Lemon Signaling in Cross-Listing
University of Virginia School of Law
March 8, 2012
Virginia Law and Economics Research Paper No. 2012-03
Despite significant premium associated with cross-listing on U.S. exchanges many firms remain in their local markets or list on exchanges with weaker legal commitments.
This paper develops a signaling model that helps in explaining controlling shareholders unique reluctance to bond. If constraints on private benefits vary across firms, by cross-listing and bonding controlling shareholders signal that they can extract only a limited amount of private benefits, a signal that adversely affects their control premium. As a result controlling shareholders propensity to cross-list is lower than it would have been if only bonding were at play; the control premium and the value of the control block of controlling shareholders that do not cross-list increases upon cross-listing by peers. In contrast to controlling shareholders this signal encourages managers to cross-list. This result explains why inclination to cross-list is inversely related to control block size.
The model helps in explaining other evidence - why the price reaction to cross-listing is strong though bonding is limited; cross-listing premia disappear over time; controlling-shareholders that cross-list have lower control premia; and cross-listing adversely affects non-cross-listed firms.
The model suggests that firms with controlling shareholders have a unique dislike for regulation. Thus the implications of their behavior for the desirability of US regulation are limited.
The result that controlling shareholders’ incentives sharply differ from managers’ could have implications to other decisions that corporations make such as distributing dividends, and raising capital.
Number of Pages in PDF File: 43
Keywords: Controlling Shareholders, Control Premium, Cross-Listing, Private Benefits, Signaling
JEL Classification: G15, G30, G32, G34, K00, K22, P51
Date posted: October 18, 2007 ; Last revised: March 14, 2012