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

26 and statstcally sgnfcant sgns on the frm- and country-level accountng varables suggest that U.S. nvestors value hgh-qualty dsclosure when choosng a foregn frm n whch to nvest. Ths s consstent wth Bradshaw, Bushee, and Mller [2004], who show that U.S. nvestment s hgher n frms wth greater conformty to U.S. GAAP. The only surprsng result for non-cross-lsted frms s the negatve assocaton between holdngs and the level of shareholder rghts protecton provded by a frm s home country. Ths result holds whether we use the LaPorta, Lopez-de-Slanes, Shlefer, and Vshny [1998] ndex of ant-drector rghts (as reported), or country-level estmates of the blockholder premum n share prces from Dyck and Zngales [2004] (not reported). The wllngness of Amercan nvestors to undertake larger postons n frms from countres n whch mnorty shareholders are vulnerable suggests a relatve lack of concern about nsttutonal enforcement of ther property rghts, or that U.S. nvestors do not feel they wll be protected, regardless of shareholder rghts scores. 26 Fnally, the selectvty correcton varable s negatve and sgnfcant, ndcatng that the set of frms that are unlsted have unobservable characterstcs that make ther stock less lkely to be held by U.S. nvestors. In other words, holdng all else constant, the mean holdngs of the unlsted sample would be hgher f the sample were drawn randomly from a group of frms wth the same observable characterstcs Determnants of addtonal holdngs n cross-lsted frms For the determnants of holdngs of cross-lsted frms, we report our results for the varous H nstruments ( Z ) n terms of the mpact ( L - U ) on the ncrease n U.S. holdngs as a result of cross-lstng (the rght column of Table 4), from our estmated parameters for equatons (7) and (8). Only the coeffcent on the MSCI member dummy s sgnfcant, wth the expected negatve 26 Whle the relatonshp s negatve at the frm level, t s essentally zero at the country level. That s, we formed country-level U.S. holdngs of non-cross-lsted frm by aggregatng the frm-level data; across countres, the correlaton between that measure and shareholder rghts s essentally zero. 24

27 sgn mplyng a smaller (by 12 percentage ponts) cross-lstng effect for the relatvely large and lqud MSCI member frms The cross-lstng decson and U.S. holdngs In accordance wth our ntuton about factors that reduce the costs of cross-lstng, the estmates for the cross-lstng equaton (the frst column) reveal that frms are more lkely to crosslst on a U.S. exchange f they are large, have better home-country accountng standards, or are domcled n Canada. Frms n ndustres wth greater mported share of U.S. supply are more lkely to cross-lst. Two of the three varables that unquely dentfy the lstng equaton enter wth estmated sgns that are n lne wth our expectatons: frms that are closely held and from more lqud markets are less lkely to cross-lst on a U.S. exchange. Interestngly, frms domcled n Cvl Law countres are less lkely to lst. Whle ths result runs counter to the ntuton that these frms would beneft more, t may be the case the frms from non Cvl Law countres fnd crosslstng less costly. Nether the expected ncrease n U.S. nvestment from cross-lstng nor the level of U.S. holdngs pror to lstng nfluences the cross-lstng probablty The average cross-lstng effect Estmates of the average cross-lstng effect are summarzed n Table 5. At the end of 1997 U.S. nvestors held an average of 16.5 percent of the market captalzaton of the 282 cross-lsted frms (row 1), an average that s slghtly less than for the somewhat larger sample n Table 3. Accordngly, for our Heckman-based and p-matchng (cross-sectonal) estmates of the average cross-lstng effect, we use 16.5 percent as our estmate of E(H L X 1). The Heckman [1979]-based estmate of E(H L X 0) s 5.9 percent of market captalzaton 27 Specfcatons exst n whch both of these varables are sgnfcant, suggestng that frms cross-lst to both expand ther nvestor base and servce ther exstng U.S. nvestor base. However, n many specfcatons, ncludng the one reported, there are nsgnfcant, owng n part to the relatvely small number of frms that have cross-lsted. 25

28 (row 2). Ths s larger than average holdngs of non-cross-lsted frms (2.9 percent of market cap), as cross-lsted stocks have attractve features even wthout the cross-lstng. But the Heckman [1979]-corrected estmates stll suggest a szeable, statstcally sgnfcant cross-lstng effect: U.S. holdngs n a typcal cross-lsted stock are 10.6 percentage ponts of market captalzaton (or 13.4 percent n terms of float) hgher than they would be wthout the U.S. lstng. 28 The p-matchng and dfference-n-dfferences methodologes produce results that are close to the Heckman [1979]-based estmates. The p-matchng produces an estmate of E(H L X 0) equal to 5.3 percent of market captalzaton or 8.1 percent of market float (row 4), mplyng a statstcally sgnfcant lstng effect equvalent to 11.2 percent of market captalzaton (17.7 percent of market float). The bottom panel of Table 5 shows that n March 1994, U.S. nvestors held 8.6 percent of market captalzaton of the 132 frms that were not cross-lsted then but that cross-lsted by December 1997 (and for whch March 1994 U.S. holdngs data exst). Addng the 0.6 percentage ncrease n the holdngs of non-cross-lsted frms over the perod yelds our hghest estmate of E(H L X 0), 9.2 percent of market captalzaton. Nonetheless, wth U.S. nvestors holdng 17.1 percent of these frms by the end of 1997, ths stll mples an average cross-lstng effect of 7.9 percent. 29 Overall, the three technques estmate a szeable average crosslstng effect that ranges from 8 to 11 percent of market captalzaton (or 13 to 18 percent of float). 28 The standard error for the lstng effect estmate s calculated as the observaton-weghted standard devaton of the 279 pared dfferences. 29 In our sample, 23 of the 132 frms that cross-lsted between the two survey dates also undertook seasoned equty offerngs (SEOs). It s plausble that the combnaton of a SEO and cross-lstng has dfferent mplcatons for U.S. holdngs than a cross-lstng alone, partcularly f the ssue targets U.S. nvestors. However, when we compare the change n U.S. holdngs for cross-lstng stocks wth and wthout these SEOs, we fnd no statstcally sgnfcant dfference. Accordngly, we do not treat cross-lstng frms that rase publc equty dfferently from other cross-lstng frms. For further evdence on the captal-rasng behavor of cross-lsted frms, see eese and Wesbach [2002] and Henderson, Jegadeesh, and Wesbach [2006]. 26

29 5.3 What s behnd the cross-lstng effect? Is t the frm or the securty? It s natural to wonder whether the cross-lstng effect mght reflect nformaton about the frm or mght just be due to the fact that the securty s avalable n the Unted States. We address ths queston n two ways and fnd that whle there s some advantage to the shares tradng drectly n the U.S., t does not entrely explan ether the cross-lstng effect or the observed pattern of holdngs n both the U.S.-traded securty and the underlyng securty. Table 6 shows that for cross-lsted frms, U.S. nvestors hold large proportons of ther shares (11.1 percent of market captalzaton) n the underlyng foregn securty purchased n the foregn home market and only a small porton (6.4 percent) n the AD purchased n the US. Ths fact has an mportant mplcaton. ADs enable U.S. nvestors to forego concerns about tradng n other currences, dealng drectly wth foregn regulatory authortes, and potentally hgh executon costs on foregn stock markets. If nvestors were respondng to the reducton n transactons costs assocated wth beng able to trade these stocks on the NYSE, we would expect most of the cross-lsted holdngs to be n the form of ADs. In contrast, most U.S. holdngs n cross-lsted frms are n the underlyng foregn securty. Ths s drect evdence aganst transacton costs as a prmary mpedment to foregn nvestment. Addtonal evdence on the motves for holdng cross-lsted shares s provded by a set of vehcles (Level I and ule 144a ADs) that are denomnated n dollars and trade n the Unted States, but trade over-the-counter rather than on an organzed exchange. 30 There are mportant dfferences between over-the-counter Level I and ule 144a ADs and ther exchange-traded Level II and III cousns. Importantly, because they are not lsted on a major U.S. exchange, frms 30 In ths paper s man analyss we treat Level I and ule 144a frms as non-cross-lsted frms. Note that many Level I AD programs have been ntated by U.S. nvestors or depostory banks, not by the foregn companes themselves. ule 144a programs typcally arse from prvate placements avalable only to nsttutonal nvestors. 27

30 wth Level I or ule 144a ADs are not requred to reconcle fnancal statements wth U.S. GAAP or submt regular dsclosures to the SEC and are not subject to most U.S. securtes laws. Thus, Level I and ule 144a ADs provde U.S. nvestors the opportunty to acqure foregn stocks that trade n the US but st outsde the protectons of U.S. securtes regulaton. The mddle of Table 6 shows that U.S. nvestors do hold a greater proporton of shares n a Level I and ule 144a AD-frm (8.9 percent of market captalzaton, 15.1 percent of market float) than n the average foregn frm not traded n the Unted States, but these holdngs are substantally lower than n foregn stocks that trade on organzed exchanges (Level II and III ADs) and are thus requred to comply wth U.S. securtes regulatons. Whle U.S. holdngs of Level I/ule 144a stocks are smaller than those of stocks lsted on a U.S. exchange, they are stll greater than U.S. holdngs of the typcal foregn equty. In Table 7, we dstngush between the porton of the ncreased holdngs of Level I/ule 144a that s due to other frm characterstcs and the porton that mght be called a Level I effect. Applyng a p- matchng methodology to compare holdngs of frms that trade n the U.S. OTC market to frms that have no vehcle for U.S. nvestment, we fnd that Level I/ule 144a stocks would have greater than average U.S. holdngs even wthout the program because of the characterstcs companes that trade Level 1 shares (9.6% of float, compared wth 5.1% of float for foregn frms wthout a U.S. tradng vehcle). But ths leaves a statstcally sgnfcant Level I effect of 5.2%. Ths Level I effect s small relatve to the 13-18% effect for cross-lsted stocks, but s not nsubstantal. A possble reason for ths non-neglgble Level I effect s that whle Level I ADs and ule 144a vehcles confer on lmted legal protecton to U.S. nvestors, the protectons could be mportant. Indeed, Ilev, Mller and oth [2011] show that recent SEC rule changes expose foregn frms wth unsponsored programs to lablty under U.S. law; these come n addton to the potental rght to 28

31 sue unsponsored enttes n state courts pror to the SEC changes. In addton, the creaton of a Level I AD could facltate nvestment by U.S. resdents that may face obstacles or extra costs that deter them from drectly nvestng n foregn securtes, although as Table 6 showed most of the holdngs are n the underlyng securty, not n the U.S.-traded AD. Overall, the evdence n ths subsecton suggests that the ablty to hold a securty that trades n the U.S. matters but s just one factor behnd the observed ncrease n nvestment n cross-lsted stocks Other Factors Table 8 reports the results from regressons usng the dfference-n-dfferences setup to generate frm-level estmates of the cross-lstng effect on the U.S. holdngs share. Specfcally, we regress the 1994 to 1997 change n holdngs of stocks that were not cross-lsted n 1994 on a cross-lstng dummy, ts nteractons wth nstruments measured as of 1994 and 1997, and the change n the value of nstruments over the 1994 to 1997 perod, H D X D X D Z - Z Z 1994 Z β, (10) D D D where X equals one f the frm cross-lsts n 1997, and zero otherwse. We nclude changes and frst-perod levels of the nstruments n the regresson as controls for changes n frm characterstcs and n U.S. nvestor preferences, respectvely. Ths s essentally a condtonal dfference-n-dfferences approach. For brevty, we report only the nteracton estmates ( β D ) n Table 8 that dentfy the margnal nfluence of the nstruments on the cross-lstng effect. Overall, the results are consstent wth the noton that mprovement n the avalablty and qualty of value-relevant nformaton about a frm s a key aspect of cross-lstng n U.S. markets. The negatve and statstcally sgnfcant coeffcent on a frm s sze relatve to ts ndustry average ndcates that the change n 29

32 holdngs for large lqud frms, whch may be more transparent than smaller frms, s lower after cross-lstng. Addtonal evdence for the mportance of transparency comes from the smaller estmated cross-lstng effect for Canadan frms. Because Canadan frms are not requred to reconcle to U.S. GAAP or ncrease dsclosures as much upon cross-lstng, cross-lstng should have less mpact on U.S. nvestors wllngness to hold Canadan stocks. Whle we observe evdence that greater transparency reduces the cross-lstng effect, results on accountng qualty are mxed. For example, we obtan a negatve and statstcally sgnfcant coeffcent estmate for the frm-level accountng qualty ndex. The estmates mply that U.S. nvestors ncrease ther ownershp n a cross-lsted frm by 2.5 percentage ponts for every unt declne n the frm s accountng qualty ndex. The coeffcent on the cross-lstng dummy nteracted wth the natonal accountng qualty ndex, however, s postve and statstcally sgnfcant. There s an ncreased cross-lstng effect for frms from countres wth a hgher natonal accountng qualty. Overall, the estmates mply that mproved frm-level accountng practces lnked to cross-lstng spurs U.S. nvestment n frms wth prevously weak accountng standards, but strong natonal accountng qualty may actually be complementary to cross-lstng. In the second column of Table 8, to ncrease the number of observatons we present a more parsmonous specfcaton that does not nclude the accountng varables or the dvdendpayng frm dummy. The coeffcent estmates on sze and the Canadan frm dummy confrm results ndcatng that more transparent frms have a smaller change n holdngs followng crosslstng. One further bt of ndrect evdence favorng an nformaton explanaton s the reduced lstng effect for the more lqud stocks that are ncluded n the MSCI World ndex. To the extent that llqudty reflects asymmetrc nformaton between company nsders and other potental traders, as n the models of Damond and Verreccha [1991] and Easley and O Hara [2004], the 30

33 enhanced dsclosure requrements assocated wth cross-lstng wll tend to matter more for less lqud stocks. Wth a postve coeffcent estmated for the nteracton of cross-lstng wth the shareholder rghts ndex, we do not fnd that U.S. nvestors respond to the enhanced protectons of U.S. securtes laws n the manner that has been suggested by some of the proponents of the nvestor-protecton hypothess. In partcular, all else equal, cross-lstng has a smaller mpact on U.S. nvestors holdngs for frms from countres wth weaker shareholder protecton. Our result here does not mply that U.S. nvestors fal to value shareholder protecton provded by other countres legal systems, but s consstent wth cross-lstng complementng such legal rghts. In fact, to the extent that cross-lstng n the Unted States makes a frm more transparent, legal protectons provded to mnorty shareholders n the home country may become more effectve. (Furthermore, the dsclosure requrements accompanyng a U.S. lstng typcally nclude nformaton about home-country legal rsks that may leave some U.S. nvestors better nformed about ther rghts.) What our results do suggest s that cross-lstng n the Unted States s not a substtute for adequate protecton of mnorty shareholders under the home-country legal system. 6. Applcaton to Country-Level Studes Usng a unque dataset, we have demonstrated that cross-lstng s the most mportant determnant of U.S. nternatonal nvestment and, mportantly, that ncorporatng cross-lstng ntroduces a selecton bas that requres estmaton wth approprate econometrc technques. Of course, n many research projects such a detaled and complete securty-level dataset mght not be avalable. Nevertheless, the nsghts gleaned are stll applcable to more aggregated data sets. Much research on nternatonal nvestment uses country-level data, so as an ad to future research 31

34 we suggest a way for country-level studes to nclude the effect of cross-lstng and address the selecton ssue n an econometrcally robust way. We start from the vew that any country-level study of U.S. nternatonal equty nvestment must have three features: the dependent varable must be float adjusted, the dependent varable should be free of a country-sze bas, and the analyss must properly account for cross-lstng. That the dependent varable must be float adjusted s well establshed n Dahlqust, Pnkowtz, Stulz, and Wllamson [2003] and Kho, Stulz, and Warnock [2009]; shares held by nsders are not avalable to dspersed portfolo shareholders and so should be omtted from portfolo analyss. Whle there s no exact measure of nsder ownershp that s avalable both across a range of countres and through tme, a country-level measure bult up from the frm-level closely-held feld n Worldscope s a reasonable proxy. Less well understood, but explored n detal n Bekaert, Segel and Wang [2012], s that the dependent varable should be free of a country-sze bas. Common dependent varables that contan a country-sze bas that researchers are unable to adequately control for nclude the dollar amount of holdngs or varants thereof (e.g., Desa and Dharmapala [2011]), the share of the country s equtes n U.S. portfolos (e.g, Andrade and Chhaochhara [2010], and even a dfference home bas measure, that would at frst glance appear to account for country sze. Bekaert, Segel and Wang [2012] suggest a measure smlar to the followng, whch they label as a foregn bas vs-à-vs a country (FB ): FB F /F - USH /USH world world, f USH /USH world F /Fworld F /Fworld USH /USH FB F /F F world world, f USH /USH world /Fworld 1- F /F world (11) 32

35 where F s float and USH s U.S. holdngs, both n U.S. dollars. 31 Note that as defned, a decrease n FB vs-à-vs a partcular country s equvalent to ncreased U.S. holdngs (relatve to the country s weght n the world float portfolo). The FB measure s both suggested by theory (nternatonal CAPM) and free of any country-sze bas. The reader mght readly accept that holdngs expressed n dollars (or log dollars) or as a share of the U.S. portfolo has a country sze bas, but mght expect a dfference bas measure (essentally the numerator from above) to be free of such bas. However, as Fgure 1 shows, the dfference home bas measure has a substantal country sze bas; a rato home bas measure a la Bekaert, Segel and Wang [2012] does not. 32 The thrd requrement, properly ncorporatng cross-lstng nto the analyss, calls for approprate econometrc technques as well as a country-level cross-lsted varable. For a countrylevel cross-lstng varable, we calculate the fracton of the destnaton country market captalzaton that s cross-lsted on a U.S. exchange. 33,34 For the econometrcs, our securty-level analyss ndcated that cross-lstng s endogenous. At the country level a straghtforward way to deal wth ths endogenety s to nstrument for a country s cross-lsted fracton. We select a parsmonous lst of nstruments from our Table 4 and Dodge et al [2009]: tradng volume, 31 The underlyng U.S. holdngs data can be taken from the IMF Coordnated Portfolo Investment Surveys (CPIS). We normally would not advse the use of these data, whch are typcally of poor qualty. But, for U.S. nvestment abroad, the entres come from hgh qualty U.S. benchmark surveys (except for 2002, when no such survey was conducted and the U.S. CPIS numbers were based on estmates n Thomas, Warnock, and Wongswan [2004]). 32 Note that at a pont n tme the top lne n equaton (10) s essentally equvalent to U.S. holdngs as a percent of the destnaton country s float (tmes a measure that s constant across countres at a pont n tme, the share of the U.S. n the world portfolo), another reasonable measure for studes lmted to one source country and one tme perod. 33 We scale our country-level cross-lstng varable usng annual country-level market captalzaton from the World Bank Development Indcators. Calculatng the market captalzaton of U.S. lsted stocks s not straghtforward. Our technque s to aggregate the market captalzaton of frms n the CSP (.e., U.S.-lsted) unverse that are ncorporated outsde the U.S. (shrcd=12) or ADs (shrcd=30 or 31) by year and by country, usng Compustat calendar prce (prcc_c) and shares outstandng (csho) data and the foregn ncorporaton code (fc). Ths approach s not foolproof. For example, Accenture PLC swtched ncorporaton from Bermuda to Ireland n 2009, and so s now Irsh based on the current CSP varable shrcd. Thus, for a fnancal center lke Ireland we rely only on nformaton on ADs to ndcate U.S.-lsted Irsh stocks. 34 Our cross-lstng varable and float adjustment are posted at 33

36 natonal accountng qualty, a dummy varable for countres wth a cvl law orgn, blateral trade lnkages (exports plus mports between the U.S. and destnaton country dvded by total trade of U.S., often referred to as economc proxmty), and log GDP per capta. 35 As an example, n a pooled annual dataset these nstruments explan a large amount of the varaton n the cross-lsted fracton (frst column of Table 9). Moreover, a comparson of the second and thrd columns suggests that they do not once the cross-lsted fracton s taken nto account have addtonal explanatory power for float-adjusted bas. Ths short lst of nstruments appears to be sutable to address the selecton ssue of a country-level cross-lstng effect n an econometrcally robust way, as the proposed country-level nstruments can explan a large porton of the varaton n the cross-lsted fracton and any subsequent effect on holdngs s lkely through the effect on cross-lstng. We apply ths selectvty adjustment to the analyses n Andrade and Chhaochhara [2010] and Desa and Dharmapala [2011]. Our objectve here s not to overturn the results from ether paper, but rather to show how the nsghts from our work can be appled to the burgeonng lterature on country-level U.S. nternatonal nvestment. Lke many studes of nternatonal nvestment, Andrade and Chhaochhara [2010] ncludes a range of control varables but focuses on one varable n partcular, n ths case the amount of U.S. Foregn Drect Investment (FDI) n each destnaton country n 1990, a proxy for nformaton endowment. We focus on the man specfcatons from ther Table 3 usng a float-adjusted bas measure (somewhat analogous to the non-float-adjusted bas measure used n ther Table B2), rather than a country-sze-bas plagued portfolo weght measure, and can closely replcate ther 35 We do not clam that our lst of country-level nstruments s exhaustve, and leave for future work the search for the ultmate nstrument set. We note that we also tred a closely held measure (from Worldscope) as an nstrument, as suggested by Dodge et al. [2009], but t was not assocated wth country-level cross-lstng and was assocated wth U.S. holdngs, suggestng that t s a poor country-level nstrument. Note that Dodge et al. [2009] use a fner measure of nsder ownershp that s not avalable across tme (or, generally, to other researchers). 34

37 results. 36 As the frst column n Table 10 shows, when replcatng ther results, countres wth more U.S. FDI n 1990 had more U.S. nternatonal nvestment (.e., less bas) n the perod. But cross-lstng s an mportant omtted varable one that s potentally correlated wth varables of nterest. 37 Specfcally, all else equal, countres that receve a lot of US FDI relatve to ther market float should tend to be the ones wth captal markets that are underdeveloped relatve to the underlyng nvestment opportuntes. Frms n such countres would have relatvely strong ncentves to cross-lst to attract more nternatonal ownershp, so cross-lstng s a potentally mportant omtted varable correlated wth the study s varable of nterest. We llustrate ths n the second and thrd specfcatons of Table 10. In the second specfcaton, n a smple OLS regresson of float-adjusted bas on the same explanatory varables as Andrade and Chhaochhara [2010] FDI poston n 1990, the share of a country s market captalzaton n the world market portfolo, and the volatlty of stock returns n the destnaton country we add the cross-lsted fracton. 38 As expected, the coeffcent on the fracton of destnaton country market captalzaton cross-lsted n the U.S. s negatve and statstcally sgnfcant; the larger the percent of a country s market captalzaton that s cross-lsted, the larger s U.S. nvestment (the smaller s the bas). But the coeffcent on FDI 1990 swtches sgn and s nsgnfcant. Whle ncludng the cross-lsted fracton solves the omtted varable problem, t does not address the endogenety that arses from the selecton ssue. Because holdngs and cross-lstngs are smultaneously determned, all coeffcent estmates are nconsstent. In the thrd specfcaton, 36 Addtonally, we update ther results usng data through 2009 and have a slghtly dfferent sample (35 countres versus ther 38) because of our nstrument choce. Nether of these dfferences materally mpacts the results. 37 Andrade and Chhaochhara [2010] descrbe a robustness check that ncludes fracton of equty cross-lsted n 1997, but not a tme seres that spans the sample used n the analyss. 38 See Appendx Table A2 n Andrade and Chhaochhara [2010] for detals on the constructon of ther varables. 35

38 we estmate the effect of cross-lstng usng an IV regresson and nstrument for the cross-lst fracton usng the nstruments proposed earler. 39 The coeffcent on the cross-lst fracton ncreases and s stll negatve and statstcally sgnfcant. The coeffcent on FDI 1990 s agan nsgnfcant. 40 We next apply the same type of adjustment to the Desa and Dharmapala [2011] analyss of the mpact of changes n dvdend tax treatment on U.S. nternatonal equty nvestment. The polcy change examned s the Jobs and Growth Tax elef econclaton Act (JGTA) of 2003, whch lowered the dvdend tax rate to 15% for a partcular subset of countres wth whch the U.S. has a tax treaty. Desa and Dharmapala [2011] fnd evdence of a substantal portfolo reallocaton toward countres for whch the tax treaty appled. Whle we would argue that cross-lstng s an mportant omtted varable n the Desa and Dharmapala [2011] study, t s less obvous that t should be correlated wth ther varable of nterest. For any cross-lstng pror to the treaty date, for there to be a meanngful correlaton the treaty countres would have had to been chosen based on cross-lstng (or, by extenson, U.S. nvestment snce cross-lstng s the most mportant determnant of U.S. nvestment). More generally, a common trend n the relatve bas for treaty countres could nduce a postve correlaton between the cross-lst fracton and the tax polcy varable. So whle a pror we suspect 39 In unreported results from the frst stage regresson, the p-value from a test of the overdentfyng restrctons s 0.55, ndcatng that we cannot reject the null hypothess that the proposed nstruments are sutably exogenous. Instruments must be chosen for a partcular applcaton. In Table 8 our goal was to dentfy a parsmonous set of economcally mportant nstruments that s broad enough to be canddates for a range of studes. For the partcular applcaton n Table 9, a narrower set of three nstruments (tradng volume, natonal accountng qualty, and cvl law) better meet the crtera for good nstruments. For contnuty the results n Table 9 use all proposed nstruments from Table 8; usng 3 nstruments (nstead of the 5) has no perceptble mpact on the results. 40 If we use a sze-based dependent varable lke the raw unadjusted portfolo weghts, compared to specfcaton (1) the effect of FDI s reduced but stll sgnfcant and the effect of Cross-Lst Fracton wthout accountng for the endogenety s very strong. If we nstrument for the Cross-Lst Fracton, the magntude of the effect of cross-lstng ncreases and the effect of FDI s almost halved but remans statstcally sgnfcant. 36

39 that the correlaton between the 2003 JGTA polcy change and cross-lstng s muted, we cannot readly dsmss the potental for an omtted varable problem. We examne ths n specfcatons (4) (6) of Table 10. Agan, for the dependent varable we use a float-adjusted bas measure smlar to that n Bekaert, Segel and Wang [2012], rather than a sze-based measure. The varable of nterest n Desa and Dharmapala s an ndcator (PostJGTA) that equals one for the years after the 2003 enactment of JGTA for countres covered by the treaty. Column (4) s analogous to the baselne regresson n Desa and Dharmapala (ther Table 3, column 2). PostJGTA s hghly sgnfcant; U.S. nvestment ncreased (bas decreased) n countres covered by the treaty. In columns (5) and (6) we brng n the cross-lst fracton, frst as an exogenous ndependent varable, then as an endogenous one nstrumented as n Table 9. In both columns, the cross-lst fracton s hghly sgnfcant and negatve, as expected. The coeffcent on PostJGTA s stll negatve and sgnfcant when cross-lstng s ncluded suggestng that the varable s not hghly correlated wth cross-lstng but the magntude of the effect decreases by more than a thrd. 41 As noted above, our objectve here s not to overturn or weaken the results of Andrade and Chhaochhara [2010] or Desa and Dharmapala [2011]. Moreover, the effect of ncludng the cross-lst fracton depends on the relatonshp between ths potentally mportant omtted varable and any other proposed determnant of foregn nvestment. In both cases, t s lkely that another specfcaton could be found that re-establshes the strength of ther man results. ather, our objectve s merely to show how the nsghts from our work can be appled to the burgeonng lterature on country-level nternatonal nvestment. A varable measurng the fracton of a market 41 One dfference between our specfcaton and that n Desa and Dharmapala [2011] s that they nclude country fxed effects. Includng country fxed effects n our specfcaton (5) has no materal effect on the results. In our specfcaton (6), ncludng country fxed effects rules out the use of some nstruments and, not surprsngly, the nstrumented cross-lst fracton s nsgnfcant. 37

40 cross-lsted on U.S. exchanges should be ncluded as an explanatory varable, preferably as an endogenous regressor. Dong so mght render coeffcents on other varables of nterest nsgnfcant or decrease ther magntude, perhaps to be expected when an omtted varable bas s addressed. We vew the applcatons n the secton as llustratve. Future work should am to refne the modelng of the endogenety of cross-lstng. 7. Concluson Usng comprehensve survey data, we document that the aggregate foregn equty portfolo of all U.S.-resdent nvestors has devated sharply from market weghts. Cross-sectonal analyss of U.S. resdents nvestment choces ndcates that U.S. portfolo flows have tended to gravtate toward larger, more lqud, and more transparent frms. However, our selecton bas-corrected estmates ndcate that cross-lstng s by far the most mportant determnant of U.S. nvestment n foregn equtes. Non-cross-lsted foregn frms have roughly 3 percent U.S. ownershp. Crosslsted frms, even pror to the cross-lstng, have characterstcs that are attractve to U.S. nvestors; all of ther attractve (pre-cross-lstng) attrbutes result n an average of percent more U.S. nvestment. On top of that we estmate, usng varous technques, that a cross-lstng n the Unted States leads to an ncrease n U.S. holdngs of 8 to 11 percent of frm market captalzaton, doublng (or more) the amount pror to cross-lstng. By examnng the holdngs n frms that trade over the counter n the U.S. but are not cross-lsted on a U.S. exchange, we can rule out that tradng costs drve ths effect. ather, t appears that frms that become more nformatonally transparent followng the cross-lstng, partcularly those frms wth poor accountng practces pror to lstng n the Unted States, experence the largest ncrease n U.S. nvestment. Our results present a clear challenge for future research on nternatonal nvestment. Cross- 38

41 lstng, whch we fnd to be the most mportant factor behnd U.S. nternatonal equty nvestment, must be consdered n any analyss. Moreover, gven that cross-lstng s a decson often made by otherwse attractve foregn frms, econometrc technques must be used that can approprately deal wth ssues of selecton bas. To llustrate ths pont, we show how to apply the lessons of frm-level nvestment to country-level studes and fnd that results are senstve both to accountng for cross-lstng as well as for estmatng the effect n an econometrcally approprate way. In addton to addressng the mportant effect of cross-lstng, any study at the country level must employ a measure of nvestment that s both float-adjusted and free from any sze bas. But emphaszng that selecton bas requres careful econometrc modelng also has mplcatons that reach far outsde the lterature on nternatonal nvestment. For example, the corporate fnance lterature on the valuaton mpact of cross-lstng has yet to fully deal wth selecton bas. 42 Our hope s that ths paper can spark nnovatons n that lterature as well. 42 See the debate that began wth Dodge, Karoly, and Stulz [2004] and has contnued through Gozz, Levne, and Schmukler [2008] and Sarkssan and Schll [2010], among others. 39

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47 Table 1: Sample Count by Country, December 31, 1997 The table shows the number of frms by country for the 12,221 non-u.s. stocks n our end-1997 sample. Country Number of Frms Country Number of Frms Argentna 41 Korea 313 Australa 284 Luxembourg 22 Austra 106 Malaysa 442 Belgum 134 Mexco 84 Brazl 149 Netherlands 181 Canada 503 New Zealand 49 Chle 92 Norway 184 Chna 111 Pakstan 78 Colomba 28 Peru 28 Czech epublc 60 Phlppnes 111 Denmark 207 Poland 45 Fnland 113 Portugal 97 France 772 ussa 20 Germany 655 Sngapore 220 Greece 139 South Afrca 206 Hong Kong 373 Span 151 Hungary 22 Sweden 242 Inda 248 Swtzerland 201 Indonesa 149 Tawan 234 Ireland 67 Thaland 277 Israel 55 Turkey 79 Italy 204 Unted Kngdom 2,029 Japan 2,402 Venezuela 14 Total 12,221 45

48 Table 2: Dstrbuton of Frm-Level U.S. Holdngs The table reports frm-level U.S. holdngs scaled by market captalzaton and float as of December 31, 1997 for our sample of frms. Data on the value of U.S. holdngs are from the U.S. Treasury/Federal eserve Board survey of U.S. holdngs of foregn securtes. Market captalzaton fgures are from Datastream, MSCI, and Worldscope. We calculate market float by scalng market captalzaton down by the fgure gven n Worldscope s closely held share feld. U.S. holdngs / Market Captalzaton U.S. holdngs / Market Float Mean 3.5% 6.3% Percentles: 0% 0.0% 0.0% 25% 0.0% 0.0% 50% 0.4% 1.2% 75% 3.9% 7.8% 90% 10.7% 19.1% 95% 16.7% 29.5% Number of frms 12,221 8,528 46

49 Table 3: Dstrbuton of Frm-Level U.S. Holdngs Splt by Cross-Lstng Status The table reports frm-level U.S. holdngs scaled by market captalzaton and float as of December 31, 1997 for our samples of cross-lsted and non cross-lsted frms. Data on the value of U.S. holdngs are from the U.S. Treasury/Federal eserve Board survey of U.S. holdngs of foregn securtes. Market captalzaton fgures are from Datastream, MSCI, and Worldscope. We calculate market float by scalng market captalzaton down by the fgure gven n Worldscope s closely held share feld. We classfy a non-u.s. frm as cross-lsted f ts shares are lsted on the NYSE, AMEX, or NASDAQ. U.S. holdngs / Market Captalzaton U.S. holdngs / Market Float Frms that are: NOT COSS- LISTED COSS- LISTED NOT COSS- LISTED COSS- LISTED Mean 2.9% 17.5% 5.6% 26.3% Percentles: 0% 0.0% 0.0% 0.0% 0.2% 25% 0.0% 7.2% 0.0% 11.4% 50% 0.3% 13.6% 1.0% 20.2% 75% 3.3% 24.2% 6.8% 36.7% 90% 9.1% 36.4% 17.2% 51.6% 95% 14.2% 43.6% 25.7% 68.8% Memo: Value-Weghted Mean 6.6% 15.4% 10.2% 19.8% Number of frms 11, ,

50 Table 4: Jontly Estmated Determnants of U.S. Investment and Frms Cross-lstng Decson The table reports estmates of a smultaneous system that ncludes a probt specfcaton of a frm s decson to cross-lst and two equatons that determne the holdngs share of U.S. nvestors (scaled by market float) one reflectng holdngs condtonal on not cross-lstng on a U.S. exchange as of December 31, 1997, and one reflectng addtonal holdngs n cross-lsted frms. The reported fgures are scaled to reflect the medan (over the frms n the sample) margnal mpact of a unt change n the varable n queston, on ether the probablty of cross-lstng (n percent) or on U.S. holdng (n percent). E[Gan n U.S. Holdngs Share] from Cross-Lstng s the endogenously estmated forecast of the change n holdngs that would resultng from cross-lstng for a gven frm and E[U.S. Holdngs Share] wthout Cross-Lstng s an analogously defned estmate of what U.S. holdngs would be f a frm dd not cross-lst. The other varables are defned n Appendx A. P-values correspondng to a null hypothess of a zero medan mpact appear n parentheses below each reported coeffcent estmate. 48

51 Table 4 (cont.): Jontly Estmated Determnants of U.S. Investment and Frms Cross-lstng Decson Percentage-pont mpact of: E[Gan n U.S. Holdngs (%) Share] from Cross-Lstng E[U.S. Holdngs (%) Share] wthout Cross-Lstng Cross-Lstng Probablty (0.494) (0.129) U.S. Holdngs / Market Float: If Not Cross-Lsted If Cross-Lsted Selectvty correcton (0.000) (0.356) Proporton of Share Held by Insders (%) (0.058) Tradng volume (0.000) Ln(Assets) mnus Industry Average of Ln(Assets) (0.000) (0.000) (0.746) Average Industry Market Cap (0.000) (0.000) (0.840) Natonal accountng qualty (0.001) (0.003) (0.445) Frm-level accountng qualty (0.000) (0.602) Shareholders ant-drector rghts (0.001) (0.985) Dvdend wthholdng tax rate (%) (0.000) (0.707) Industry-level mported share of U.S. supply (%) (0.003) (0.009) (0.311) Dummy varables: MSCI member (0.000) (0.000) Dvdend-payng frm (0.000) (0.678) Canadan frm (0.000) (0.000) (0.612) Cvl law (0.004) Number of observatons 8,086 7,

52 Table 5: Average Cross-Lstng Effect for Cross-Lsted Stocks The table reports estmates of the average cross-lstng effect usng three alternatve treatment estmators. The Heckman-based estmates (rows 2 and 3 of Panel A) are based on ftted holdngs from the non crosslsted holdngs equaton (4) usng data on the cross-lsted frms. Parameter estmates for these equatons appear n the mddle column of Table 4. The p-matchng estmates (rows 4 and 5) are U.S. holdngs of a sample of non cross-lsted frms that have been pared wth the cross-lsted sample on the bass of ftted probabltes from a reduced-form probt model of the cross-lstng decson. Panel B presents dfferencen-dfferences estmates usng data on U.S. holdngs for March 31, 1994 and December 31, The sample n Panel B s restrcted to stocks that were not cross-lsted n U.S. markets n the earler perod, wth the columns dstngushng between stocks that cross-lsted before the second perod and those that dd not. Standard errors are shown n parentheses. Panel A: Heckman-based and P-Matchng Methods 1. Mean holdngs of cross-lsted stocks, L E( H X 1) U.S. nvestors aggregate holdngs as percentage of: Market Cap Market Float Heckman-based estmate of E(H L X 0) Heckman-based estmate of cross-lstng effect, L L E( H X 1) E( H X 0) 10.6 (0.8) 13.4 (1.3) 4. P-matchng estmate of E(H L X 0) P-Matchng estmate of cross-lstng effect, L L E( H X 1) E( H X 0) 11.2 (0.8) 17.7 (1.3) Panel B: Dfference-n-Dfferences Stocks Cross-lsted on U.S. Stocks not Cross-lsted on U.S. for U.S. holdngs / market cap exchange by December 1997 exchange by December Holdngs: March 31, Holdngs: December 31, Change n holdngs ( ) Dfference-n-dfferences estmate of cross-lstng effect L L E( H X 1) E( H X 0) 7.9 (0.5) 10. Number of Observatons

53 Table 6: Summary Statstcs for Holdngs n AD Form and of Level I ADs The table reports addtonal nformaton. For cross-lsted frms, t reports the amount of U.S. holdngs n the actual AD (as opposed to the underlyng foregn equty). For Level I ADS, whch trade only on overthe-counter markets and are not consdered to be cross-lsted on a U.S. exchange, t reports the amounts held by U.S. nvestors, as well as the portons held n AD form and n the underlyng foregn equty. For comparson, the table ncludes data on non-cross-lsted frms as well. For further detals, see notes to Tables 2 and 3. Frm Market Captalzaton Avalable (46 countres) Frm Market Float Avalable (46 countres) Frms Cross-Lsted on a U.S. Exchange Average share held by U.S. nvestors 17.5% 26.3% Average share held n D form 6.4% 12.4% Average share held n underlyng equty 11.1% 13.9% Frms wth Level 1 or ule 144a ADs Average share held by U.S. nvestors 8.9% 15.1% Average share held n D form 1.8% 2.9% Average share held n underlyng equty 7.1% 12.2% Frms wth no vehcle for U.S. tradng 11,066 7,767 Average share held by U.S. nvestors 2.6% 5.1% 51

54 Table 7: Estmated Average Impact of Level 1 or ule 144a ADs on U.S. Investment The table reports estmates of the average effect of Level 1 or ule 144a ADs on the share of market float held by U.S. nvestors, usng p-matchng to correct for selecton bas. The mddle row shows U.S. holdngs of a sample of frms (drawn from those wthout a vehcle for U.S. tradng) that have been pared wth the Level 1 / ule 144a sample on the bass of the ftted probablty (of a Level 1 or ule 144a AD program) from a frst-stage probt model that uses the nstruments lsted n Table 4. The standard error s shown n parentheses. U.S. nvestors aggregate holdngs as percentage of market float Mean holdngs n Level 1 and ule 144a AD frms (443 frms) P-matchng estmate of what holdngs would have been wthout a Level 1 or ule 144a AD program P-Matchng estmate of Level 1 / ule 144a effect 5.2 (0.9) 52

55 Table 8: Determnants of the Cross-Lstng Effect on the U.S. Holdngs Share The table reports coeffcent estmates from a regresson of the change n U.S. holdngs (as a percentage of market captalzaton) between March 31, 1994 and December 31, 1997 on a cross-lstng dummy nteracted wth 1994 values of the nstruments lsted n the table. The sample s restrcted to stocks that were not cross-lsted n U.S. markets n the earler perod. A dummy varable for cross-lstng between 1994 and 1997, frst-perod values of the nstruments, and changes n the nstruments (between the frst and second perod) are ncluded as control varables n both equatons. P-values (for a null hypothess of a zero coeffcent) are shown n parentheses. cross-lstng dummy nteracted wth: (1) (2) Ln(Assets) mnus Industry Average of Ln(Assets) (0.001) (0.000) Average Industry Market Cap (0.933) (0.256) Frm-level accountng qualty ndex (0.003) Dvdend-payng frm dummy (0.186) MSCI member dummy (0.391) (0.030) Natonal accountng qualty ndex (0.000) Shareholder rghts ndex (0.388) (0.003) Industry-level mported share of U.S. supply (%) (0.185) (0.144) Canadan frm dummy (0.002) (0.000) Number Not Cross-Lsted 7,311 7,722 Number Cross-Lsted Adjusted -squared

56 Table 9: Country-Level Cross-Lstng Determnants The table reports results from panel regressons usng annual data from 2001 to 2009 for thrty-fve countres. Dependent varables are cross-lst fracton (the fracton of foregn market captalzaton crosslsted on a U.S. exchange) and a float-adjusted bas measure (bas float, adapted from Bekaert, Segel and Wang [2012], and defned n Eq. (11)). A decrease n bas float s equvalent to an ncrease n a country s weght n U.S. portfolos relatve to ts weght n the world float portfolo. Year tme dummes are ncluded n every specfcaton. Standard errors are clustered by destnaton countres and are robust to heteroskedastcty. P-values are n parentheses. Dependent Varable: Cross-Lst Bas Float Fracton Cross-Lst Fracton (0.000) (0.000) Tradng volume (0.307) (0.158) Natonal accountng qualty (0.058) (0.802) Cvl law (0.015) (0.740) Economc proxmty (0.000) (0.921) Log GDP per Capta (0.490) (0.570) N

57 Table 10: Applcatons of Cross-Lst Fracton to Country-Level Studes The table reports results from panel regressons of the bas float measure of U.S. nternatonal equty nvestment. Bas float, adapted from Bekaert, Segel and Wang [2012], s defned n Eq. (10). Thrty-fve countres from 2001 to 2009 are ncluded n specfcatons (1)-(3); thrty-seven countres for 1994, 1997, 2001, 2003, 2004, and 2005 are ncluded n specfcatons (4)-(6). Cross-lst fracton s the fracton of the foregn market captalzaton that s cross-lsted on a U.S. exchange. TreatyPostJGTA s an nteracton between and ndcator varable (Treaty) for countres lsted n Desa and Dharmapala [2011] and an ndcator (PostJGTA) for the years after the enactment of JGTA n The samples n specfcatons (4)-(6) ends n 2005 because, as noted by Desa and Dharmapala [2011], the treaty countres changed n Year tme dummes are ncluded n every specfcaton. Standard errors are clustered by destnaton countres and are robust to heteroskedastcty. P-values are n parentheses. OLS OLS IV OLS OLS IV (1) (2) (3) (4) (5) (6) Cross-Lst Fracton (0.000) (0.012) (0.000) (0.000) FDI (0.067) (0.544) (0.489) World Market Float (0.072) (0.278) (0.376) (0.817) (0.011) (0.0055) Stock eturn Volatlty (0.246) (0.849) (0.924) TreatyPostJGTA (0.001) (0.066) (0.096) N

58 Fgure 1: Sze and Measures of U.S. Internatonal Equty Investment The fgure shows the relatonshp between float-adjusted sze and two measures of U.S. nternatonal equty nvestment n The top graph uses a float-adjusted rato measure of home bas, as n equaton (11) smlar to that n Bekaert, Segel and Wang [2012]. The bottom graph uses a float-adjusted dfference measure of home bas, as n the numerator of equaton (11). Other sze-based measures of U.S. nvestment, such as the dollar amount, log dollar amount, or portfolo share, would be smlar to the bottom graph; other measures wthout sze bases, such as U.S. nvestment as a percentage of destnaton float, would resemble the top graph. Bas Float ato and Sze Basfloat ato COA MY PK PH T G ZA BE VE CLIN PE AT TH PT DK SE ID K NZ NO B FI IL SG HK ESIT AU NL DE CH CA F JP UK MX Sze Bas Float Dfference and Sze Basfloat Dfference F DE CA CH HK AU ES IT NL A BE CO AT CL G DK K SE MY B IN FI PK PEPH VE NZ TH IDIL NO T PT SG MX Sze JP UK 56

59 Appendx A: Varables and Instruments Varable Defnton Included n: Frm-level varables Assets relatve to ndustry average Proporton of shares held by nsders (%) MSCI ndex member Dvdend-payng frm Frm-level accountng qualty Natural logarthm of the 1997 book value of a frm s assets from Worldscope mnus the average for frms n the same Worldscope Major Industry, ncluded as the wthnndustry part of our measure of frm sze. Worldscope s 1997 value for the number of closely held shares as a percentage of common shares outstandng, adjusted to remove those stakes mstakenly counted as nsder ownershp by Worldscope. These nclude holdngs by the Bank of New York, Morgan Guarantee Trust, and Ctbank, because these shares are holdngs for AD programs, and the New Zealand Central Securtes Depostory. Dummy varable equal to one when a frm s ncluded as a member of the MSCI Allcountry World ndex at the end of Dummy varable equal to one when a frm pays a dvdend n 1997, as reported by Worldscope. Index rangng from zero to four, calculated usng crtera from Aggarwal, Klapper, and Wysock [2005]. Four components takes a value of one f the frm (1) used a BgSx audtor, (2) receved a clean audt report, (3) used nternatonal accountng standards or U.S. GAAP, and (4) reported consoldated statements. The ndex s the sum of the four components. X Z, X Z H Z H Z H Z H Z 57

60 Appendx A (contnued): Varables and Instruments. Varable Defnton Included n: Industry-level varables Industry-average market cap Industry-level mported share of U.S. supply (percent) Average natural logarthm of frms 1997 market caps for all frms n a gven Worldscope Major Industry, ncluded as the across-ndustry part of our measure of frm sze.. Matched by 2- and 4-dgt SIC code to 1992 data from the Bureau of the Census and the Bureau of Economc Analyss, ncluded as a measure of economc proxmty of the frm to U.S. markets. X Z, X Z, H Z H Z Country-level varables Tradng volume Home-country tradng value/gdp(%) dollar volume of tradng n the home market of a frm, normalzed by the dollar value of the country s 1997 gross domestc product (GDP). The volume data are obtaned from the Internatonal Fnance Corporaton [1998] and the GDP fgures are collected from the Internatonal Monetary Fund s Internatonal Fnancal Statstcs. X Z Tax ate Canadan frm Cvl law Home-country dvdend wthholdng tax rate faced by U.S. nvestors. For countres mantanng a blateral tax treaty wth the Unted States, we use the treaty tax rate, as reported n the IS publcaton 901, U.S. Tax Treates. For countres wth no U.S. tax treaty, we calculate dvdend wthholdng rates from 1997 gross and net dvdend payments to holders of ADs, as reported n Bloomberg s Corporate Acton Calendar. Dummy varable set equal to one for Canadan frms. Dummy varable set to one for frms from countres usng a cvl law system. H Z X Z, X Z H Z 58

61 Appendx A (contnued): Varables and Instruments. Varable Defnton Included n: Natonal accountng qualty ndex Shareholder rghts ndex Values for 1995 reported by Bushman, Potrosk, and Smth [2004]. Compled by the Center for Fnancal Analyss and esearch, 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. Calculated by La Porta, Lopez-de-Slanes, Shlefer, and Vshny [1998]. Index takes on a value between 0 and 6 dependng on how many of the followng apples to a country s equty market: percentage of outstandng shares requred to call an extraordnary meetng less than or equal to 10 percent, cumulatve votng or proportonal representaton of mnorty nterests on board, votng by mal permtted, mechansms n place for oppressed mnorty nvestors, preemptve rght that can only be waved by a shareholder vote, and protecton of shareholders from requrements that shares be deposted before a shareholder meetng. X Z, H Z H Z 59

62 Table A1: Instrument Sample Statstcs Non-Cross-Lsted Frms Cross-Lsted Frms Mn Mean Medan Max Mn Mean Medan Max Share Held by Insders (%) Tradng volume (% of GDP) Ln(Assets) mnus Industry Average Ln(Average Industry Market Cap) Natonal accountng qualty Frm-level accountng qualty Shareholders ant-drector rghts Dvdend wthholdng tax rate (%) Industry-level mported share (%) MSCI member (dummy) Dvdend-payng frm (dummy) Canadan frm (dummy) Cvl law (dummy)

63 Appendx B: Estmatng the Structural Model Lee [1978] proposes a mult-stage method for consstently estmatng a system lke ours n whch a frst-stage, reduced-form probt generates Heckman [1979]-type correcton terms for the holdngs equatons. The corrected second-stage estmaton of the holdngs equatons produces consstent estmates of the relaton between the nstruments and holdngs, and makes t possble to calculate ftted holdngs values as a functon of the nstruments. The fnal stage of estmaton nvolves usng the ftted holdngs for estmaton of the structural probt n equaton (7). To facltate mplementaton of the Lee [1978] estmaton framework, we assume that the jont X L U statstcal dstrbuton of the resduals n the lstng equaton ( ) and the two holdngs equatons (, ) are jontly normally dstrbuted, X L U (,, ) ~ N(0, ), (B-1) where Ω s a 3 x 3 varance covarance matrx. Lee [1978] has shown that mult-stage estmaton wll produce estmates of structural parameters that are consstent n the presence of selecton bas. L One advantage of ths framework s that although we only observe H for frms that have a U.S. lstng and H U for frms that do not, we can use our parameter estmates to make nferences about what U.S. holdngs of a frm s stock would have been had the frm made the counterfactual choce about whether to cross-lst. Furthermore, we can generate estmates of the cross-lstng effect.e., the mpact of crosslstng on U.S. holdngs ( H L U - H ) ether uncondtonally or condtonal on specfc frm characterstcs. In the frst stage of the Lee [1978] methodology, the two holdngs equatons are substtuted nto the lstng probt to form a reduced-form lstng equaton that can be estmated on a stand-alone bass by numercal maxmum lkelhood. The set of ndependent varables (Z ) for the frst-stage reduced-form probt specfcaton conssts of all of the nstruments n the structural equatons for lstng and holdngs: X Z Z Z H. (B-2) We can wrte the frst-stage equaton as where X * Z, (B-3) U X L 0 Z 0 1. (B-4) The estmates from the probt model emboded n equatons (B-2), (B-3), and (B-4) can be used to construct the selectvty-bas correcton n the holdngs-equatons resduals (ε L and ε U ). It can be shown that for lsted frms (X * = 0), L * X L ( Z ) E( X 0) cov(, ), (B-5) ( Z ) where the varance of ε X has been normalzed to one and ф and Ф denote the probablty densty functon and cumulatve densty functon, respectvely, of the standard normal dstrbuton. The rato 61

64 ( ( Z Z ) ) (B-6) s often referred to as the nverse Mlls rato. Estmates of the rato form 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]). Intutvely, the nverse Mlls rato accounts for the unobserved correlaton between the lstng decson and holdngs. There s also a smlar, but less frequently used correcton for selectvty bas for the non-selected observatons, U * X U ( Z ) E( X 0) cov(, ). (B-7) 1 ( Z ) The second stage of the Lee procedure nvolves estmatng the holdngs equatons by ordnary least squares by rewrtng them as and H H ( Z ) Z ( Z ) L H L L L L ( Z ) Z. 1 ( Z ) U H U U U U (B-8) (B-9) X k L * U * Note that k cov(, ) for k = L, U and E( X 0) E( X 0) 0. We use our frst-stage estmates of the parameters α and β to construct the selectvty varables, and then substtute these varables nto equatons (B-8) and (B-9). The coeffcent assocated wth the selectvty adjustment provdes an estmate of the unobserved covarance between the lstng decson and each of the holdng equatons. The fnal stage of the Lee procedure nvolves usng the consstent estmates of α L, α U, β L, and β U from (B-8) and (B-9) to construct ftted values usng the orgnal holdngs equatons. The ftted holdngs are nserted back nto the structural lstng decson equaton, whch s then estmated as a probt model va numercal lkelhood maxmzaton. As noted by Lee [1978], t s possble to construct consstent standard errors for the holdngs equatons after makng a correcton for heteroscedastcty assocated wth the selectvty terms. Because the estmated parameters of the model are dffcult to nterpret, we rescale the estmates to show the margnal effect of a one-unt change n the nstrument on the percentage pont probablty of cross-lstng, specfcally the medan effect over the frms n the sample. 62