U.S. International Equity Investment

Transcription

1 Board of Governors of the Federal eserve System Internatonal Fnance Dscusson Papers Number 1044 March 2012 U.S. Internatonal Equty Investment John Ammer Sara B. Holland Davd C. Smth Francs E. Warnock NOTE: Internatonal Fnance Dscusson Papers are prelmnary materals crculated to stmulate dscusson and crtcal comment. eferences n publcatons to Internatonal Fnance Dscusson Papers (other than an acknowledgment that the wrter has had access to unpublshed materal) should be cleared wth the author or authors. ecent IFDPs are avalable on the Web at Ths paper can be downloaded wthout charge from Socal Scence esearch Network electronc lbrary at

2 U.S. Internatonal Equty Investment John Ammer Sara B. Holland Davd C. Smth Francs E. Warnock * Abstract: U.S. nvestors are the largest group of nternatonal equty nvestors n the world, but to date conclusve evdence on whch types of foregn frms are able to attract U.S. nvestment s not avalable. Usng a comprehensve dataset of all U.S. nvestment n foregn equtes, we fnd that the sngle most mportant determnant of the amount of U.S. nvestment a foregn frm receves s whether the frm cross-lsts on a U.S. exchange. Correctng for selecton bases, cross-lstng leads to a doublng (or more) n U.S. nvestment, an mpact greater than all other factors combned. We also show that our frm-level analyss has mplcatons for country-level studes, suggestng that research nvestgatng equty nvestment patterns at the country-level should nclude cross-lstng as an endogenous control varable. We descrbe easy-to-mplement methods for ncludng the mportance of cross-lstng at the country level. Keywords: Home Bas, Portfolo Choce, Fnancal Dsclosure, Corporate Governance JEL Classfcaton: G11, F21, C35 * Ammer s Chef of the Global Captal Markets secton n the Dvson of Internatonal Fnance of the Board of Governors of the Federal eserve System. Holland s at the Terry School of Busness, Unversty of Georga, Smth s at the McIntre School of Commerce, Unversty of Vrgna, and Warnock s at the Darden Graduate School of Busness Admnstraton, Unversty of Vrgna. Prevous versons of ths paper were ttled Look at Me Now: What Attracts U.S. Shareholders? The authors thank Sandro Andrade, Mark Carey, Mhr Desa, Laura Feld, Charles Hadlock, Andrew Karoly, Chrstan Leuz, oss Levne, Mchelle Lowry, Darus Mller, Greg Nn, Bent Sorensen, Mark Spegel, Mchael Wesbach, an anonymous referee,and semnar partcpants at the 2004 EFA Meetngs, 2006 AFA Meetngs, Bnghamton Unversty (SUNY), College of Wllam and Mary, European Central Bank, Federal eserve Board, Federal eserve System SCIEA Meetngs, ISCTE Busness School, Mchgan State Unversty, NYSE, Penn State Unversty, Stockholm Insttute for Fnancal esearch, Unversdad Catolca Portuguesa, Unversdade do Porto, Unversty of Houston, Unversty of Mnnesota, and Unversty of Vrgna for helpful comments. Nathanael Clnton and Alex othenberg provded exceptonal research assstance. The vews expressed n ths paper are solely the responsblty of the authors and should not be nterpreted as reflectng the vews of the Board of Governors of the Federal eserve System or of any other employee of the Federal eserve System. The statstcal analyss of securty-level data on U.S. nvestors holdngs reported n ths study was conducted at the Internatonal Fnance Dvson of the Board of Governors of the Federal eserve System under arrangements that mantaned legal confdentalty requrements. Warnock thanks the Darden School Foundaton for generous support.

3 1. Introducton U.S. nvestors are the sngle largest group of nternatonal equty nvestors n the world. As of end-2007, U.S. nternatonal equty nvestment totaled $5.3 trllon, an amount comparable to the securtes holdngs of all soveregn wealth funds or to the total holdngs of all global reserves held by natonal governments. 1 The past decade has wtnessed a resurgent nterest n studyng patterns of nternatonal nvestment, and U.S. nternatonal equty nvestment fgures promnently n many studes. 2 Despte the sze of the U.S. foregn equty portfolo and the renewed focus on nternatonal nvestment research, no study can pont to the most mportant determnants of the amount of U.S. nvestment that a foregn frm receves. Perhaps the largest roadblock n the lterature s that, untl recently, there has been no dataset that s partcularly well-suted to examnng U.S. equty nvestments abroad. Many exstng studes use country-level data (e.g., U.S. nvestors holdngs of German equtes as compared to Japanese equtes), whch s publcly avalable but naturally lmted. Some studes utlze frmlevel data, but wth narrow datasets (e.g., focusng on a small set of foregn countres, or lmted to the portfolos of nsttutonal nvestors wth publc dsclosure oblgatons) or wth smple methodologes that make establshng causaton dffcult. In ths paper we use the most comprehensve dataset avalable on U.S. nternatonal equty nvestment a confdental securty-level dataset of all U.S. nvestors holdngs of foregn equtes used by U.S. Treasury offcals to calculate foregn holdngs by U.S. resdents to answer one mportant queston: What are the most mportant determnants of U.S. nvestment n the equty of foregn frms? 1 On the nvestments of soveregn wealth funds, see Bernsten, Lerner, and Schoar [2009]. 2 See, among many others, Glassman and ddck [2001], Dahlqust, Pnkowtz, Stulz, and Wllamson [2003], Ahearne, Grever, and Warnock [2004], Chan, Covrg and Ng [2005], Fdora, Fratzscher, and Thmann [2007], Kho, Stulz, and Warnock [2009], Lane and Mles-Ferrett [2008], Bekaert, Segel and Wang [2012], Desa and Dharmapala [2011], Dder, gobon, and Schmukler [2010], Amram and Frank [2010], and Yu [2010].

4 To motvate ths queston further, consder the composton of U.S. nvestors foregn equty portfolos compared to what would be mpled by tradtonal portfolo theory. The smplest portfolo approach to nternatonal nvestment predcts that all nvestors hold portfolos wth a weght on each frm that s proportonal to the frm s weght n the world market portfolo. Whle t s well-establshed that U.S. nvestors, n aggregate, underweght foregn equtes (and overweght domestc stocks) relatve to smple benchmarks, our frm-level holdngs data show that on a frm-by-frm bass the U.S. nternatonal equty portfolo also dffers dramatcally from the market portfolo weghts. 3 U.S. nvestors gnore many foregn stocks the medan foregn frm receved U.S. nvestment amountng to only 0.4 percent of market captalzaton and concentrate dsproportonately on others. Foregn frms n the 90 th and 95 th percentles attract U.S. nvestment totalng 10.7 and 16.7 percent, respectvely, of ther market captalzaton. As t turns out, a sgnfcant proporton of these frms wth heavy U.S. weghts have also cross-lsted on a U.S. exchange. These observatons, as well as past work that noted an assocaton between U.S. nvestment and cross-lstngs, 4 prompts us to explore the dfferences n U.S. holdngs of crosslsted and non-cross-lsted foregn frms. In fact, merely dstngushng whether or not a foregn frm cross-lsts n the Unted States reveals a strkng contrast. Medan U.S. nvestment n crosslsted frms s 13.6 percent of the frm s market captalzaton, dwarfng the 0.3 percent medan holdngs n non-cross-lsted frms. Ths stylzed fact, whle nterestng, cannot be nterpreted wthout reference to the 3 On the home bas, see Lews [1999], Ahearne, Grever, and Warnock [2004], and Kho, Stulz, and Warnock [2009], among many others. 4 Our paper s not the frst to note that cross-lstng can ncrease U.S. nvestment. See, for example, Ahearne, Grever, and Warnock [2004], Bradshaw, Bushee, and Mller [2004], Edson and Warnock [2004], Aggarwal, Klapper, and Wysock [2005], Ferrera and Matos [2008], and Kho, Stulz, and Warnock [2009]. However, due to data lmtatons, none of these papers can accurately measure and dstngush a cross-lstng effect from potental selecton bases, nor do they nvestgate causaton. 2

5 underlyng causal lnks between cross-lstng and U.S. nvestment. In partcular, cross-lstng s a voluntary decson, and t s typcal for large, well-establshed and hghly lqud frms to choose the Unted States as a cross-lstng venue. Thus, the knds of frms that choose to cross-lst mght be the types that attract substantal U.S. ownershp even wthout the cross-lstng. Moreover, these frms mght choose to cross-lst exactly because ths attracts large U.S. nvestment. As we dscuss below, dstngushng these effects has mportant economc mplcatons. What the summary statstcs do tell us s that any attempt to understand the most mportant factors determnng whch foregn frms are able to attract U.S. nvestment must also address the frm s decson of whether or not to cross-lst on a U.S. exchange. Because the econometrcs lterature suggests that there s no sngle statstcal methodology that perfectly accounts for the endogenety nherent n a frm s decson to cross-lst, we use three complementary technques to study the mpact of selecton and solate the cross-lstng effect on U.S. holdngs. 5 We frst estmate a parametrc model that explctly accounts for the underlyng endogenety between U.S. holdngs behavor and the decson to cross-lst on a U.S. exchange. The model jontly estmates the cross-lstng and holdng decsons as a system of smultaneous equatons, usng a Heckman [1979]-type methodology frst proposed by Lee [1978] to study the mpact of unon membershp on wages. Ths framework not only allows us to adjust for the effects of selecton bas, but also produces structural estmates of the relaton between holdngs and crosslstng. We follow the parametrc results wth two addtonal methods for selecton-bas adjustment: sem-parametrc propensty score matchng and non-parametrc dfference-ndfferences estmates. The results from all three methodologes present a consstent and compellng pcture of the 5 For recent crtques and revews of selecton-bas correctons, see Lalonde [1986], Heckman, Ichmura, Smth, and Todd [1998], and Larcker and ustcus [2010]. 3

6 determnants of U.S. nvestment n nternatonal stocks. Frst, we fnd that the selecton adjustments do matter; frms wth characterstcs (such as sze) that help attract ample U.S. nvestment even wthout the cross-lstng are more lkely to elect to cross-lst n the Unted States. But more mportantly, we show that a dramatc cross-lstng effect remans once we control for selecton bas. The frm s decson to cross-lst s the sngle most mportant determnant of the amount of U.S. nvestment t wll receve, and the act of cross-lstng causes a substantal ncrease n U.S. nvestment. Adjusted for sample selecton, average U.S. holdngs n foregn frms that cross-lst on a U.S. exchange s two to three tmes hgher than t would have been had the frm not cross-lsted n the Unted States. The mpact of cross-lstng cannot be gnored. The cross-lstng effect tself accounts for 25-35% of all U.S. nvestment n foregn equtes, even though only 4% of foregn frms are crosslsted. 6 Our estmates mply that of the $5.2 trllon n foregn equty held by U.S. nvestors n 2007, nvestment due to cross-lstng accounted for $2 trllon, an amount equvalent n sze to all foregn exchange reserves held by Chna and the eurozone or to the holdngs of the largest fve soveregn wealth funds. A U.S. cross-lstng s not the only measurable characterstc that nfluences U.S. portfolo choce among foregn frms; we also report evdence that among the set of non cross-lsted frms U.S. nvestors prefer frms that are large, transparent, and lqud. However, the frm s decson of whether or not to cross-lst appears to have a greater mpact than all other dentfable factors combned. We explore explanatons for the cross-lstng effect and show the most obvous that tradng costs for U.S. lsted stocks are lower for U.S nvestors cannot explan the effect. The majorty of U.S. nvestment n foregn companes s held drectly n the foregn-traded shares, 6 The cross-lstng effect s 8-11%, dependng on the methodology and sample. In our sample, the market captalzaton of cross-lsted frms s $3,300 bllon, so the cross-lstng effect accounted for $264-$363 bllon n U.S. nvestment, or roughly 25-35% of the $1018 bllon total U.S. portfolo nvestment. 4

7 rather than n the correspondng Amercan Depostary ecepts (ADs) that are traded on U.S. exchanges. That s, the majorty of U.S. nvestors do not even use the U.S. market to acqure foregn shares of cross-lsted frms; rather, they acqure the shares n the frms home market. Moreover, U.S. holdngs n Level I ADs experence a much smaller Level I effect. Whle traded on U.S. over-the-counter markets, Level I ADs do not afford the legal and dsclosure protectons of foregn frms lsted on a U.S. exchange. Instead, U.S. nvestors seem most attracted to cross-lsted frms that become more nformatonally transparent followng the cross-lstng, partcularly those frms wth poor accountng practces pror to lstng n the Unted States. Identfyng the most mportant factor behnd U.S. nternatonal equty nvestment could drectly mpact the lterature on nternatonal nvestment. Much of the recent research on U.S. nternatonal nvestment (e.g., Dder, gobon, and Schmukler [2010], Andrade and Chhaochhara [2010], and Desa and Dharmapala [2011]) does not control for cross-lstng, mplctly treatng the cross-lstng effect as a sample selecton ssue. Because we establsh that causaton runs from cross-lstng to U.S. nvestment, t s mportant to ascertan whether falure to nclude the cross-lstng effect could alter nferences n the current lterature. 7 A pror, one would expect that nferences n papers nvolvng varables that are hghly correlated wth cross-lstng, but that omt a measure of cross-lstng n ther specfcatons, are most lkely to be altered. In the fnal secton of the paper, we reproduce regressons from two recent country-level U.S. equty nvestment papers, Andrade and Chhaochhara [2010] and Desa and Dharmapala [2011]. We add a cross-lstng varable to these regressons, nstrumentng for potental endogenety n the crosslstng decson, and use a dependent varable that s both adjusted for closely held shares (followng Dahlqust, Pnkowtz, Stulz, and Wllamson [2003] and Kho, Stulz, and Warnock [2009]) and free of a sze bas (Bekaert, Segel and Wang [2012]). Wth the addtonal cross-lstng control n place, 7 We thank our referee for makng ths suggeston. 5

8 we show that the Andrade and Chhaochhara [2010] result tyng U.S. equty nvestment n a country to the level of U.S. foregn drect nvestment no longer holds, whle the Desa and Dharmapala [2011] results showng a shft n portfolo allocatons followng the lowerng of U.S. dvdend taxes are somewhat weakened. Our objectve s not to overturn the results of these papers ndeed, we estmate regressons that dffer n mportant ways from the ones they mplemented but smply to show that conclusons from U.S. nternatonal nvestment papers are senstve to the ncluson of a cross-lstng varable (and a properly constructed dependent varable). The rest of the paper proceeds as follows. Secton 2 ntroduces the data used n the paper. Secton 3 provdes smple but nformatve summary statstcs. Secton 4 descrbes the methodologes we use for estmatng the average cross-lstng effect. Secton 5 reports the man frm-level results. Secton 6 apples the nsghts from our frm-level analyss to country-level U.S. studes, and shows that ncludng cross-lstng as an endogenous explanatory varable alters some past results. Secton 7 concludes. 2. Data 2.1. Benchmark Survey Data Our nvestgaton reles on comprehensve securty-level data on U.S. holdngs of foregn stocks as obtaned confdentally through perodc benchmark surveys conducted jontly by the U.S. Treasury Department and the Federal eserve Board. 8 The surveys cover holdngs at two dstnct ponts n tme: December 1997 and March These surveys are somewhat dated, but are the latest avalable; snce the 1997 survey no such survey has been processed n a way that 8 Grever, Lee, and Warnock [2001] provde a prmer on the survey. Complete detals of the 1997 survey, ncludng forms, nstructons, and data, are avalable from 6

9 allows the type of securty-level analyss necessary to adequately assess the determnants of U.S. nvestment. Each survey must be completed by all U.S. fnancal nsttutons, both wthn the Unted States and abroad, that are entrusted wth the management or safekeepng of clent equty holdngs. Insttutons covered nclude all U.S. custodan banks, other commercal and nvestment banks, mutual funds, penson funds, nsurance companes, endowments, and foundatons. espondents are requred to report the foregn stock holdngs of all U.S. resdent clents and are subject to penalty under law for noncomplance. 9 The survey, desgned to pck up all recorded U.S. resdent portfolo holdngs of foregn equtes, s the source for offcal U.S. data on cross-border portfolo nvestment. 10 The only portfolo nvestments mssed by the survey are uncountable holdngs.e., those that evade detecton because the U.S. resdent used a foregn custodan, provded a foregn home address, or nstructed the custodan not to employ a U.S. sub-custodan. Federal eserve cross-checks wth non-u.s. data collectors suggest that the number of uncountable holdngs s small Sample Selecton 9 Custodans are the man source of nformaton, coverng 97 percent of the market value of the securtes n the 1997 survey. Insttutonal nvestors report n detal on ther ownershp of foregn securtes only f they do not entrust the safekeepng of these securtes to U.S.-resdent custodans. If they do use U.S.-resdent custodans, nsttutonal nvestors report only the names of the custodans and the amounts entrusted, nformaton that s then used to crosscheck the securty-level data submtted by custodans. 10 Portfolo nvestments exclude holdngs for control purposes, defned to be ndvdual holdngs of 10 percent or more of shares outstandng. Excludng these large holdngs s lkely to have lttle mpact n our sample because t s relatvely uncommon for a sngle U.S. nvestor to hold more than 10 percent of a publcly traded foregn company. 11 Other data sources of U.S. nvestor holdngs are relatvely lmted. For example, U.S. nsttutonal nvestors holdngs as reported to the SEC on Form 13(f) exclude holdngs n securtes that do not trade n U.S. markets and n foregn securtes that underle ADs. Only a small fracton of publcly traded frms domcled outsde of the Unted States actually trade n U.S. markets (3.5 percent n 1997, accordng to the U.S. Treasury/Federal eserve survey), and, as shown below, among those that do trade wthn U.S. borders U.S. nvestors hold more than half of ther ownershp n the underlyng securty, not through ADs. Thus, Form 13(f) flngs cover only a small segment of the securtes avalable to U.S. nvestors and underestmate U.S. holdngs n the frms covered n ther sample. 7

10 We nclude n our nvestgaton U.S. holdngs of all non-u.s. companes tracked by Worldscope. We use the May 1999 release of Worldscope, whch contans 1997 fnancal and accountng data on 13,445 non-u.s. companes domcled n 52 dfferent countres. Dahlqust, Pnkowtz, Stulz, and Wllamson [2003] and Kho, Stulz, and Warnock [2009] argue that float-adjusted measures of holdngs provde a better sense of stock avalable for purchase by dspersed portfolo nvestors who have no nsde connecton to the frm. Thus, where possble we normalze frm-level U.S. holdngs by float, defned to be market captalzaton net of the value of holdngs by nsders, whch requres data on both market captalzaton (market value of equty) and nsder holdngs. Datastream, whch provdes the broadest nternatonal coverage of market prce data, s our prmary source for frm-level market captalzatons. When a value s mssng n Datastream, we turn to reports from Morgan Stanley, whch provde relable market data for companes ncluded n the MSCI All-country World ndex, or Worldscope, whch provdes December market captalzatons for those companes that complete ther fscal year at the calendar year-end. We also use Morgan Stanley and Worldscope to cross-check the Datastream numbers for recordng errors. In total, we are able to calculate market captalzaton fgures for 12,236 of the orgnal 13,445 Worldscope frms. Because of obvous data errors we dscard 15 very small frms for whch the reported value of U.S. holdngs exceeds reported stock market captalzaton. The remanng sample of 12,221 frms spans 46 home countres, as lsted n Table 1. To get to float, we scale market captalzaton down by the fgure gven n Worldscope s closely held share feld, whch reports the fracton of equty owned by corporate offcers, drectors and ther famly members, ndvdual shareholders wth more than 5 percent holdngs, other corporatons, and the frm s own penson funds and trusts. We adjust these Worldscope fgures to exclude the value of depostary nsttuton holdngs, whch are sometmes mstakenly 8

11 counted n the closely held felds. 12 Because of mssng data on nsder holdngs, our float-adjusted sample contans 8,528 frms. Note, too, that accurate frm-level data on float are largely unavalable for our 1994 sample, so when we analyze that sample we scale holdngs by market captalzaton. Our sample s qute representatve. The 12,221 frms for whch we could match Worldscope and U.S. holdngs data had an end-1997 market captalzaton of $11,079 bllon, representng more than 90 percent of the value of all non-u.s. equty (Internatonal Fnance Corporaton [1998]). U.S. nvestors $1,018 bllon stake n these companes accounted for over 92 percent of the $1,208 bllon total U.S. foregn equty holdngs. Most of the $90 bllon n U.S. holdngs omtted (by necessty) from our sample are n frms located n the Carbbean fnancal centers, for whch frm-level varables are generally unavalable. 3. Summary Statstcs 3.1. U.S. holdngs across all foregn frms Table 2 reports the dstrbuton of U.S. holdngs of non-u.s. frms as of December As a benchmark, note that f U.S. nvestors followed a smple portfolo model n whch the weght of each frm n U.S. portfolos equaled ts weght n the world market portfolo, U.S. holdngs would amount to 49.6 percent of the market captalzaton (58.3 percent of float) of each foregn frm. The table shows that frm-level U.S. holdngs dffer dramatcally from the world market 12 Specfcally, we exclude holdngs by the Bank of New York, Morgan Guaranty Trust, and Ctbank, because these shares are lkely to be holdngs for AD programs, and the New Zealand Central Securtes Depostary. There are other reasons to beleve that the Worldscope measure of nsder holdngs contans measurement error. Worldscope coverage of the closely held shares feld s uneven, and reportng requrements dffer across countres. Moreover, t s unclear whether the classfcatons wthn Worldscope of what consttutes a closely held share conform well to theory on who gans prvate benefts from control and who would be wllng to sell to a U.S. nvestor. For example, the measure ncludes holdngs of large, unafflated blockholders. 9

12 portfolo. Mean U.S. holdngs are 3.5 percent of foregn frms market captalzaton (6.3 percent of float). Ths substantal undernvestment relatve to the world market portfolo s, of course, one representaton of the home bas. Whle the home bas s well-establshed, the extent of the undernvestment s strkng, wth fully one-quarter of all foregn frms recevng no U.S. nvestment at all, and medan U.S. nvestment equvalent to only 0.4 percent of market captalzaton (1.2 percent of float). However, the fgures for the 90 th and 95 th percentles show that holdngs n these less popular frms are offset by a sgnfcant mnorty of nternatonal companes n whch U.S. nvestors own 10 percent or more of the market captalzaton and at least 20 percent of the outstandng float. In other words, the aggregate foregn equty portfolo of a very large, dverse, and quanttatvely sgnfcant group of nvestors appears to devate qute sharply from market weghts. Ths fact seems partcularly surprsng gven that much of ths nvestment s drected by professonal managers whose performance tends to be measured aganst broad market benchmarks. It s also at odds wth the noton that U.S. nvestors, were they relatvely unnformed outsders, ought to take a passve approach to portfolo choce n foregn equtes U.S. holdngs and cross-lstng Why do some foregn frms receve so much more U.S. nvestment than others? What s the most mportant determnant of the extent of U.S. nvestment a foregn frm receves? As a frst pass at answerng these questons, we reexamne the dstrbuton of U.S. holdngs, but ths tme we splt the sample by whether a frm s cross-lsted on a U.S. exchange (Table 3). 13 The summary 13 Most cross-lsted frms n the U.S. do so va an AD, a traded fnancal clam backed by a set number of equty shares n the underlyng company. ADs are created when a frm ntates a relatonshp wth a broker that buys the frm s shares and nstructs a U.S. fnancal nsttuton, called a depostary, to hold the shares n custody and ssue 10

13 statstcs reveal a strkng pattern. The vast majorty of non-u.s. frms are not cross-lsted on a U.S. exchange, so the dstrbuton of U.S. holdngs for the non-cross-lsted sample closely resembles that of the full sample. In contrast, the summary statstcs for cross-lsted foregn frms are dramatcally dfferent. U.S. nvestors hold substantal stakes n almost all cross-lsted frms. The medan cross-lsted foregn frm receves U.S. nvestment totalng 13.6 percent of market captalzaton (20.2 percent of float), whle the 90 th percentle cross-lsted frm has almost 40 percent U.S. ownershp (and over 50 percent of float). Taken at face value, these results suggest that a U.S. cross-lstng s an mportant determnant of the extent to whch U.S. nvestors hold shares n a foregn frm. Whether selecton can explan ths large dfference n that those frms that cross-lst n the Unted States are those that U.S. nvestors would prefer to hold anyway or whether ths dfference s due to a true cross-lstng effect s the key queston that we address n the followng sectons. 4. Methodology: Controllng for Selectvty Selecton bases arse when a researcher attempts to compare two dfferent populaton groups as f they are smlar. The problem commonly occurs when heterogeneous partcpants selfselect nto groups rather than are randomly assgned to the groups. We cannot observe the amount U.S. nvestors would have held n cross-lsted frms n December of 1997 f those frms had not cross-lsted, nor can we drectly observe the reasons why the foregn frms decded to cross-lst n the Unted States. Smple estmates of the relaton between U.S. nvestment n foregn frms and cross-lstng wll be based f the frm s propensty to cross-lst on a U.S. exchange s correlated wth other characterstcs of the frm that affect U.S. nvestors holdng decsons. Moreover, frms negotable securtes backed by the shares, the recepts, to an nterested nvestor. Level I ADs trade OTC, whle the cross-lsted Level II and III ADs lst and trade on one of the major U.S. stock exchanges. 11

14 mght cross-lst n the Unted States for the specfc purpose of ncreasng U.S. nvestor nterest, n whch case the causaton between cross-lstng and U.S. holdngs could run n both drectons. Our goal n determnng whether there s an actual cross-lstng effect s to estmate the unobservable component of what U.S. holdngs would have been n cross-lsted frms had they not cross-lsted. Then, the cross-lstng effect s an estmate of the treatment effect E(H L X L 1) E(H X 0), (1) where X s an ndcator varable set to one when a frm has cross-lsted on a U.S. exchange, E(H L X 1) s the expected level of U.S. holdngs n cross-lsted frm condtonal on t beng lsted, and E(H L X 0) s the expected level of holdngs n cross-lsted frm f t had not crosslsted. 14 Correctons for selecton bas are themselves subject to specfcaton error (Lalonde [1986]; Heckman, Ichmura, Smth, and Todd [1998]; Larcker and ustcus [2010]). Therefore, whle we motvate much of our analyss of holdngs and cross-lstng usng fully parameterzed structural models of the holdngs and cross-lstng decsons, we ultmately ncorporate three dfferent estmators a structural model, p-matchng, and dfference-n-dfferences to robustly measure the cross-lstng effect. We frst descrbe the structural model, and then turn to the more general estmaton of the cross-lstng effect. 4.1 Modelng the holdngs and cross-lstng decsons: a structural framework Our frst estmator adopts the structural framework n Lee s [1978] study of unonzaton and wages, whch extends the Heckman [1979] selecton-bas correcton to a smultaneous system. 14 One could also estmate the lstng mpact from the non cross-lsted frms, E(H U X=1) - E(H U X=0), or from both cross-lsted and non cross-lsted frms to generate an uncondtonal lstng mpact, E(H X=1) - E(H X=0). Heckman, Ichmura, Smth, and Todd [1998] provde an overvew of ssues relatng to the dfferent measures. 12

15 In our applcaton, the framework allows feedback from bas-adjusted holdngs equatons to the cross-lstng decson U.S. nvestors preferences for foregn equtes The system begns wth a model of U.S nvestor preferences for holdng foregn equty: U U H Z H β. (2) U U H Z β (3) L H L L L We use the same set of determnants ( Z ) to model both U.S. holdngs of non-cross-lsted stocks ( H ) and holdngs n cross-lsted stocks ( H ), but we place no restrctons on the U H coeffcents, recognzng that decsons to hold these two types of stocks may be fundamentally dfferent. Ths not only provdes more flexblty n estmaton, but also can help dentfy the structural parameters. Note that observatons of H are gven pont n tme, we can only observe a frm as cross-lsted or not. The nstrument set L L U H are truncated by selecton because, at a H Z contans frm- and country-level proxes for a varety of factors that could nfluence the wllngness of U.S. nvestors to nvest n a foregn frm. We motvate the contents of ths nstrument set n the followng paragraphs. Appendx A contans specfc defntons for each varable. U.S nvestors may want nformaton both smple and more fundamental about a foregn stock before decdng to purchase t. Frm sze s a natural varable to nclude; larger frms are generally beleved to be more transparent than smaller frms, n part because they tend to get more coverage both from the press and from securtes analysts. Because measures of sze are not consstent across ndustres there s, n partcular, a dsconnect between sze measures for fnancal servces frms and frms n other sectors we measure sze usng a combnaton of 13

16 average ndustry market captalzaton and the frm s sze (assets) relatve to ts ndustry average. We also nclude an MSCI member dummy; MSCI ndex members are selected on the bass of lqudty, sze, and market representaton. Illqudty can reflect asymmetrc nformaton (e.g., Easley and O Hara [2004]) that would put U.S. nvestors at a dsadvantage. The qualty or relevance of nformaton about a foregn company wll depend on, among other thngs, the accountng and dsclosure practces of the company. Therefore, U.S. nvestors may favor companes that provde an accurate and tmely accountng of ther fnancal performance (Leuz and Verreccha [2004]; Bradshaw, Bushee, and Mller [2004]), and may be attracted to foregn stocks domcled n countres wth forthrght accountng practces (Lang, Lns, and Mller [2003]). Thus, we nclude two measures of accountng qualty. The frst measure s the natonal accountng qualty ndex compled by the Center for Fnancal Analyss and esearch (CIFA). As reported by Bushman, Potrosk, and Smth [2004], the ndex averages across frms wthn a gven country the number of tems, out of a possble maxmum of 90, that are ncluded as part of a frm s fnancal statements. The second measure s a frm-level accountng qualty ndex, constructed as the sum of four ndcator crtera based on whether the frm uses a Bg Sx audtor, receved a clean audt report, used nternatonal accountng standards or U.S. GAAP, and reported consoldated statements. Ths varable measures varaton n frm-specfc accountng qualty not pcked up by the natonal accountng qualty varable. U.S. nvestors may care about the safety of ther nvestment n the hands of managers who operate outsde U.S. borders. LaPorta, Lopez-de-Slanes, Shlefer, and Vshny (LLSV [1999], [2002]) document substantal cross-country varaton n how well legal systems protect outsde shareholders from expropraton by frm nsders. Durnev and Km [2005], among others, show that the qualty of corporate governance wthn a country can vary greatly across frms. Thus, U.S. 14

17 nvestors could tlt ther nvestments toward countres wth strong legal protectons of mnorty nvestors and seek out frms wth a reputaton for good corporate governance. We consder two measures that capture governance/legalty ssues: the country s LLSV shareholder rghts ndex and a dummy for dvdend-payng frms. U.S. nvestors may choose to underweght frms from markets wth weak protectons of mnorty shareholders. 15 A company s dvdend-payng record can be vewed as a commtment devce, wth the wllngness to dspense cash sgnalng a commtment not to exproprate funds from mnorty shareholders. 16 A dvdend-payment dummy also helps control for a varable that cannot be ncluded n float-adjusted regressons because t would nduce measurement bas: the proporton of shares held by nsders. 17 Both nstrument sets also nclude some more general control varables. We nclude a country s dvdend tax wthholdng rate faced by U.S. nvestors. Wthholdng taxes can cause U.S. nvestors to face hgher tax rates on dvdends orgnatng from a gven foregn country than on U.S. stock dvdends. Ths would make stocks from the foregn country less attractve to U.S. nvestors, partcularly f other potental nvestors n stocks from the two countres dd not face the same tax rate dfferental (otherwse, prces could adjust to equlbrate after-tax expected returns). 15 See La Porta, Lopez-de-Slanes, Shlefer, and Vshny [1998]. 16 See Facco, Lang, and Young [2001], Kalcheva and Lns [2007], Pnkowtz, Stulz, and Wllamson [2006], Easterbrook [1984], and Jensen [1986]. 17 Kalcheva and Lns [2007] provde evdence of the lnk between dvdend payments and potental expropraton by nsders. Evdence that outsde nvestors avod ownershp n closely held companes, perhaps fearng the power of nsders to exproprate frm resources at the expense of mnorty shareholders, s provded n La Porta, Lopez-de- Slanes, Shlefer, and Vshny [1999], Johnson, La Porta, Lopez-de-Slanes, and Shlefer [2000], and Leuz, Lns, and Warnock [2009]. To see the bas f a closely held varable was ncluded n our float-adjusted regressons, let Fˆ represent our market-float adjusted holdngs, Û represent the market captalzaton (unadjusted) holdngs, and Î be our measurement of the proporton of shares held by nsders. Then, by defnton, ˆ ˆ U F. 1 Iˆ Suppose that the nsder stake s measured wth some error so that Iˆ I, where I s the nsders true stake and η s some whte-nose error. Then, cov( F ˆ, ˆ F I I ) 0. In other words, measurement error n the proporton of nsder holdngs mparts a postve bas on the coeffcent estmate n the holdngs model when scaled by market float. Intutvely, a postve measurement error shock ncrease the rght-hand-sde varable (measured proporton of shares held by nsders) as t also ncreases the dependent varable (holdngs, by reducng the denomnator). 15

18 Often a U.S. nvestor can obtan a tax credt that fully offsets a dvdend tax that has been wthheld by a foregn government. However, U.S. penson funds are not taxed drectly on dvdends, so tax credts are of no use to them, and thus taxes charged on foregn dvdends generally wll represent a dfferental between the foregn and domestc dvdend tax rates that U.S. pensons face (the domestc rate s zero). Thus, at least one mportant nvestor group s clearly affected by dvdend wthholdng tax rates. As a measure of economc proxmty (Sarkssan and Schll [2004]), we nclude the share of mports n total U.S. supply at the ndustry level. Greater economc proxmty may ncrease famlarty and mprove the flow of nformaton. We also nclude n H Z a dummy varable for frms that mght be fundamentally dfferent. For example, we nclude a dummy for Canadan frms for two reasons. Insttutonal smlartes and tes wthn North Amerca may make Canadan frms specal. In addton, for cross-lsted stocks, SEC dsclosure requrements are dfferent for frms based n Canada than for those from other countres, whch could affect ther relatve transparency to U.S. nvestors, all else equal Frms decsons to cross-lst The second part of the smultaneous system nvolves a frm s decson to cross-lst on a U.S. exchange. We motvate the decson by consderng the potental benefts and costs of crosslstng. Let X * represent the net benefts that flow to frm from cross-lstng on a U.S exchange. We assume that these benefts can be descrbed by the followng relaton, X * x 0 L U U X X H H γ H Z β ε α γ, (4) 1 x where H L and H U are the endogenously determned proporton of frm s equty that would be held by U.S. nvestors f the frm were cross-lsted (L) n the Unted States or not cross-lsted (U), respectvely. 16

19 The dfference H L - H U models the antcpated mpact of lstng on U.S. holdngs. It s ncluded n (4) to allow for foregn frms to cross-lst n the Unted States precsely because t attracts greater U.S. nvestor nterest. U H also enters equaton (4) ndependently to allow the level of U.S. holdngs pror to cross-lstng to affect a frm s decson to cross-lst. We post that frms wth large pre-exstng U.S. shareholdngs could cross-lst on a U.S. exchange to reduce tradng costs for ther shareholder base. The vector Z contans frm- and country-specfc varables that are assocated wth X benefts and costs of cross-lstng, but that are taken to be exogenous. There are both drect and ndrect costs assocated wth lstng n the Unted States that could make frms reluctant to crosslst. Most cross-lsted frms face a host of drect regstraton, dsclosure, and complance costs. They must regster wth the U.S. Securtes and Exchange Commsson (SEC) and submt perodc flngs that are n Englsh and nclude fnancal statements reconcled to U.S. generally accepted accountng prncples (GAAP). They must meet the lstng requrements of the U.S. exchange, whch are often strcter than those n the frms home country, and pay both lstng fees to the exchange and flng fees to the SEC. Frms that cross-lst to rase new captal must also regster ther securtes under the SEC 1933 Securtes Act and the 1934 Exchange Act. Indrect costs nclude the commtments that cross-lsted frms make to abde by U.S. regulatons and law. Frms that volate exchange regulatons rsk fnes and the threat of delstng. Those that volate SEC regulatons face potental shareholder lawsuts and cvl or crmnal penaltes under U.S. law. Closely held frms may be especally reluctant to cross-lst f the ncreased level of dsclosure and legal oversght gves more power to mnorty shareholders. The benefts of cross-lstng vary across frms and can nclude product market consderatons (to the extent that lstng on the NYSE can help make a foregn company a 17

20 household name n the Unted States), employee compensaton (to the extent that t ncludes grants of optons or stock), and takeover strategy (where a cross-lsted stock can serve as a takeover currency). One potental beneft that both practtoners and theorsts cte as a reason for crosslstng s to ncrease the set of nvestors that can, at low cost, access nformaton and trade shares n the frm. That s, cross-lstng reduces recever costs assocated wth expandng the shareholder base (Merton [1987]]. 18 Ths n turn may mprove rsk sharng, prcng, and the lqudty of a frm s stock. Accordngly, frms seekng to expand ther shareholder base through ncreased U.S. ownershp mght have the strongest ncentve to cross-lst. Frms may also lst n the U.S. to reduce nsttutonal frctons assocated wth mantanng ther exstng nvestor base. For example, f a frm already has U.S. nvestors, t may cross-lst to make t easer for those nvestors to manage ther stock portfolos. But the other consderatons (product market, compensaton, takeover currency) mght be more mportant: Any consderaton that nvolves expandng the shareholder base must be weghed aganst that of relnqushng any prvate benefts of control. We also nclude some of the varables from H Z, as these varables are also lkely to nfluence the cross-lstng decson. Frm sze wll be mportant for the lstng decson f there are economes of scale n the drect costs of lstng, ncludng regulatory complance and accountng dsclosure. Cross-lstng may be less costly for frms n ndustres wth greater economc proxmty. We nclude the Canada dummy because cross-lstng should be less costly for Canadan 18 Lang, Lns, and Mller [2003] argue that foregn frms may cross-lst smply to expand ther shareholder base, the set of nvestors avalable to purchase a gven frms shares. See also Merton [1987], Mller [1999], Foerster and Karoly [1999], Karoly and Stulz [2003], and Dodge, Karoly, and Stulz [2004]. The argument s also popular among U.S. practtoners who encourage foregn clents to cross-lst. See Fanto and Karmel [1997], and the AD webstes at JPMorgan ( and the Bank of New York ( 18

21 frms, as they enjoy an exempton from most SEC reportng requrements. 19 We also post that frms from countres wth weak accountng standards wll fnd t more costly to prepare fnancal statements n accordance wth U.S. GAAP. In addton, we nclude three varables that are unque to the cross-lstng specfcaton: home-country tradng volume/gdp (because the benefts from cross-lstng mght be partcularly hgh for frms that quckly outgrow ther underdeveloped home equty markets), a Cvl Law dummy (followng Dodge, Karoly, and Stulz [2004]), and the proporton of shares held by nsders (whch proxes for the cost of relnqushng prvate control benefts through ncreased dsclosure and montorng assocated wth cross-lstng) Closng the structural model We do not observe varable X, * X n equaton (4). Instead, we observe realzatons of the ndcator X X * 0 f X 0 (5) * 1f X 0. (6) X equals one when frm s cross-lsted on a U.S. exchange, and zero otherwse. Note that equatons (4)-(6), coupled wth an assumpton that the error term that the lstng decson can be estmated usng a probt model. X s normally dstrbuted, mply Takng nto account selectvty adjustments, U.S nvestor preferences for holdng crosslsted and non-cross-lsted stocks become: 19 Under the Mult-Jursdctonal Dsclosure System (MJDS) agreement between the SEC and the Canadan Securtes Admnstraton, Canadan frms can cross-lst on a U.S. exchange wthout conformng to U.S. GAAP and wth only mnmal reportng to the SEC. 20 Importantly, dentfcaton n the structural model depends on some varables drectly determnng one of the two endogenous varables, but not the other. Structural models can be crtczed for mposng too much structure, whch s one reason we also use sem- and non-parametrc technques, descrbed below. 19

22 H ( ˆ ˆ Z ) Z ( ˆ Z ˆ ) L H L L L L (7) and H ( ˆ ˆ Z ) Z. 1 ( ˆ Z ˆ ) U H U U U U (8) Now H L and H U take on the addtonal nterpretaton of beng the estmated holdngs n frm when the frm s cross-lsted and when t s not, whle ϕ and Ф denote the probablty densty and cumulatve densty functons of the standard normal dstrbuton. Equatons (4), (7), and (8) now consttute a system of equatons that can be estmated wth maxmum lkelhood technques. The estmaton procedure s dscussed n Appendx B. We note here only that the coeffcent on λ L n (7) s the nverse Mlls rato, whch forms the bass for standard correctons for selectvty bas when ncluson n an estmaton sample s contngent on a dscrete outcome (see Heckman [1979] or Maddala [1983]), whle the coeffcent on λ U n (8) s a smlar but less frequently used correcton for selectvty bas for the non-selected observatons. Importantly, the estmates ˆ, ˆ and ˆ, ˆ from (7) and (8) are used to calculate ftted L L U U values Ĥ L and Ĥ U, whch can then be plugged nto the structural probt specfcaton, (4). Because H and H are scaled (by market captalzaton or market float) to only take on values between L U zero and one, we work off of transformatons of equatons (7) and (8). These transformatons, along wth other detals of the estmaton process, are descrbed n the appendx. 4.2 Methodologes to measure the cross-lstng effect One of our prmary nterests s measurng the magntude of the cross-lstng effect, defned 20

23 by equaton (1) and reproduced here: E(H L X L 1) E(H X 0). (1) Consstent estmaton of (1) and, thus, the cross-lstng effect, nvolves averagng across frms the dfference between U.S. holdngs n the frm and estmates of what the counterfactual holdngs n the cross-lsted frms would have been had the frm not cross-lsted. Snce the frst component of L (1), E( H X 1), can be estmated as the average the observed holdngs n cross-lsted frms, we only have to estmate the unobservable second component, E(H L X 0). Because no method s perfect, we consder three methodologes for estmatng the unobservable component. The frst estmator derves from the structural model from the prevous subsecton. We estmate E(H L X 0) by estmatng the ftted holdngs from equaton (8) for each frm, and then averagng over the resultng ftted holdngs. The second estmator uses the propensty-score method of matchng, also termed pmatchng, orgnally developed by osenbaum and ubn [1983]. 21 P-matchng uses ftted crosslstng probabltes ( propensty scores ) generated from estmates of equaton (4) to match each cross-lsted frm wth a non cross-lsted frm. 22 The dea s that the holdngs of p-matched noncross-lsted frms are lkely to be smlar to what a lsted frm s holdngs would have been f unlsted, so the average holdngs of p-matched frms can be used to estmate E(H L X 0). The advantage of the p-matchng estmator s that t requres no explct model of holdngs, whch reduces the rsk of specfcaton error (Drake [1993]; Deheja and Wahba [2002]; and Zhao [2004]). The estmator has also been shown to outperform Lee/Heckman-style correctons n expermental studes of selecton bas (Glazerman, Levy, and Myers [2003]). One drawback to the 21 See Imbens [2004] and Stuart [2004] for recent revews of matchng applcatons to treatment effect estmators. 22 The asymmetry n our data makes p-matchng a partcularly attractve method because we have a large set of frms from whch to select a match (roughly 30 non cross-lsted frms for each of our cross-lsted frms). 21

24 p-matchng estmator s that t does not account for unobserved correlaton between the holdngs and cross-lstng decsons. We generate our thrd estmate of the average cross-lstng effect usng the dfference-ndfferences estmator (Heckman and obb [1985]; Heckman, LaLonde, and Smth [1999]). Ths estmator requres holdngs observatons on cross-lsted frms pror to ther cross-lstng. For ths, we draw upon U.S. holdngs data from the earler March 31, 1994 survey. The dfference-ndfferences estmator compares the change n holdngs of a frm that was not cross-lsted n 1994 but cross-lsted by 1997 to frms that remaned non cross-lsted between 1994 and That s, the cross-lstng effect s gven by E(H L X L L,1997 U,1994 U,1997 U,1994 1) E(H X 0) (H H ) (H H ), (9) where ndexes a frm that cross-lsts between the 1994 and 1997 surveys, j ndexes a frm that remans non cross-lsted n both surveys, and bars over the varables reflect sample means across the and j categores. The dfference-n-dfferences estmator ncorporates many of the advantages of the p-matchng estmator. Moreover, unlke the p-matchng estmator, the dfference-ndfferences estmator accounts for unobservable components of selecton bas, assumng that the characterstcs of a type- frm do not change n a way that s left uncontrolled by the type-j frms. 23 For our applcaton, the key drawback of the dfference-n-dfferences estmator s that t reles on a relatvely narrow subset of 132 frms that were traded only n ther home market n 1994, but cross-lsted by j j 23 Heckman, Ichmura, Todd, and Smth [1998] provde expermental evdence that dfference-n-dfferences estmators outperform both standard Heckman [1979] correctons and p-matchng estmators. 24 Because the sample sze would be reduced to an even greater extent by requrng nsder holdngs nformaton for 1994 and we have no way of correctng mstakes n 1994 nsder holdngs data, we do not report dfference-ndfferences estmates usng the market float measure. 22

25 5. esults 5.1 esults from the structural model Table 4 reports estmates of our structural model of cross-lstng and U.S. holdngs as of end-1997 scaled by float. 25 esults usng holdngs scaled by market captalzaton (not shown, but avalable from the authors) are not materally dfferent. equrng a complete set of explanatory varables for the Heckman [1979]-based and p-matchng estmators reduces our sample to 8,086 frms, 282 of whch cross-lsted on a U.S. exchange Determnants of holdngs n frms that are not cross-lsted Whle our focus s on the cross-lstng effect, and holdng of non cross-lsted frms are qute small (medan holdngs are 1 percent of float), t s nonetheless nformatve to understand the factors behnd U.S. nvestment n frms that are not cross-lsted. Among the 7,804 frms that are not cross-lsted (the mddle column n Table 4), all of the explanatory varables are sgnfcant, often wth sgns that accord wth ntuton. U.S. nvestors prefer frms that are larger, ncluded n the MSCI World ndex, and pay dvdends. They are also attracted to frms from Canada and frms wth low dvdend tax wthholdng rates. The latter result ndcates that an addtonal reason that a home bas mght exst s that U.S. nvestors shy away from nternatonal nvestments when crossborder dvdend tax wthholdng rates are hgh. Holdngs are hgher for frms n ndustres wth a larger share of mports n U.S. supply, whch s consstent wth the ntuton that greater economc proxmty ncreases nvestment. A number of the non cross-lsted holdngs estmates ndcate that U.S. nvestors are senstve to the amount and qualty of nformaton avalable on foregn-traded frms. The postve 25 To make our results more readly nterpretable, we report rescaled functons of the estmates. Specfcally, for the coeffcents on nstruments n the lstng decson equaton, we calculate the margnal effect of a one-unt change n the nstrument on the percentage pont probablty of cross-lstng. Smlarly, the coeffcents n the holdngs equatons are scaled to reflect the margnal effect of a change n the nstrument on the holdngs share of U.S. nvestors (measured n percentage ponts). See Appendx B for complete detals on transformatons and on the estmaton technque. 23