Determinants of Liquidity (Re)Allocation and the Decision to Cross‐List or Cross‐Delist

• Published date: 01 October 2016
• Author: Roland Füss,Ulrich Hommel,Jan‐Carl Plagge
• Date: 01 October 2016
• DOI: http://doi.org/10.1002/ijfe.1555

DETERMINANTS OF LIQUIDITY (RE)ALLOCATION AND THE DECISION

TO CROSS-LIST OR CROSS-DELIST

ROLAND FÜSS

1,2,

*, ULRICH HOMMEL

3

and JAN-CARL PLAGGE

3

1

Swiss Institute of Banking and Finance (s/bf), University of St. Gallen, Rosenbergstrasse 52, CH-9000 St. Gallen, Switzerland

2

ZEW, Mannheim, Germany

3

Department of Finance and Accounting, EBS Business School, EBS Universität für Wirtschaftund Recht, Gustav-Stresemann-Ring 3, D-65189

Wiesbaden, Germany

ABSTRACT

This paper examines the factors influencing the liquidity allocation between local and foreign dual listings. Based on a compre-

hensive data set covering the period between 2001 and 2011, empirical results suggest that the fraction of trading in the foreign

listing decreases with a higher degree of stock market integration measured as the stock price correlation with the world market.

Furthermore, the analysis of individual cross-listings reveals that both an improvement of a country’s state of economic devel-

opment and a better regulatory environment significantly affect the allocation of trading. While an improvement in economic

development increases both local and foreign liquidity, a strengthening of regulatory standards leads to a decrease in trading

volumes at foreign exchanges. Finally, the liquidity share in the foreign listing is found to decrease over time, a trend that turns

out to be driven by developing rather than by developed markets. Copyright © 2016 John Wiley & Sons, Ltd.

Received 03 July 2014; Revised 17 March 2016; Accepted 12 April 2016

JEL CODE: G12; G15

KEY WORDS: Cross-listing; capital market regulation; economic development; liquidity allocation; market integration

1. INTRODUCTION

Many companies around the world have started to cross-list their shares in the form of depository receipts (DRs) on

well-known international stock exchanges in order to improve access to integrated capital markets.

1

Typical cross-

listing motives are higher liquidity, more investor recognition and a decrease in the cost of capital. In recent years,

however, some corporations have decided to reverse this move and terminate their dual listing. The most often-

cited reasons are broadly related to the development of the DR’s liquidity. While some companies decide to

terminate their dual listing due to poor liquidity development, others fear that the foreign listing might become

too successful, which in turn could lead to a reallocation of liquidity away from the home market and consequently

to a decrease in local visibility.

2

Our analysis aims at identifying the factors that explain liquidity shifts between home and foreign stock mar-

kets.

3

Rising DR liquidity can be taken as an indicator of a foreign listing’s success because of an increased use

of secondary listings by market participants. In contrast, if liquidity remains at a low level or even dries up over

time, it can be interpreted as a sign of investor’s lack of interest.

The literature points to two major determinants of the liquidity allocation in cross-listed stocks: capital market

segmentation and liquidity concentration. Market segmentation seems to always work in favour of the DR pro-

gramme because international investors can more easily invest via a foreign listing.

4

However, the impact of liquid-

ity concentration is less clear. One would expect that, in the absence of extreme differences in trading and

*Correspondence to: Roland Füss, Swiss Institute of Banking and Finance (s/bf), University of St. Gallen, Rosenbergstrasse 52, CH-9000, St.

Gallen, Switzerland and ZEW, Mannheim, Germany.

E-mail: roland.fuess@unisg.ch

Copyright © 2016 John Wiley & Sons, Ltd.

International Journal of Finance & Economics

Int. J. Fin. Econ. 21: 447–471 (2016)

Published online 6 June 2016 in Wiley Online Library

(wileyonlinelibrary.com). DOI: 10.1002/ijfe.1555

transaction costs, liquidity will tend to concentrate on one exchange, either local or the foreign.

5

The development

of the local capital market would then play a key role in determining the direction of liquidity concentration.

This paper is the first to simultaneously measure and explicitly disentangle the effects stemming from (1) the

stage of economic development, (2) the regulatory environment, (3) the development of the local capital market,

and (4) the degree of integration of a company’s local market into the international capital market. While related

studies, such as Halling et al. (2008), primarily focus on the relationship between foreign and local liquidity, this

paper additionally considers the liquidity reactions of both foreign and local liquidity separately.

6

The empirical results show that the fraction of trading in the foreign listing decreases with a higher degree of

stock market integration, which is defined in this study as the stock price correlation with the world market. The

analysis of individual cross-listings further reveals that both an improvement of a country’s economic development

and a better regulatory environment affect the allocation of trade. While an increase in economic development pri-

marily increases both local and foreign liquidity, an improvement in regulatory standards leads to a decrease in for-

eign trading. In addition, the ratio of foreign to local liquidity, measured relative to the initial cross-listing date,

decreases over time. A closer inspection of the liquidity development in foreign and local markets reveals that

the relative liquidity (re)allocation is primarily shaped by the decrease in foreign liquidity of firms domiciled in

emerging markets. Splitting the sample into firms domiciled in developed, emerging and frontier markets shows

that the decrease in foreign liquidity is, in turn, driven by cross-listings of companies domiciled in emerging mar-

kets. As liquidity across the entire sample is more highly concentrated in the local rather than the foreign listing, the

trend of a liquidity reallocation towards the local listing is in line with the concentration hypothesis. It states that

trading tends to agglomerate on the exchange that offers relative informational advantages for traders. This is typ-

ically the local exchange, where information density is presumably the highest.

The identification of the underlying factors driving the liquidity allocation between local and foreign listings is

of essential importance for companies that face a choice of whether to cross-list in a foreign market. As pointed out

by Amihud et al. (2005), illiquidity in the form of transaction costs has a direct influence on firm value. According

to their reasoning, the price discount due to illiquidity equals the present value of the expected stream of transaction

costs throughout the lifetime of an investment. The higher these costs are, the higher are also the future expected

returns and the lower is the present value of a company. Chordia et al. (2000) find a positive relationship between

transaction costs and trading volume. Thus, liquidity as an indirect proxy for transaction costs has a direct influence

on share prices and, in turn, on the value of a cross-listed company. The findings are also of interest for financial

institutions such as ETF providers, which offer products based on DRs. As our analysis suggests, the derived ben-

efits are only of a transitory nature given that the liquidity in the foreign listing tends to decrease over time. Finally,

Chan et al. (2008) find that foreign listings are traded at a premium over the underlying stock, which increases (de-

creases) depending on the liquidity of the foreign (local) listing. Thus, market participants are willing to pay a price

for liquidity. The results of our study enable companies to better anticipate such a potential premium ex ante.

The rest of the paper is structured as follows: The next section presents the various rationales explaining why

companies may decide to cross-list their shares in a foreign market and why a substantial number of companies

have recently decided to terminate their cross-listing. Section 3 derives the testable hypotheses based on the general

discussion of the determinants of liquidity allocation. Section 4 describes the data and the estimation approach. The

empirical results, including several robustness tests, are presented and interpreted in Section 5. Section 6 concludes.

2. MOTIVES FOR LISTING AND DELISTING DEPOSITORY RECEIPTS

2.1. Reasons to cross-list

A considerable number of theories have been developed to explain why companies decide to cross-list their

shares. The majority of them can be traced back to a few underlying hypotheses:

2.1.1. Market segmentation hypothesis

Bekaert and Harvey (1995) argue that ‘markets are completely integrated if assets with the same risk have iden-

tical expected returns irrespective of the market.

7

[…] If the market is segmented from the rest of the world, its

ROLAND FÜSS ET AL.448

Copyright © 2016 John Wiley & Sons, Ltd. Int. J. Fin. Econ. 21: 447–471 (2016)

DOI: 10.1002/ijfe