PDF Ebook The effect of cross listing on the sensitivity of managerial compensation to firm performance
La Porta et al. (1998, 2000) show that investor protection is poor in many countries, which in turn carries significant economic consequences, such as low external finance and share prices, and underdeveloped financial markets. Starting with the influential papers by Coffee (1999) and Stulz (1999), the cross listing literature has argued that firms incorporated in countries with poor investor protection can credibly bond themselves to better investor protection by cross listing their shares in a foreign stock exchange with better investor protection (hereafter referred to as the bonding hypothesis). The reason cross listing can serve as a credible bonding mechanism is that cross listed firms will be subject to the increased scrutiny of multiple external monitors in the cross listing country. For example, Coffee (2002) argues that cross listing on a U.S. stock exchange subjects a foreign firm to the enforcement powers of the Securities and Exchange Commission (SEC), potential class action and derivative lawsuits by minority shareholders, stringent financial disclosures, and increased monitoring by reputational intermediaries (e.g., underwriters, credit rating agencies, analysts, and institutional investors). Consistent with this hypothesis, the existing literature finds that cross listing on the U.S. stock exchanges is associated with lower private benefits of control (Doidge 2004), higher firm valuation (Doidge et al. 2004), lower cost of capital (Hail and Leuz 2006), more scrutiny by financial analysts (Lang et al. 2003), and better access to external finance (Reese and Weisbach 2002).
However, the existing cross listing bonding literature is subject to several important limitations. First, there is little research on the effect of cross listing on a cross listed firm’s internal governance structure, such as managerial compensation, board structure, etc. This is an important omission in the literature because improvement in internal governance structure (if exists) could be a competing explanation for the positive benefit of cross listing. In addition, many external and internal corporate governance mechanisms are complementary to each other (see, e.g., Shleifer and Vishny 1986; Cremers and Nair 2005) and thus the effectiveness of the external monitoring mechanisms articulated in the bonding hypothesis (e.g., monitoring by sophisticated investors) may also depend on the extent of changes in a cross listed firm’s internal governance.
Second, the existing literature does not offer a clear sense on the closeness that cross listing can bring a foreign firm’s level of investor protection to that of a comparable domestic firm in the cross listing country. This issue is important because to the extent that cross listing can elevate a foreign firm’s investor protection to the same level as that of a comparable domestic firm, the divergence in investor protection around the world documented in La Porta et al. (1998) should not be a big concern because firms in poor investor protection countries can always opt to list their shares in a country with better investor protection.
Third, as Leuz (2006) and Licht (2003) indicate, the existing literature has not paid enough attention to the potential influence of home country institutional factors (e.g., ownership concentration) on cross listed firms’ behavior. This is surprising because a cross listed firm is subject to the relevant laws and regulations of both its home country and cross listing country. The evidence in Leuz (2006) and Lang et al. (2006) suggest that in the case of earnings management, home country institutional factors still exert a significant effect on the quality of cross listed firms’ financial reporting.
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