Does Sarbanes-Oxley Act Chase Away Foreign Firms? Evidence from ADR Terminations

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INTRODUCTION

Foreign firms cross-list ADRs in U.S. to achieve greater capital access, overcome market segmentation, increased shareholder base, greater liquidity, and transparency (Doidge, Karolyi, and Stulz, 2004; Foerster and Karolyi, 1999; Miller, 1999). In addition, legal literature offers an explanation for cross-listings from the functional convergence stand point, also referred to as bonding hypothesis (Coffee, 1999, 2002; Stulz, 1999). According to bonding motivation, by cross-listing in U.S. foreign firms "rent" U.S. regulations but retain their domestic country allegiance, and therefore only functionally converge to U.S. There are two types of bonding--legal, by listing shares on exchange and fully complying with exchange and SEC rules and reputational, which implies reputational benefit from being present in the U.S. capital markets (usually OTC) but not fully legally complying with the regulations mandated by U.S. exchanges.

The implementation of Sarbanes-Oxley Act of 2002 (SOX) introduced a shift in the set of bonding benefits for foreign firms. The main purpose of SOX was to increase the corporate governance standards in U.S. by mandating stricter disclosure and monitoring of accounting practices. It considerably toughened accounting and disclosure requirements for the listing firms, raising the "rent" on U.S. laws (Ribstein, 2003). Compliance with SOX provides increased benefits by bonding with stronger regulatory environment as well as increased compliance costs.

Foreign firms listing shares in US capital markets are facing the increased costs associated with compliance with SOX. As a result there has been an increased trend in foreign delistings from US (Pozen, 2004; Marosi and Massoud, 2006). These delistings lead to value decrease. Due to the restrictive requirements imposed by SOX, there has been a shift in foreign listing from NYSE to European exchanges--mainly London and Luxemburg. Furthermore, Witmar (2006) shows that firms are more likely to voluntarily cross-delist after 2001, and that overall firms that cross-delist have higher proportion of trading volume in their home market, are from countries with weaker investor protection, and have lower Tobin's Q. Li (2007), Piotroski and Srinivasan (2007), and Witmer (2006) all report increased levels of foreign delistings following the adoption of SOX.

With the implementation of SOX, foreign firms benefit from cross-listing as they are subject to better corporate governance and disclosure regulations. However, SOX is associated with high compliance costs. Therefore, studying the decision to delist will provide a clarification on the question of cost benefit trade of SOX for the international issuers.

My study is the first to examine the impact of SOX on the determinants of ADR terminations based on the location of the ADR placement--exchange versus OTC markets. SOX has differential impact on the propensity of foreign firms to delist from OTC and exchange. In addition, I study the impact of SOX on duration of listing. My findings show that after SOX, foreign firms are generally more likely to terminate their ADR programs and SOX decreases the duration of optimal ADR listings. Pre-SOX, firms with high Market-to-Book ratio and high Sales Growth are less likely to delist from U.S. capital markets, consistent with a need a raise capital at a broader investor base to finance the potential growth. Post-SOX high Market-to-Book and Sales Growth firms are more likely to delist. The increased propensity of firms with high Sales Growth to delist post-SOX is attributable primarily to firms from common law countries. Firms from civil law countries post-SOX still benefit from ADR listing, consistent with the bonding hypothesis.

Overall, my study suggests that SOX on its own impacts the propensity of foreign firms to terminate ADR programs and that this impact is different depending on the location of listing, the type of firm, and the duration of the existence of the ADR program. …

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