The Cost of Listing Overseas

GE, Weili | MATSUMOTO, Dawn | 汪京 | ZHANG, Jenny Li

Listing on a U.S. stock exchange can be good for business, but U.S.-listed foreign firms pay a big price for deliberately misleading investors, according to a 2020 study by Ge, Matsumoto, Wang, and Zhang. . The authors compared the responses of U.S. stock markets to accounting irregularities—intentionally misstated financial information—disclosed by U.S.-based and foreign firms. Why, they asked, do investors tend to impose higher penalties on foreign firms that commit accounting fraud?

“Foreign firms represent a non-trivial group of firms on U.S. exchanges,” the researchers tell us. Indeed, 17 percent of all U.S.-listed firms are based overseas. Although such firms are subject to the same regulatory requirements as their U.S.-based peers, they have “unique incentives and information risks” arising from their different home country environments. “It is thus an empirical question,” say the researchers, “whether these firms suffer similar, or perhaps greater, market penalties to accounting irregularities.”

All firms listed in the U.S., whether based at home or overseas, are required to promptly correct and restate financial statements found to contain material errors. Such restatements may cast doubt on the quality and credibility of firms’ financial reporting, eliciting negative reactions from investors. This problem is particularly serious for firms listed overseas, because U.S. investors are less familiar with and have fewer alternative information sources about foreign firms than their U.S.-based peers. “Thus,” the researchers explain, “the quality of a foreign firm’s financial statements is likely to be of greater importance to U.S. investors.”

To test this hypothesis, the researchers analyzed U.S.-based and foreign firms listed on three major U.S. exchanges, the NYSE, NASDAQ, and AMEX, from 2001 to 2016. They focused on accounting irregularities, which are “more egregious than simple accounting errors” and thus raise particular concern among investors. In response to such irregularities, the stock prices of foreign firms decreased by 5.5% in the short term, compared with only 3% for U.S. firms, after carefully controlling for the severity of accounting irregularities and other firm characteristics. The researchers concluded that “the stock market penalizes foreign firms more than U.S. firms for irregularities.”

The next step was to determine why foreign firms that commit accounting fraud reap more severe consequences than their U.S. peers. Interestingly,  “We do not find that market reactions vary with proxies for country-level institutional features that might be thought to increase information risk,” the authors report. Nevertheless, investors’ familiarity with individual firms mitigates the market penalty. These findings suggest that there are limits to foreign firms bonding themselves to the relatively rigorous U.S. legal system by oversea listing. The mere act of listing in the U.S. does not mean that the U.S. investors would perceive foreign firms as credible as domestic firms. It pays off for foreign firms to develop reputational capital through creditable financial reporting over time. This innovative study offers important insights into investors’ perceptions of the quality and credibility of firms’ financial reporting. The findings have implications for all stakeholders in the market—from investors analyzing financial statements to firms seeking to increase their valuation by reducing their information risk in the global financial market.