Equity Cross-Listings in the U.S. and the Price of Debt *

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1 Equity Cross-Listings in the U.S. and the Price of Debt * Ryan T. Ball Booth School of Business University of Chicago Luzi Hail The Wharton School University of Pennsylvania Florin P. Vasvari London Business School April 2009 (Preliminary Please check with us before quoting) Abstract This paper examines whether foreign firms can raise debt capital at lower costs after their shares are cross-listed in the U.S., and the sources of these debt market benefits. Employing a large global sample of public bonds and syndicated loans, we find strong evidence that firms with shares cross listed on U.S. exchanges or in the over-the-counter market can lower their offering yield spreads by about 45 basis points, but only for arm s length debt transactions. Consistent with legal bonding playing a lesser role in settings that allow private communication and monitoring, no or an opposite effect on offering spreads is evident for bank loans. In further analyses, we find that the reduction in bond spreads is larger for firms from countries with lax disclosure regulation, higher private control benefits and underdeveloped local debt markets. However, equity cross-listings do little to overcome weak creditor protection in the country of domicile. We also provide initial evidence that highly leveraged firms and firms that raise new equity capital in the U.S. pay higher yields for bonds and loans, consistent with debt holders facing greater risks of wealth expropriation associated with U.S. cross-listings. Our findings underscore that legal procedures protecting debt holders are less fungible than legal procedures protecting shareholders, and that equity cross-listings can create negative spillover effects with respect to the costs of debt financing. JEL classification: F30, G12, G15, G32, G38, K22, M41 Key Words: Corporate Governance, Cross-listing, Bonding hypothesis, Debt financing, Disclosure, Law and finance, International finance * We thank Anne Beatty, Wayne Guay, Cathy Schrand, René Stulz, and workshop participants at Ohio State University, and the University of Pennsylvania for helpful comments. Florin Vasvari gratefully acknowledges the financial support of the London Business School RAMD Fund.

2 1. Introduction Does cross listing equity shares in the U.S. affect foreign firms access to more and cheaper debt financing? A large body of literature emphasizes the equity benefits of U.S. cross-listings (e.g., Karolyi, 1998, 2006). In particular, firms domiciled in countries with poor minority shareholder protection, limited availability of equity capital and segmented markets can overcome these shortfalls by subjecting themselves to U.S. securities regulation and oversight (Coffee, 1999; Stulz, 1999). Consistent with this notion, prior evidence suggests that firms cross listing on a U.S. exchange obtain higher equity valuations (e.g., Foerster and Karolyi, 1999; Doidge, Karolyi, and Stulz, 2004), lower costs of equity capital (e.g., Errunza and Miller, 2000; Hail and Leuz, 2009), improved liquidity of the traded equity (e.g., Baruch, Karolyi, and Lemmon, 2007), an expanded investor base (e.g., Ammer et al., 2008; King and Segal, 2008), and raise equity capital more frequently (e.g., Reese and Weisbach, 2002). While equity market effects are important and ultimately serve to justify the cross-listing decision, there is almost no direct empirical evidence on how the structure and cost of debt contracts change as a result of an equity cross-listing in the U.S. In this paper, we provide initial evidence on the debt market effects of cross-listing. These aspects are particularly relevant given that debt markets, traditionally, are a much larger source of external finance than equity markets (e.g., Rajan and Zingales 1995; Henderson, Jegadeesh, and Weisbach, 2006). Also, issues such as enforcement of debt holder rights, monitoring of debt contracts, or agency conflicts between debt holders and equity holders, indicate that results obtained from equity markets might not apply to debt financing. The paper s main objectives are twofold. First, we examine if foreign firms can raise more debt capital at lower costs after their shares are cross-listed on U.S. exchanges. Employing a large sample of public and private debt issuances around the world we find evidence consistent with a higher propensity to issue debt and lower debt 1

3 financing costs, but only for arm s length debt transactions. 1 The second objective is to explore the sources of these benefits. Our findings suggest that U.S. exchange listings generally help overcome weak institutions like lax disclosure regulation or forces that convey large private benefits of control, but are unable to mitigate ineffective debt enforcement in the country of domicile. Moreover, a higher likelihood of wealth transfers from debt to equity holders triggered by U.S. cross-listings tends to offset part of the debt-related benefits. The main theories underlying the cross-listing decision are the market segmentation hypothesis of Stulz (1981), the investor recognition hypothesis of Merton (1987), and the bonding hypothesis of Stulz (1999) and Coffee (1999, 2002). They suggest that companies choose to crosslist in the U.S. to broaden their shareholder base, to increase their visibility, and to credibly signal their commitment to protect minority interests. The empirical evidence so far suggests that, on average, firms are successful along these dimensions. In particular, the bonding argument received strong empirical support. Legal bonding builds on the comparative advantages of the U.S. judicial system and disclosure regime, combined with greater scrutiny from regulators, analysts, media and investors. Bonding also implies similar benefits in debt markets in the form of more favorable debt terms. Better disclosures and enforcement of property rights together with strong creditor protection should decrease the costs of contracting between borrowers and lenders (Hart, 1995). In turn, this should reduce the price protection required by lenders and translate into lower borrowing costs for firms with cross-listings. The legal environment affects lenders access to information and their ability to monitor or renegotiate debt agreements, especially in case of significant declines in credit quality or default. U.S. institutions provide a series of contracting cost savings mechanisms to debt holders. First, 1 A transaction is conducted at arm s length if all the investors are on an equal footing, i.e., have access to the same set of information. 2

4 stringent disclosure requirements decrease information acquisition costs before and after contracting thereby lowering the ex ante information asymmetries, and allowing debt holders to detect credit problems early during the post contracting period (Ball, Bushman, and Vasvari, 2008). Second, if corrective actions against borrowers are needed, debt holders are able to pursue them at lower costs and through mechanisms that might not be available in the home country (e.g., class action suits). Third, strategic defaults, which occur when potentially solvent borrowers are unwilling to repay the debt, are less likely in the U.S. with its efficient debt enforcement mechanisms (e.g., Djankov et al., 2008). Fewer defaults lower the costs of recontracting and increase the likelihood that lenders will recover the debt s face value. Finally, regulatory bodies such as the U.S. Securities and Exchange Commission (SEC) as well as reputational intermediaries like auditors, underwriting banks or debtrating agencies, facing the threat of U.S. litigation, limit the ability of management or controlling shareholders to expropriate resources from lenders. As a result, these third parties might significantly reduce the monitoring costs of lenders. However, the realization of debt-related benefits after foreign firms cross list their shares in the U.S. is far from certain. The quality of local debt enforcement mechanisms and the level of creditor protection in the country of domicile are also likely to affect the availability, structure and terms of debt contracts (La Porta et al., 1997; Qian and Strahan, 2007). This applies even to Yankee bonds, i.e., public debt issued by foreign firms in the U.S. For instance, Miller and Puthenpurackal (2002) and Miller and Reisel (2009) show that Yankee bond investors require higher yield spreads and impose more restrictive debt covenants on issuers located in countries with weak creditor rights protection. 2 For debt issued outside of the U.S., this might be a more significant concern since, usually, the physical location of firm assets determines the applicability of bankruptcy laws. 3 Hence, 2 3 Atilgan, Davis-Friday, and Ghosh (2007) also confirm the importance of home country institutions when comparing the costs of issuing debt in the U.S. for a sample of foreign firms to their U.S. counterparts. In our sample, only about 4% of the public debt observations consist of Yankee bonds. 3

5 lenders are likely to demand higher risk premiums for debt issued by firms located in countries that do not protect their rights despite the U.S. cross-listing, just because the protection provided by the U.S. regulatory system may not apply to them in full. In addition, cross-listings can significantly exacerbate the agency costs of debt, which result from an increase in the conflicts of interest between equity holders and debt holders (e.g., Jensen and Meckling, 1976; Myers, 1977). An exchange listing in the U.S. exposes firms to a more active market for corporate takeovers and buyouts, and increases their visibility. It is also followed by an increase in both the number and value of equity offerings (Reese and Weisbach, 2002). All these changes tend to favor equity holders over debt holders. For instance, takeovers, disciplinary or not, can benefit target s equity holders, but likely hurt debt holders by increasing the riskiness of their claims. 4 Moreover, cross-listings could further strengthen shareholder control if U.S. institutional investors use it to extend their blockholdings (e.g., Bradshaw, Bushee, and Miller, 2004; Ammer et al., 2008). Greater shareholder control not only makes takeovers more likely (Shleifer and Vishny, 1986; Cremers and Nair, 2005), but also facilitates acquisitions of U.S. targets that could be financed with the newly issued stock (Burns, 2004; Tolmunen and Torstila, 2005; Kumar and Ramchand, 2008). Acquisitions tend to divert cash flows from lenders and, hence, the agency costs of debt increase. 5 Because the expected costs of such opportunistic behavior on the part of the owners are taken into account when debt is issued, debt holders will require higher yields after 4 5 Kim and McConnell (1977), Cook and Martin (1991), and Ghosh and Jain (2000) show that, on average, firm leverage significantly increases after takeovers. Increases in leverage can reduce the value of the outstanding debt not only by increasing the probability and the deadweight costs of a possible future bankruptcy but also by reordering the priority of claims in bankruptcy. Furthermore, lenders may suffer economic losses even before a takeover occurs. Since takeovers are associated with management changes, the current management might engage in protective actions that destroy debt holder value by recapitalizing the firm (e.g., swapping debt for equity before maturity), increasing the payouts to shareholders through dividends and repurchases, paying out excess liquid assets to equity holders or themselves, or refocusing the firm (divestitures and spin-offs) by increasing its risk. Roll (1986) argues that a bidding firm that has debt in its capital structure is willing to bid more aggressively since part of the acquisition costs is borne by existing debt holders. 4

6 equity cross-listings. Yet, the extent of the debt holder-equity holder conflict is likely to vary substantially across firms (e.g., Parrino and Weisbach, 1999). To shed light on the tradeoff between external governance mechanisms imposed by the U.S. legal system and their presumably beneficial effects for borrowers, the extent of debt holder protection in the country of domicile, and the increase in agency conflicts between equity holders and debt holders after an equity cross-listing in the U.S., we analyze offering yield spreads for a large international sample of public bonds and syndicated loans. Our sample covers more than 3,800 bond-year observations (combined Thompson Deals and Mergent databases) and about 3,000 loan-year observations (Dealscan) from 41 countries over the period 1992 to In each group, we identify about 800 observations from firms with a contemporaneous U.S. equity cross-listing outstanding, either in the form of private placements under Rule 144A, shares traded in the overthe-counter market (OTC), or exchange listings (Level II or III). 6 Our research design has two special features. First, by separately analyzing public and private debt contracts we are able to better isolate the role of agency conflicts after U.S. cross-listings. Public debt investors exercise limited control over the decisions of borrowers in that they generally do not assume an active monitoring role, solely rely on publicly available information and, due to free rider problems, rarely renegotiate the contract if credit problems arise (e.g., Diamond, 1984, 1991). Hence, when providing debt capital in at arm s length transactions, lenders likely rely more on country-level corporate governance institutions, either in the country of the equity cross-listing or the country of domicile, in specifying the contract terms (e.g., Doidge, Karolyi, and Stulz, 6 We refer to a foreign firm s U.S. cross-listed equity as ADR, regardless of whether it is an actual American Depositary Receipt, a direct listing (e.g., for Canadian firms), a globally or New York registered share, an OTC listing, or a private placement. 5

7 2007). 7 On the other hand, private bank debt is more closely monitored, significantly lowering information asymmetries and moral hazard problems. This gives bank lenders access to private information about borrowers, and allows them to become more efficient monitors (Fama, 1985). 8 Therefore, the differential between home country institutions and the U.S. regulatory system is less likely to affect the costs of syndicated bank loans. 9 However, similar to public debt investors, members of the loan syndicate will likely incur higher agency costs after equity cross-listings. If they are able exploit their privileged position with the borrowers, in particular if their clients lack reputation, they can pass on the incremental monitoring costs in the form of higher loan spreads. 10 The second special feature is the distinction between three types of cross-listings, which lets us account for the different regulatory consequences that firms are facing (e.g., Foerster and Karolyi, 1999; Miller, 1999). While Level II and III ADRs are subject to strict SEC oversight, extensive disclosure requirements and U.S. securities litigation, cross-listings in the OTC market face limited additional disclosures, but still bear the risk of SEC enforcement actions or private class action suits. Private placements are not registered with the SEC, nor do they require any additional disclosures. Therefore, if equity cross-listings have any implications on the price of raising debt capital, the effects should be strongest for exchange listings, less for OTCs, and negligible for private placements We are using the term corporate governance in this paper in a broader sense. That is, we do not just refer to the alignment of interests between managers and shareholders, but also consider how such a better alignment could affect the debt holder versus the equity holder relationship (e.g., by committing shareholders to not take certain detrimental ex post actions against creditors). Banks have bargaining power over the firm s profits due to extensive monitoring (Rajan, 1992). Berger and Udell (1995) and Petersen and Rajan (1994) show that small U.S. firms with close banking ties have easier access to credit at lower costs due to the fact that bank monitoring decreases agency costs. Note, though, that the institutional environment also plays a role in the private debt market. For instance, Esty and Megginson (2003) or Bae and Goyal (2009) show that international differences in creditor rights and legal enforcement affect risk-sharing arrangements by bank syndicates and important syndicated loan characteristics such as spreads, size and maturity. Diamond (1991) observes that firms without reputation are more likely to receive more expensive bank debt financing, while Fama (1985) argues that banks recoup monitoring costs from borrowers via financing terms. 6

8 Consistent with the above arguments, we find strong evidence that after cross-listing their shares in the U.S., firms are more likely to raise debt capital via public bond markets and reduce the frequency of taking on syndicated bank loans. These results generally apply to all types of ADRs, but are more pronounced for exchange listings. We obtain our results from probit regressions employing all observations with sufficient data from the entire Worldscope universe, and after controlling for various firm-specific characteristics related to the decision to issue debt as well as country, industry and year fixed effects. We interpret these findings as suggesting that U.S. crosslistings clearly have an impact on firms choice of capital structure and venue of debt financing. Going beyond a descriptive analysis, we next examine the effects on firms debt offering spreads. In line with the bonding hypothesis and the argument that in at arm s length transactions countries institutional environment is important, we find that yield spreads of public bonds are lower after firms cross list their shares on a U.S. exchange. 11 The benefits are statistically and economically significant, with a decrease in yield spreads of about 45 basis points. This translates into yearly cost savings of US$ 0.8 million based on the average bond size of US$ 190 million. The results are similar in magnitude and significance levels for firms with OTC cross-listings, but again consistent with bonding nonexistent for private placements. In sharp contrast to the public bond results, we find higher spreads for syndicated loans of firms with U.S. exchange listings (about 33 basis points), which are sometimes statistically significant, and no effects for other ADRs. This is consistent with the idea that in private debt markets opting out of the local institutional environment does not improve debt holders position, but rather imposes incremental agency costs. The results are robust to the inclusion of a comprehensive set of bond or loan specific variables, to the potentially confounding effects of several firm attributes, macroeconomic factors and the time- 11 It is possible that public debt holders anticipate the cross listing decision and require lower yields even before the U.S. cross-listing. While this effect effectively biases against finding results, we run sensitivity tests that eliminate a two-year window before and after the cross-listing year. Our inferences remain the same. 7

9 invariant unobserved heterogeneity across countries and industries, and within years. We also conduct a series of sensitivity analyses, which do not affect the inferences from our main tests. Our final set of analyses examines whether the observed cost of debt effects exhibit a plausible cross-sectional variation with respect to the institutional framework in cross-listed firms home countries and their susceptibility to agency conflicts between debt and equity holders. We find that, for public debt, the reduction in offering yield spreads is larger for firms from countries with lax disclosure regulation, higher private benefits of control and underdeveloped local debt markets, corroborating the notion of legal bonding. However, when it comes to the enforcement of debt holders rights and the efficiency of bankruptcy procedures, cross-listing shares in the U.S. does little to overcome the institutions in the country of domicile. This finding is consistent with Miller and Puthenpurackal (2002), and underscores that legal procedures protecting borrowers are less fungible than legal procedures protecting shareholders. With respect to the conflict between debt and equity holders, we find that highly leveraged firms pay higher yields after cross listing. Also, firms that use their cross-listing to raise new capital in the U.S. exhibit higher spreads, as predicted, but the results are not significant in a statistical sense. For syndicated loans, the results splitting by home country institutions are weak and mixed, as expected for this type of debt that heavily relies on private monitoring and information sharing. We find, though, some evidence pointing to increased agency costs for lenders to firms with high leverage and new equity issuances after cross listing, consistent with greater risks of wealth expropriation. This study makes several contributions. To our knowledge, this is the first study to explicitly examine the effects of cross-listings to a security category other than the one cross-listed in the 8

10 U.S. 12 Even tough the primary means to cross list is via equity shares, for many firms debt financing remains the main source of external funding. Evidence that firms can issue bonds in at arm s length transactions at a lower cost after they have cross-listed their shares on a U.S. exchange is an important and new finding that adds to the extensive literature on the equity market benefits of cross-listing. We also extend the literature on the bonding hypothesis by confirming it for publicly listed debt instruments and, more importantly, by showing that in debt markets legal bonding does not uniformly apply to all types of monitoring. While the importance of firms country of domicile for the enforcement of debt contracts has been shown in other settings, the role of a credible commitment to more transparent reporting via cross listing for the structure and terms of debt contracts should be of interest to regulators and policy makers. By looking at syndicated loans we also show that private monitoring mechanisms can substitute for legal bonding thereby adding to the literature on the interaction of country-level and firm-level corporate governance (e.g., Klapper and Love, 2004; Doidge, Karolyi, and Stulz, 2007). Finally, we provide preliminary evidence on the effect of cross-listings on the agency conflicts between debt holders and equity holders, an area not yet explored in the literature. In Section 2, we discuss the sample, introduce the primary variables used in the analyses and provide descriptive statistics. Section 3 presents the propensity analysis of issuing public bonds or syndicated loans, and discusses our main findings on the average cost of debt effects of U.S. equity cross-listings. In Section 4, we report the cross-sectional analyses using country-level and firm-level variables to partition the set of ADR observations. Section 5 concludes. 12 In a similar vein, Datta, Iskandar-Datta, and Patel (1999) examine whether the existence of a (private) bank relationship lowers the cost of public debt financing, and find lower offering yield spreads for public bonds of firms with bank debt outstanding. 9

11 2. Data In this section, we start with providing institutional background information on the structure of public and private lending contracts, and discuss the sample selection criteria. We then describe our main variables of interest, namely the bond and loan offering yield spreads and the U.S. crosslisting variables. Finally, we introduce a comprehensive set of bond and loan attributes, various firm characteristics and macroeconomic factors that we use as control variables in our tests, and provide distributional statistics on these variables Sample Selection The starting point for our sample construction is the availability of data on public and private lending contracts. We obtain the bond data from two sources. We first collect all observations from Thompson Deals (part of Thompson One Banker), and then augment this data set by observations from the Mergent Fixed Income Securities Database (FISD). These sources provide data items such as bond-issue size and type, issue date, bond features, bond ratings, coupon rates and borrower information. We note that for many data items the availability is much sparser for international bonds than for U.S. bonds. We only retrieve bond issues from Mergent FISD if they do not overlap with the bond issues in Thompson Deals. An overlapping observation is a bond issued by the same firm on the same date that has the same coupon rate, maturity and face value. Public bonds are regularly traded on over-the-counter markets (only few are traded on exchanges), and therefore are subject to limited disclosure requirements. They come in many different forms like convertible bonds, callable bonds, bonds with collateral, subordinated bonds, etc. Bonds are frequently issued in the issuer s country of domicile. In addition, bonds are sometimes denominated in a currency different from the local currency, with U.S. Dollars, Euros, Japanese Yens and Swiss Francs being the primary choices. Typically, bonds have a dispersed ownership, rendering renegotiation of the bond contract costly. Because individual bondholders do not have a significant informational 10

12 advantage over each other, and there is a free-rider problem, most bond investors engage in limited monitoring activities. We retrieve syndicated loan data from Dealscan, which is provided by Reuters Loan Pricing Corporation (LPC). 13 This database contains detailed information on a global set of syndicated loans. Syndicated loans are provided to a borrower by two or more banks, and represent a significant source of corporate financing. Over the last few years these types of loans have generated more underwriting revenue than either the equity or the bond market (e.g., Altunbas et al., 2006). Syndicated loans are private lending instruments, but have some features similar to public debt. That is, they have credit ratings and trade in relatively liquid secondary markets. Also, they are usually structured in packages of multiple loans with different maturities and repayment schedules. Members of the syndicate can be either senior syndicate bank members (lead arrangers) or junior bank participants. Once a syndicated loan deal is completed, lead arrangers are responsible for monitoring the borrower s compliance with the contractual terms. They usually have strong lending relationships with the borrowers, and receive significant fees in exchange for arranging the syndication deal and monitoring the debt contract. Next, we manually match the bond and loan data to firm-level financial information in Worldscope via the issuing firm s name, country of domicile and 4-digit SIC code. 14 Due to the nature of the business and the existence of industry specific regulations, we exclude financial firms from the analyses (i.e., one-digit SIC code equal to 6). We also require that issuing firms are publicly traded, and firms raise at least US$ 10 million of new debt capital. We exclude countries in which none of the bonds or loans has a contemporaneous American Depositary Receipt (ADR) or 13 LPC collects syndicated loan data for public firms from public regulatory filings (outside the U.S.), SEC filings (if the firm is listed in the U.S.), or through its connections with the major banks in the syndicated loan market. 11

13 direct listing in the U.S. outstanding. Furthermore, we require bond and loan year observations to have data available for all the control variables used in the analyses. Finally, if a firm issues multiple bonds or loans in a given year, we retain only the bond or loan issue with the largest principal and facility amount, respectively, assuming that the characteristics of these bonds and loans are representative of the firm s financing terms in the debt markets. Our final sample used in the main analyses comprises 3,842 publicly issued bonds and 2,995 syndicated loans from 41 countries over the period 1992 to Table 1 provides an overview of the sample composition by country and year. The table presents the number of unique firms, the total number of firm-year observations and the proportion of ADR firm-year observations, separately for the public and private debt samples. It also contains descriptive information on the bond spreads and loan spreads, which we discuss in Section We note a large percentage of bonds issued by Japanese firms (55%). Thompson Deals and Mergent FISD have a bias towards Japanese bonds (about 30% of all bond issues outside the U.S. are from Japanese borrowers), and this bias is further strengthened by the comprehensive coverage of Japanese firms in Worldscope. Moreover, prior evidence suggests that Japanese companies moved away from bank debt towards public debt financing in the 1990s (Hoshi et al., 1993). Aside from Japan, only Canada, France, South Korea and the U.K. comprise more than 5% of the bond sample. The syndicated loan sample is much more dispersed with the U.K. contributing the largest number of observations (14%). No unusual pattern is apparent in either the bond or the loan sample over time. 14 This matching procedure does not allow to identify bonds or loans that are issued by a subsidiary of the firm if this subsidiary is incorporated under a different name, domiciled in a different country or belongs to a different industry than its parent company. 12

14 2.2. Variable Definitions and Descriptive Statistics Bond Spreads, Loan Spreads, and Cross-Listing Variables On a conceptual level, we are interested in the price of raising new debt capital after U.S. equity cross-listings. We measure the cost of debt, our dependent variable, as the offering yield spread of bonds or syndicated loans. The Bond Spread is the yield-to-maturity at issuance minus the contemporaneous yield of a U.S. Treasury security with the same maturity and the closest coupon rate. 15 The Loan Spread is equal to the All-in-Spread data item provided by Dealscan, i.e., the amount the borrower pays (including annual fees) over LIBOR or a LIBOR equivalent for each dollar drawn down. To avoid data errors and outliers, we truncate the spreads at the first and 99th percentile. We draw the cross-listing variables, our primary independent variables, from a comprehensive data set of active and inactive U.S. equity cross-listings using information from Citibank, JP Morgan, Bank of New York, Datastream and Bloomberg (see Hail and Leuz, 2009). We use this panel to construct binary variables indicating the existence and type of a U.S. equity cross-listing in a given year. This coding accounts for changes in ADR types over time and, hence, the sequence of U.S. cross-listings for a given firm. Apart from using an aggregate cross-listing indicator (ADR) in some of the analyses, we differentiate between exchange listings on NYSE, NASDAQ, and AMEX (EXCH), over-thecounter listings in the Pink Sheets or the OTC Bulletin Board (OTC), and private placements under Rule 144A (PP). This distinction reflects the different regulatory consequences of the ADR types. Foreign firms with a U.S. exchange listing have to file Form 20-F with the SEC, requiring extensive 15 We adjust for U.S. treasury rates to control for shifts in the interest rates and the time preference for money. As a result of using U.S. risk-free rates, about half of the bond spreads are negative, in particular, in countries with prime rates below those in the U.S. (e.g., Japan). To test the sensitivity of our results to this research design choice, 13

15 disclosures and, during our sample period, a reconciliation of foreign financial statements to U.S. GAAP. 16 Moreover, by virtue of filing with the SEC, firms are subject to SEC enforcement and could face legal liabilities from shareholder litigation. Cross-listings in the OTC markets do not require a 20-F filing, but have to file a registration statement using Form F-6 and home-country disclosures to the SEC. They are also subject to Rule 10b-5 and the Foreign Corrupt Practices Act, under which SEC enforcement actions and private securities litigation can be brought. Private placements do not require any registration with the SEC or any additional disclosures, but are only made available to qualified institutional investors. Finally, we construct a Cross-listing Firm indicator variable marking the entire time-series of ADR firms regardless whether the ADR has already been issued or not. The purpose of this variable is to control for time-invariant selection effects, i.e., potentially significant differences between firms that choose to cross list and firms that do not, which could induce a spurious correlation between the variables of interest. 17 As reported in Table 1, the main sample comprises 848 bond-year observations (or about 22% of the bond sample) and 800 loan-year observations (or about 27% of the loan sample) from firms with contemporaneous U.S. equity cross-listings (i.e., observations with the ADR indicator variable equal to 1). The table also provides univariate evidence on the price of debt differential between firms with and without ADRs. For 26 out of the 34 countries in the bond sample the average bond spread is larger for non-adr firms, consistent with a reduction in bond yields after cross listing. No such tendency is apparent in the loan sample. For 19 out of 38 countries the average loan spread is we also run the regression analyses using the raw yield-to-maturity as dependent variable (and including U.S. riskfree rates on the right-hand side). This alternative specification does not affect the inferences from our tests. We include Canadian firms in this group because they can directly list their shares on U.S. exchanges without using depository receipts and, at the same time, are exempted from certain U.S. reporting requirements under the Multi-Jurisdictional Disclosure System. When we replace the aggregate Cross-listing Firm indicator by three distinct firm indicators for each ADR type, the results remain largely unchanged. 14

16 larger for non-adr firms, suggesting that U.S. cross-listings have no systematic effect on the offering yield spread for syndicated loans Bond-Specific and Loan-Specific Control Variables In our multiple regression analyses we control for a large set of bond and loan characteristics that, as suggested by prior literature, potentially affect the offering yield spreads of the two debt instruments. 18 We use the following bond-specific control variables: Bond Maturity measures the number of months from the date of issuance until maturity. Longer maturities increase the risk and, therefore, should require higher yields. Bond Size equals the principal amount at the date of issuance, denominated in US$ million. Larger bonds increase the risks of default, but at the same time are expected be more actively traded thereby lowering the liquidity premium. To capture a bond s default risk, we create a binary indicator variable (Investment Grade) equal to 1 if the bond s credit rating is BBB- or higher (Standard & Poor s) or Baa3 or higher (Moody s). If issue-specific credit ratings are missing (i.e., for about 75% of the bond sample), we use Altman s (1968) Z-score to determine firms investment grade status in a given year. 19 Riskier firms should pay larger spreads. Callable, Convertible and Subordinated are three indicator variables set equal to 1 if the issuer retains the privilege of redeeming the bond before maturity (positive effect on yield), the bond can be converted into shares of the issuing firm (negative effect), and the bond ranks after other debt instruments in case of liquidation (positive effect), respectively. Finally, in an attempt to measure firms reputation in the bond market, we define a Previous Bond Issues indicator that assumes the value of 1 if the firm has issued other bonds over the last two fiscal years. Firms with a reputation have already shared information with market participants and, hence, should face lower information For our analyses, we truncate all dependent and independent variables at the first and 99th percentile, except for variables with natural lower or upper bounds, and use the natural logarithm where indicated in the tables. Using Worldscope financial data, we compute the Z-score as (1.2*working capital + 1.4*retained earnings + 3.3*EBIT *sales)/total assets + (0.6*market value of equity/book value of total liabilities), and assign investment grade status based on a cutoff value of

17 asymmetries. In the loan-spread regressions, we also use a comprehensive set of issue-specific control variables. Loan Maturity, Loan Size, and Investment Grade are defined similarly as for the public bond sample, and should assume the same signs. Term Loans measures the percentage of individual loans in the loan package (based on the facility amount) with a specified repayment schedule and maturity. Due to their long-term nature they should positively impact yield spreads. The Number of Lenders stands for the number of individual banks that participate in the deal syndicate. More syndicate members allow for better risk sharing thereby lowering the expected spreads. Previous Loan Issues, equal to the number of syndicated loan packages previously taken by the same borrower, is again a proxy for the firm s reputation, this time in the syndicated loan market. Borrowers with good reputation likely receive better loan terms. Performance Pricing and Revolver are two indicator variables set equal to 1 if the interest rate of the loan is tied to a firm s performance and credit rating, or the loan comprises a renewal option. Both loan features should decrease the monitoring costs for the syndicate members in the post-contracting period. Finally, we create three Purpose of Loan indicators that mark if the loan was taken to repay existing debt, invest for corporate purposes, or finance working capital needs. In Table 2, Panels A and B, we provide descriptive statistics for the various public bond and syndicated loan attributes. While loan spreads, by construction, are always positive, the bond spreads become negative if U.S. risk-free rates exceed the yield-to-maturity. Bonds, on average, have a longer time until maturity (6.6 years vs. 4.3 years), and are smaller than loans (US$ 190 million vs. US$ 342 million). These numbers are similar to other research using international bond and loan data (e.g., Miller and Puthenpurackal, 2002; Carey and Nini, 2007). 16

18 Firm-Specific and Macroeconomic Control Variables We further control for a series of firm characteristics that are likely associated with debt funding needs and offering yield spreads. We measure firm size by using Total Assets in US$ million. Larger firms should obtain more favorable debt terms given their reputation and tangible asset base. In addition, size is a proxy for information asymmetry between firms and investors. Market-to-Book is the ratio of market value of equity to book value of equity. Firms with valuable growth options (i.e., high market-to-book ratios) need more financing, and are more likely to generate sufficient cash flows to repay the principal, but might also be more risky. An increase in Leverage, measured as the ratio of long-term debt divided by total assets, increases the probability of future default, and therefore leads lenders to require higher returns. We define Return on Assets as the ratio of operating income divided by average total assets. Firms with low profitability should have to pay higher interest rates. Tangibility stands for the quality of assets available as collateral, and equals firms book value of property, plant and equipment scaled by total assets. Our final set of control variables attempts to capture factors in the macroeconomic environment that influence the price of debt. We measure Inflation as the median monthly percentage change in the consumer price index in a given country and year (source: Datastream). High inflation typically translates into higher interest rates on government securities and, as a result, higher spreads for corporate debt. We also control for countries financial development and longrun growth prospects by including annual gross domestic product GDP (measured in constant US$) and GDP Growth (source: World Bank). Panel C of Table 2 presents descriptive statistics on the firm characteristics and macroeconomic factors for the combined bond and loan sample. 17

19 3. Average Debt Market Effects of U.S. Equity Cross-Listings In this section, we first test if and how firms propensity to issue bonds or syndicated loans changes after equity cross-listings in the U.S. This allows an initial assessment of the relevance of our research question. We then examine the economic consequences related to this choice, i.e., whether the offering yield spreads are affected by the cross listing decision, and how the debt market effects vary across ADR types and public or private financing channels Propensity to Issue Bonds or Loans Research Design According to Myers (1984), firms that face high costs of asymmetric information use external funds only when internally generated funds are not adequate. If external funds are required, firms will issue debt first, and then equity. 20 One of the advantages of private lenders is their preferred access to inside information as well as their superior monitoring and screening functions. However, when companies cross list and subject themselves to higher disclosure standards and a more rigorous enforcement regime, private lenders are losing part of their informational advantage. Hence, private debt financing becomes relatively more costly, and firms increasingly rely on arm s length debt financing. To test these assertions, we specify the following probit model, which estimates the propensity of raising new capital in private or public debt markets after U.S. equity cross-listings: Public debt issuance i,t (Private debt issuance i,t ) = ADR i,t ( 1a PP i,t + 1b OTC i,t + 1c EXCH i,t ) + 2 Cross-listing firm i + j Firm-specific controls i,t + k Country, industry and year fixed effects i,t + i,t. (1) 20 The value of debt changes least when inside information is revealed to the market (Myers, 1984). 18

20 The dependent variable is either a public or private debt issuance indicator that takes on the value of 1 if a firm issues bonds or loans in a given year and zero otherwise. The primary variables of interest are the aggregate ADR indicator ( 1 ) and the three ADR types ( 1a, 1b, 1c ), respectively. The coefficient estimates on these variables reflect the marginal change in the propensity to issue debt compared with the pre-cross listing period of the same firms and a benchmark sample consisting of firms that do not cross list. To control for potential selection effects in the pre-period, we include the Cross-listing Firm variable in the model. We also control for a series of firm attributes that have been shown to be associated with debt funding needs. We include Total Assets, Leverage, Tangibility, Return on Assets, Market-to-Book and the Z-score, as previously described in Section 2.2. In addition, we include the following variables: Negative Earnings takes on the value of 1 if the firm reports operating losses in a given year, and 0 otherwise. Loss firms are expected to face more scrutiny from investors, reducing their propensity to issue debt. We define Funding Needs as net cash flows from operations divided by total assets. Greater funding needs (i.e., lower net cash flows) should lead to more external financing, either debt or equity. Return Variability is a proxy for the firm s riskiness, and is computed as the annual standard deviation of monthly stock returns, using Datastream stock price information. Finally, we control for time-invariant unobserved heterogeneity across firms by including country, one-digit SIC industry and year fixed effects. 21 To further alleviate concerns about unobserved within-firm correlations, we compute the statistical significance levels of the coefficient estimates based on standard errors that are clustered by firm. 21 The corporate bond market has steadily increased over time in the U.S. from US$ 241 billion in 1994 to US$ 1,059 billion in 2006 according to the Securities Industry and Financial Markets Association. It is therefore important to control for the time trend in the underlying data. 19

21 Results Table 3 reports the results on the propensity of public and private debt issuance after U.S. equity cross-listings. The sample for this analysis consists of up to 184,254 firm-year observations representing the entire Worldscope universe with sufficient data to compute the control variables. Out of these observations about 3 and 5 percent represent years with public bond or loan issues, respectively. Models 1 through 4 vary depending on whether we analyze the aggregate ADR variable, the three individual ADR types, and include only a partial or the full set of firm-specific control variables. The table reports coefficient estimates from probit regressions together with z- statistics (in parentheses). In Panel A, we report results for public debt issuances. On an aggregate level, we find that after cross listing in the U.S. foreign firms are more likely to issue bonds. The coefficients on ADR are positive and significant at the 5% level or better. When looking at the sources driving these results, we find significantly positive coefficients on EXCH and PP, and weaker but still positive coefficients on OTC. 22 Thus, regardless of the type of cross listing, firms issue bonds more frequently. The results suggest that cross-listings clearly represent an important factor affecting firms optimal capital structure, and that public debt becomes relatively more attractive. While the positive coefficients on EXCH and, to a lesser degree, on OTC are consistent with the U.S. legal environment providing some bonding benefits, the results with respect to private placements suggest that other reasons such as an expansion in growth opportunities or company specific investment needs go hand in hand with U.S. cross-listings. The control variables generally have the expected sign. Consistent with Houston and James (1996) or Cantillo and Wright (2000), we find that larger and more leveraged companies issue more debt. Tangibility is not significant in the full model, probably because it is highly correlated with 20

22 firm size. Contrary to Denis and Mihov (2003), we find that foreign firms with higher credit quality (high Z-Scores) are less likely to issue public debt. In Panel B of Table 3 we present results for the propensity of issuing debt in the form of syndicated loans. In contrast to the bond results, we find that, after cross listing, foreign firms are less likely to take on syndicated loans. While the aggregate ADR coefficient is negative and significant, these results seem primarily driven by equity cross-listings on U.S. exchanges or in the OTC markets. In conjunction with the findings in Panel A, these results suggest that firms with equity cross-listings outstanding shift from syndicated bank debt to public debt. This shift in the debt structure indicates a decrease in information asymmetry between the firm and its lenders, consistent with the argument of Leland and Pyle (1977), Diamond (1984) or Fama (1985) that firms with a low degree of information asymmetry prefer public debt Bond and Loan Offering Yield Spreads Research Design Our second and main set of tests focuses on the economic consequences with respect to debt financing in conjunction with an equity cross-listing in an environment with extensive disclosure rules and tight enforcement mechanisms. Under the bonding argument, we would expect a reduction in information asymmetries, in particular for arm s length financing, leading to reduced price protection. Yet, in a situation with private monitoring and selective disclosure, the consequences of cross listing are ambiguous. To empirically investigate whether firms with ADRs obtain any debt related benefits, we estimate the following two ordinary least squares (OLS) regression models: 22 The magnitude of the coefficient estimates suggests that cross listing in the U.S. increases the probability that a company will issue public debt by about 0.4 to 0.6 percent. 21

23 Bond Spreads i,t = ADR i,t ( 1a PP i,t + 1b OTC i,t + 1c EXCH i,t ) + 2 Cross-listing firm i + j Bond-specific controls i,t + k Firm-specific and macroeconomic controls i,t + l Country, industry and year fixed effects i,t + i,t. (2a) Loan Spreads i,t = ADR i,t ( 1a PP i,t + 1b OTC i,t + 1c EXCH i,t ) + 2 Cross-listing firm i + j Loan-specific controls i,t + k Firm-specific and macroeconomic controls i,t + l Country, industry and year fixed effects i,t + i,t. (2b) Equation (2a) shows the bond-spread specification. Our primary variables of interest are the aggregate ADR indicator ( 1 ) or the three ADR types ( 1a, 1b, 1c ). The coefficient estimates represent the marginal effects of U.S. equity cross-listings on the offering yield spread for public bonds after controlling for all the bond attributes, firm characteristics, macroeconomic factors and fixed effects (see Section 2.2 for a variable description). The identification of the cross-listing effects stems from the bond-years before the cross listing and the firms that do not cross list. Again, we attempt to control for potential selection effects by including the Cross-listing Firm indicator. 23 In a similar vein, equation (2b) illustrates the loan-spread specification Results Table 4 presents our main results, i.e., the effects of U.S. cross-listings on public debt offering yields (Panel A) and syndicated loan spreads (Panel B). In these analyses our sample is limited by the existence of debt data, reducing the number of firm-year observations to about 3,800 bonds or 3,000 loans from 41 countries between 1992 and 2005 (see Table 1). The first three columns present results for the largest bond (loan) per firm-year. That is, if a firm has multiple debt issues in a given year, we retain only the bond and loan with the largest principal and facility amount, respectively. To assess this research design choice, we also present results for a randomly selected bond or loan 23 Note that since we do not have a balanced panel, we cannot sensibly run a firm fixed effects regression for our sample. However, by clustering standard errors at the firm level, we implicitly control for unobserved within firm correlation over time. 22