetric information, declines after an international Iisting, but the decline is not signi~cant.5
5. Summary and conclusions In this paper, we examine the impact of an international listing on a variety of risk-related measures. Listings do not appear to cause significant shifts ‘in risk, regardless of the risk measure examined. The results are consistent with: (1) markets which are already reasonably well integrated; or (2) listing as an ineffective mechanism for reducing segmentation. Segmentation is often envisioned as occurring along national boundaries. An alternative interpretation is that the degree of segmentation is a function of the type and size of the firm; Jorion and Schwartz (1986) refer to the cause of this type of segmentation as ‘indirect’ (as opposed to legal) barriers. Companies that list their stock overseas are large, well-established companies. It may well be that these firms have already mitigated the effects of segmentation through other mechanisms, such as direct foreign investment and/or mergers with foreign firms [as discussed by Stapleton and Subrahmanyam (1977)]. This may explain why overseas listings have little or no effect on risk. By implication, greater benefits to a dual listing wouid accrue to small firms with relatively low levels of foreign investment activity.
‘We also tested for the robustness of these findings by dividing the sample by chronology. A reasonable conjecture would be that listings occurring earlier (in the 1970s) might have had an impact because markets were less integrated then. However, no evidence to support this conjecture was found.
1142
J.S. Howe and .I. Madura, Impact of international listings on risk
References Adler, M. and B. Dumas, 1983, International portfolio choice and corporation finance: A synthesis, Journal of Finance 38,925-984. Agmon, T., 1972, The relations among equity markets: A study of share price co-movements in the United States, United Kingdom, Germany and Japan, Journal of Finance 27, 839-855. Alexander, G.J., C.S. Eun and S. Janakiramanan, 1987, Asset pricing and dual listing on foreign markets: A note, Journal of Finance 42, 151-158. Alexander, G.J., C.S. Eun and S. Janakiramanan, 1988, International listings and stock returns: Some empirical evidence, Journal of Financial and Quantitative Analysis 23, 135-151. Bodurtha, J.N., Jr., 1989, International factors and U.S. equity excess returns, Working paper, University of Michigan, January. Chen, N., R. Roll and S. Ross, 1986, Economic forces and the stock market, Journal of Business 59, 383-403. Cho, D.C., C.S. Eun and L.W. Senbet, 1986, International arbitrage pricing theory: An empirical investigation, Journal of Finance 41, 313-329. Demsetz, H., 1986, Corporate control, insider trading and rates of return, American Economic Review 76, 313-316. Errunza, V. and E. Losq, 1985, International asset pricing under mild segmentation: Theory and test, Journal of Finance 40, 105-124. Howe, J.S. and K. Kelm, 1987, The stock price impacts of overseas listings, Financial Management 16, 5 l-56. Jacquillat, B. and B. Solnik, 1978, Multinationals are poor tools for diversification, Journal of Portfolio Management 4, 8-12. Jorion, P. and E. Schwartz, 1986, Integration vs. segmentation in the Canadian stock market, Journal of Finance 41,603-614. Moses, E.A. and J.M. Cheney, 1989, Investments: Analysis, selection and management (West Publishing Company, St. Paul). Stapleton, R. and M. Subrahmanyam, 1977, Market imperfections, capital market equilibrium and corporation finance, Journal of Finance 32, 307-319. Stonehill, A. and K. Dullum, 1982, Internationalizing the cost of capital (Wiley, New York). Stulz, R.M., 1981, On the effects of barriers to international investment, Journal of Finance 36, 923-934.
of Banking
and Finance
THE IMPACT
14 (1990)
1133-1142.
North-Holland
OF INTERNATIONAL
LISTINGS
ON RISK
Implications for Capital Market Integration
John S. HOWE* Louisiana State Unioersity, Baton Rouge, LA 70803-6308,
USA
Jeff MADURA* Florida Atlantic University, Boca Raton, FL 33431, USA Received October
1989. final version
received
March
1990
In this paper, we examine the impact of international listing on common-stock risk. While previous research has used event study methodology, our research focuses on permanent shifts in risk. Different measures of risk are estimated to test for intertemporal shifts in risk attributable to an overseas listing. No signilicant shifts in risk from international listing are documented. The results are robust with respect to the location and year of listing. These findings suggest that: (1) markets are already reasonably well integrated; or (2) listing is an ineffective mechanism for reducing segmentation.
1. Introduction
A growing body of literature, both theoretical and empirical, has examined the issue of the segmentation of international capital markets. For example, Stulz (1981) models the pricing effects of barriers to international investment. The empirical evidence has generally shown at least some degree of segmentation [e.g., Errunza and Losq (1985), Jorion and Schwartz (1986)]. However, the topic remains controversial. Bodurtha (1989), employing a multi-factor model similar to that of Chen, Roll and Ross (1986), finds evidence consistent with integration rather than segmentation. The issue of the degree of capital market integration is relevant for the pricing of assets. Increasing attention has been paid in recent years to theories and tests of asset pricing models in an international context, such as the International Capital Asset Pricing Model and International Arbitrage Pricing Theory [see, e.g., Cho, Eun and Senbet (1986)]. These theories and the empirical tests thereof must make (sometimes implicit) assumptions about *Correspondence address: Department of Finance, Louisiana State University, Baton Rouge, LA 70803, USA. The authors would like to thank Alan L. Tucker and an anonymous referee for helpful comments. Any remaining errors are our own responsibility. 0378-4266/90/$03.50
J B.F
B
0
1990-Elsevier
Science
Publishers
B.V. (North-Holland)
1134
J.S. Howe and J. Madura,
Impact of international
listings on risk
the flow of capital across national boundaries and the degree of independence of different markets. Because capital market integration can influence pricing model specification, it has obvious implications for portfolio construction and investment management. Capital market integration is also an important topic for corporate finance [see Adler and Dumas (1983)j. If the markets of different countries are segmented, then corporate managers may be able to engage in investment and/or financing activities which serve to mitigate the effects of segmentation. Stapleton and Subrahmanyam (1977) suggest three categories of corporate financial policies which can reduce the negative effects associated with market segmentation: (1) direct foreign investment; (2) mergers with foreign firms; and (3) listing of the fum’s securities on foreign exchanges. In spite of the theoretical benefits of foreign listings when capital markets are at least mildly segmented, existing empirical studies find little or no evidence of net gains from dual listing. Howe and Kelm (1987), e.g., examine the stock price effects of American firms which listed their stock overseas. They find that first, second and third listings are associated with negative abnormal returns. Alexander, Eun and Janakiramanan (i988) use a sample of foreign firms which listed their stock in the U.S. While they find weak evidence of lower expected returns in the post-listing period, they do not find evidence of an increase in stock price that would presumably accompany a wealth-enhancing listing. Generally, evidence of significant benefits associated with an overseas listing has been lacking. This paper uses a different approach to measure the effects of overseas listings by U.S. corporations. Specifically, we explore whether the risk characteristics of the listing firms shares change as a result of the listing, in a manner consistent with a greater degree of market integration. We find no evidence of such changes. This finding is consistent with: (1) markets which are already reasonably well integrated; or (2) listing as an inegective mechanism for reducing se~entation. This paper is organized as follows. Section 2 reviews the relevant literature and section 3 outlines the methodology and data. The empirical findings are reported in section 4 and the paper ends with a summary and our conclusions. 2. Literature The potential benefits associated with international listings have been demonstrated in several models [Stapleton and Subrahmanyam (1977), Alexander, Eun and Janakiramanan (1987), Errunza and Losq (1985)]. The intuition behind these models is that, in the presence of partial or complete segmentation of capital markets, foreign listings can serve to lessen the degree of segmentation. These listings should therefore cause (theoretically) a
J.S. Howe and .I. Madura,
Impactof international
listings on risk
1135
change in equilibrium prices for the dual listed securities. Generally, listings are shown in these models to result in higher prices and/or lower expected returns. While changes in domestic listing location have been studied extensively, little empirical attention has been paid to international listings. In an early article, Stonehill and Dullum (1982) provide a detailed case study. The two most prominent studies are by Howe and Kelm (1987) and Alexander et al. (1988). Howe and Kelm examine a sample of U.S. firms undergoing their first, second and third overseas listings. The foreign exchanges involved are Paris, Frankfurt and Basel. Using standard event study analysis, they measure the abnormal returns in the 131 day period surrounding the announcement of the listing. They find this period to be associated with negative abnormal returns (about - 5.1% for the initial listing), suggesting a net cost to overseas listings. They speculate that uncertainty is increased for an internationally listed stock due to increased regulatory uncertainty, but offer no evidence to support this conjecture. Alexander et al. examine a sample of 34 foreign firms which listed their stocks in the United States. Thirteen of these were Canadian stocks, while the remaining 21 were American Depository Receipts (ADRs) of firms from Japan, Australia and other countries. They find positive abnormal returns in the pre-listing period, no abnormal returns in the listing period, and negative abnormal returns in the post-listing period. They argue that the timing of the abnormal returns is consistent with a reduction in the expected return on the sample stocks. However, they also note (p. 149), ‘. . .if a decline in the expected return on a stock does occur, there should be a large increase in the stock price.. . . However, . . . no such increase was observed here.’ In sum, there is little or no evidence documenting significant benefits to the shareholders of firms which list their stock on a foreign exchange. However, given the relative paucity of evidence, further empirical work is clearly justified.
3. Methodology and data 3.1. Methodology
The approach taken in this study starts from a simple premise: if capital markets are segmented and if listings are an effective mechanism for reducing the degree of segmentation, then an international listing should have an effect on the listing firm’s stock. Conversely, if markets are well integrated, listing should have no effect [as noted by Alexander et al. (1988, p. 136)]. In order to derive specific empirical hypotheses, we define a segmented market as having two salient characteristics. First, capital does not flow into or out of a
1136
J.S. Howe and J. Madura, Impact of international
listings on risk
perfectly segmented market. Second, an asset in a segmented market is priced in the context of that market. That is, the risk of an asset is measured relative to the systematic factor(s) present in that market. We focus in this paper on various risk characteristics and related measures in the pre- and post-listing periods. Five lines of empirical inquiry are pursued. First, we search for evidence of a change in ‘domestic beta,’ the beta of the stock measured with respect to the U.S. market index. An international listing which decreases segmentation will increase the influence of the foreign market on the listing firm’s stock returns. The influence of the domestic market will be correspondingly less pronounced. The null hypothesis is no change in domestic beta; the alternative hypothesis is a decline in domestic beta. The domestic betas for the sample firms are estimated in both a singleindex [bi in eq. (1)] and a two-index model [ci in eq. (2)]: (1) Ri = a: + CiR,, us + diR,,for + Ui,
(2)
where Ri is the return on stock i, R, us is the return on U.S. market index, and Rmsroris the return on country of listing (foreign) market index. Second, the ‘foreign betas’ of the sample firms are estimated. These betas are measured with respect to the market index for the country in which the listing occurred [di in eq. (2)]. If markets are sufficiently segmented, international listing will increase the sensitivity of the firm’s stock to market movements in the country of listing; i.e., the stock’s foreign beta would rise. In the absence of a high degree of segmentation, the listing will have no effect. Formally, the null hypothesis is no change in foreign beta before versus after international listing and the alternative hypothesis is an increase in foreign beta. Third, stock returns of the listing firms are examined for evidence of changes in standard deviation. If the domestic and foreign markets are not perfectly correlated, a ‘diversification effect’ should result from an international listing, causing a decrease in standard deviation. In contrast, an increase in standard deviation would be consistent with the Howe-Kelm conjecture of increased uncertainty as a result of listing. Thus, the null hypothesis is no change in standard deviation and the alternative hypothesis is two-sided. Changes in volatility are also of interest because they have important consequences for the pricing of related instruments such as options, warrants and convertible securities. Fourth, a complementary test of the listing-as-integration-mechanism hypothesis is to examine the R-squared of the univariate market model [eq. (l)] before and after listing. A decline in this measure would mean that less of the firm’s variability is attributable to the domestic market, suggesting an
J.S. Howe and J. Madura,
impact of international
listings on risk
1137
increase in integration. Likewise, an increase in the R-squared in eq. (2) would be consistent with greater integration. In each case, the null hypothesis is one of no difference in the pre- and post-listing periods. Last, we explore whether an overseas listing decreases the degree of information asymmetry. Information asymmetry might decline if the firm must abide by a different set of reporting standards or if the listing in some other way lowers the cost of acquiring information about the firm. Demsetz (1986) has suggested residual variance from the univariate market model (non-systematic risk) as a measure of information asymmetry. In the context of this study, we use the residual variance from the two-index model [eq. (2)] as an asymmetry proxy and look for changes in this variable, pre- versus post-listing. The null hypothesis is that there is no change in residual variance.
3.2. Data We identified the sample by writing to stock exchanges in Australia, Belgium, France, Germany, Japan, the Netherlands, Switzerland and the United Kingdom. Information about American firms’ listings was received from Germany, France, Japan and Switzerland. Listings after the first quarter of 1985 are excluded because a sixteen-quarter post-listing period is needed, as discussed below. Panel A of table 1 shows the distribution of listings by year and country. Thirteen international listings occurred in 1974, more than in any other year. The number of listings per year typically ranges from three to six. Over one-half the sample listings took place in Switzerland. Panel B shows the distribution of SIC codes for the sample firms. Companies from a variety of industries have engaged in overseas listing. Quarterly data are used in the study. ’ The 16 quarters prior to listing constitute the ‘pre-listing’ period; likewise, the 16 quarters after the listing constitute the ‘post-listing’ period. The number of quarters used to calculate betas should be sufficiently long to allow reliable estimates. However, because betas can be intertemporally unstable, the use of very long periods may disguise any true shift in betas attributable to the foreign listing. The choice of sixteen-quarter periods reflects this trade-off. Individual stock prices and dividends were taken from The Daily Stock Price Record. Data on the French, Japanese and West German market indices were compiled from the Wall Street Journal (WSJ). Because data on the Swiss market index were not available in the WSJ in some earlier years, The Economist was used as a data source for this index. ‘Quarterly 147-152).
data
are commonly
used to estimate
betas,
e.g., Moses
and
Cheney
(1989, pp.
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J.S. Howe and J. Madura, Impact of international listings on risk
I
Table Descriptive
statistics:
sample of international companies.
Panel A. Distribution Year
Germany
1 3
5 1 2 1 1 1
1
1
1
16
4
Panel SIC code
1
B. Distribution Number firms I 3
1 6
1 1 8 7 1 2 2 1 1 3 6 2
1 1
1 2 1 4 1
1 2 1 2 1
1 2 1 68
of
4
by U.S.
by year and country Switzerland
Total 1 4 4 6 4 13 1 5 6 3 6 4 3
1
I 1
2 1
Total
Total
Japan
I
1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984
10 13 16 20 21 26 28 29 30 32 33 34 35 36 37 38 42 48 49 53 58 60 61 62 63 67 78 79 80 89 Unknown
of listings
France
listings
2 6 3 5 2 5 3 5 2 3 1 2 3
I 4 3
44
68
by two digit SIC code Years in which occurred
listing
1980 1970, 74, 81 1977 1973(2), 76, 80, 83, 84 1983 1980 1972(2), 73, 74(2), 76, 78, 79 1969, 76, 77, 79(2), 81, 84 1974 1971, 80 1972, 82 1983 1977 1970, 71, 74 1970, 72, 74(2), 75, 76 1970, 72 1974 1974 1978 1974, 79 1983 1971, 74(2), 76 1977 1978 1973, 77 1974 1977, 79 1979 1984 1971, 81 1972
J.S. Howe and .I. Madura, Impact of international listings on risk
1139
Table 2 Comparison of pre- and post-listing betas using the singleindex model, Ri, I = ai + b,R,,,, + ei.
Entire sample Germany France Japan Switzerland
Average pre-listing beta (b,)
Average post-listing beta (bJ
1.11 1.41 1.35 1.19 0.91
0.98
1.05 1.25 0.96 0.93
t-statistic (difference) 1.32 1.80 0.22 0.72 0.33
4. Empirical results 4.1. Domestic
beta
The domestic beta is estimated initially from eq. (l), the univariate regression of the stock’s return on the U.S. market index. The findings are shown in table 2 for the entire sample and for the sample disaggregated by country of listing, estimated pre- and post-listing.’ Although in all cases the average domestic beta does decline, none of the changes is statistically significant.3 The 16 German-listing firms had the biggest decline, which is not quite significant at the 5% level. A second manner in which to estimate the domestic beta is with a twoindex model such as eq. (2). Here, the explanatory variables are the U.S. market index and the country-of-listing market index. The domestic beta is coefficient Ci from the equation; statistics on the average domestic beta are reported in panel A of table 3. The average domestic beta measures are strikingly similar to those found in table 2. This similarity suggests that collinearity between the two market indices is not a problem. In all cases, slight declines in the average beta are observed, none of which is significant. In sum, domestic betas do not seem to be affected by an international listing.
4.2. Foreign beta Panel B of table 3 shows the average foreign beta estimates. Foreign beta is here defined as the beta with respect to the market index of the country in ‘The results reported in table 2 use an equal-weighted domestic index. The outcomes are similar when a value-weighted index is used. ‘Throughout the paper, nonparametric tests of significance (sign and Wilcoxon signed rank tests) were also conducted. In all cases, conclusions about signiticance (or lack thereof) were unchanged.
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J.S. Howe and J. Madura,
impact
of international
listings on risk
Table 3 Comparison
of pre- and post-listing betas using the two-index model, Ri.,=aj+ciR,,vs+diR,,r.,+u,. Panel A. Domestic (U.S.) beta Average pre-listing
Entire sample Germany France Japan Switzerland
beta (c.1
Average post-listing beta (c,)
t-statistic (difference)
1.10 1.31 1.37 1.12 0.98
0.97 1.01 1.17 0.80 0.95
1.10 1.54 0.43 0.84 0.25
Panel B. Foreign (country of listing) beta Average pre-listing beta (d,) Entire sample Germany France Japan Switzerland
0.04 0.09 0.09 0.13 -0.01
Average post-listing beta (di) 0.04 0.07 0.07 0.70 - 0.03
t-statistic (difference) - 0.02 0.26 0.10 -1.88 0.15
which the foreign listing occurred. Again, the results are shown for the entire sample and for the individual countries. The foreign betas, both before and after listing, are quite small. Indeed, they are (on average) insignificantly different from zero, a finding similar to that of Jacquillat and Solnik (1978) for multinational corporations in general (irrespective of their listing status). Further, there is no evidence of changes in the foreign betas after listing. 4 Thus, listings do not affect a security’s sensitivity to the country-of-listing market. 4.3. Other measures We repeat our assessment of a listing impact, substituting total risk for systematic risk. A foreign listing could reduce a stock’s total risk, even if systematic risk is unaffected. Because Howe and Kelm (1987, p. 56) speculate that an overseas listing exposes the firm to increased regulatory uncertainty and therefore increased risk, a two-tailed test is appropriate. We test for a shift in total risk by comparing the pre- and post-listing standard deviation of stock returns. As noted earlier, this measure is also important for the valuation of securities convertible into common stock. The average pre-listing standard deviation of return is 15.5% (table 4). The 4Because of a small sample size, the observed increase in average beta for companies listing in Japan is not quite significant at the 5% level.
J.S. Howe and J. Madura, Impact
of international
listings on risk
1141
Table 4 Additional pre- and post-listing comparisons.
Standard deviation RZ single-index model R2 two-index model Residual variance
Pre-listing average
Post-listing average
0.155 0.375 0.426 0.017
0.144 0.382 0.43 1 0.015
t-statistic (difference) 1.19 - 0.20 -0.15 0.54
average post-listing standard deviation is 14.4%, which is not significantly lower (t= 1.19). This finding is robust across location of listing and does not support the idea of a shift in total risk associated with a dual listing. Table 4 also shows the average R-squared from eqs. (I) and (2). Indirect evidence of an integration effect would consist of a lower R-squared in the single-index model or higher R-squared in the two-index model due to the foreign listing. Neither effect is evident. Finally, table 4 also shows that the residual variance, a proxy for asymmetric information, declines after an international Iisting, but the decline is not signi~cant.5
5. Summary and conclusions In this paper, we examine the impact of an international listing on a variety of risk-related measures. Listings do not appear to cause significant shifts ‘in risk, regardless of the risk measure examined. The results are consistent with: (1) markets which are already reasonably well integrated; or (2) listing as an ineffective mechanism for reducing segmentation. Segmentation is often envisioned as occurring along national boundaries. An alternative interpretation is that the degree of segmentation is a function of the type and size of the firm; Jorion and Schwartz (1986) refer to the cause of this type of segmentation as ‘indirect’ (as opposed to legal) barriers. Companies that list their stock overseas are large, well-established companies. It may well be that these firms have already mitigated the effects of segmentation through other mechanisms, such as direct foreign investment and/or mergers with foreign firms [as discussed by Stapleton and Subrahmanyam (1977)]. This may explain why overseas listings have little or no effect on risk. By implication, greater benefits to a dual listing wouid accrue to small firms with relatively low levels of foreign investment activity.
‘We also tested for the robustness of these findings by dividing the sample by chronology. A reasonable conjecture would be that listings occurring earlier (in the 1970s) might have had an impact because markets were less integrated then. However, no evidence to support this conjecture was found.
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J.S. Howe and .I. Madura, Impact of international listings on risk
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