We are planning to list our fast-growing Israel-based software firm soon. We estimated that being listed in Frankfurt costs about $5 million a year less than being on Nasdaq. What are the costs and benefits of each stock market?

Your question is very relevant in today’s market. In the past, foreign companies preferred the US market to other markets. Marco Pagano, Ailsa A. Röell, and Josef Zechner, in their paper “The Geography of Equity Listing: Why Do Companies List Abroad?” (Journal of Finance, 57 (6), December) point out that during the 90s the number of foreign companies listed on the NYSE increased from 100 to almost 400. This trend has been interrupted in recent years. Not only foreign companies have started preferring other exchanges, but for the first time US companies have chosen to list in foreign exchanges in recent years.

While I cannot give an answer specific to your company, as costs and benefits are company-specific, I can list the benefits and costs that one would want to analyze in choosing one market over the other.

Benefits:
1) Higher liquidity of one market over the other (this can be measured by percentage spread). Generally speaking (again some of these evaluations are company-specific), the NYSE remains the most liquid market in the world. Some recent evidence, however, shows that markets in developed countries have caught up with NYSE (see, Halling, M., M. Pagano, O. Randl, and J. Zechner, 2006, “Where is the Market? Evidence from Crosslistings in the U.S.” University of Vienna working paper) and the gap between NYSE and other markets have been reduced recently.
2) Higher visibility of one market over the other. If we measure visibility with number of analysts following a company, the evidence points out that the number of analysts following a stock has decreased in the US market over the recent years, but the number is still substantially higher in the US.
3) Better valuation attained in one market over the other. The argument here is based on the idea that if there is more expertise in a given country (e.g. ability of a stock analyst to understand the business of your company) that improves the valuation of the company.
4) Commitment to better governance practices. This argument is very difficult to evaluate. The idea is that if you are from a country with worse governance practice, the market will take that into account in pricing the company resulting in a lower price at IPO and subsequently. However, if you decide to list in an exchange where there are better governance practices, you can signal to the market your commitment to good practices and obtain capital at a lower cost. Estimates for this effect have been calculated for the average firm listing in the US at the end of the 1990s. Hail and Leuz (“Cost of Capital Effects of U.S. Cross-Listings” University of Chicago working paper, 2006) find that cross listing in a U.S. exchange reduces the cost of capital by 70 to 110 basis points. According to this estimates a company with a $300M in market capitalization would save $2.7M a year in capital cost by listing in the United States. Some authors claim that it is hard to measure the costs from too strict governance practices and that in recent years the US regulators may have done too much in this respect. The evidence however points in an interesting direction relatively to your specific question. If one measures how the premia changed by country of origin between before SOX and after SOX, the premia of the US market has gone down relatively to markets with good corporate governance, for the US vs. Germany market the premia has gone down by 46 basis points (see the paper by Luigi Zingales, “Is the U.S. Capital Market Losing Its Competitive Edge?”).
5) Labor market spillovers associated with the prestige of being listed in a leading stock exchange. The fast rate growth of the United States in the 1990s had made this market very attractive. How much this is changing is very hard to quantify.

Costs:
1) Listing costs. The NYSE has significantly higher listing costs that its competitors. With the caveat that it has been developed under the auspices of the London Stock Exchange, you should look at the study (available as a PDF document) “The Cost of Raising Capital: An International Comparison”. According to this study, it is much more expensive to list in NYSE than in Deutsche Börse (a company with capitalization equal to £100,000 pays £3,440 to list on Deutsche Börse and £81,900 to list in NYSE. Annual fees are £5,160 in Deutsche Börse and £81,900 in NYSE.
2) Disclosure costs. These are very difficult to estimate, especially because legislation has changed only recently (Sarbanes-Oxley in the US). The initial estimates are likely to greatly overestimate the average cost. SOX has imposed a high up-front fee (the cost of starting the certification process). Hopefully, with learning these costs will be much lower.
3) Potential additional liabilities. These are the risk of legal suit (class action suit) and are very difficult to quantify.

Why have independent directors become so popular nowadays? Because of regulations or market forces? (Lola Epstein, Greensboro, NC, USA)

The fraction of independent directors has increased dramatically in recent years. Kenneth Lehn, Sukesh Patro and Mengxin Zhao, in their paper “Determinants of the Size and Structure of Corporate Boards, 1935-2000” document that in the period between 1980 and 2000 the fraction of inside directors in the board of US corporations has decreased from 33% to 16%.

I chose to look at the changes between 1980 and 2000, because during this period there was no change in legislation (while after the passage of SOX, the SEC specified minimum conditions in 2003 for director independence for directors who serve on the audit committee and the exchanges - NYSE and NASDAQ - proposed a revision of their corporate governance standards, that included the requirement that the majority of board members were independent). Thus, it is fair to say that despite regulators have recently modified the minimum fraction of independent directors in a board, the trend toward more independence had started much before regulation occurred and regulation, alone, cannot be considered responsible for that.

On the contrary, self imposed measure by US corporations during the 80s have addressed the issue of board independence. In the 1980s and 1990s, various panels and committees developed somewhat influential “best practice” guidelines for board independence. The most important is the ALI’s 1992 Principles of Corporate Governance, which recommended that the board of a public corporation “should have a majority of directors who are free of any significant relationship with the corporation’s senior executives.”

These observations suggest that this trend is at least partly due to some self-imposed standard, and that regulation can only be considered responsible for the changes occurred in very recent years (from 2003 on).

Your research suggests that independent directors can be as self-serving as CEOs. European regulators, on the contrary, consider them champions of shareholder value: shouldn’t they rather foster shareholder activism? (Emil Carlsson, Stockholm, Sweden)

I do not think my research shows that. It simply shows that independent directors can make more money than the market in trading their company’s stock. This also implies that in the process of sitting on the board they can acquire information, even if they are not insiders. What my research does not tell us is whether they use this information to monitor the management of the company in the shareholders’ best interest.

Regarding this evidence the existing literature has mixed results. Evidence shows that boards with a significant fraction of independent directors are more likely to fire the CEO and to avoid certain value decreasing actions (i.e. excessive price in takeovers). However, the correlation between independent directors and the firm’s economic performance are weak at best. All in all it is very hard, with the existing evidence available, to claim that this measure will improve corporate governance. But it is fair to say, that regulators are not simply focusing on the composition of the board.

US companies have to face tight immigration policies when hiring talents from abroad, and meet the world’s most costly corporate governance requirements. Isn’t all this undermining US competitive advantage?

Recent research shows indeed that US capital markets are loosing some of their competitive advantage. In his paper titled “Is the U.S. Capital Market Losing Its Competitive Edge?” Prof. Zingales finds that while in the late 1990s the U.S. capital market was attracting 48% of all the global IPOs, its share has dropped to 6% in 2005 and is estimated to be only 8% in 2006.

You are pointing out at two possible causes of this effect. You say that this is due to (1) tight immigration policies; and (2) over regulation in financial market. While I agree with the evidence that the US is losing its competitive advantage, I think it is hard to point out at one specific cause for this phenomenon.

Capital markets around the world have become better and deeper, encouraging companies to raise capital elsewhere. It is hard to claim that the loss of competitive advantage it is due to over-regulation, but it is fair to warn US regulators that excessive regulation could prove to be extremely costly now given the shrinking quality gap between U.S. and overseas capital market.

In your view, is Sarbanes-Oxley the result of a hurried political reaction to the Enron scandal or of a genuine effort to serve american investors? (James Bonanni, USA)

I believe that SOX was motivated by genuine concerns about corporate-governance problems in the U.S. But, regulation often gets intertwined with politics. The public reaction to Enron gave legislator more power to intervene.

While adjustment to Sarbanes-Oxley should and will be made the existing evidence suggest that the regulation had a positive impact on shareholders’ value for shareholders of large corporations. It is hard to quantify the effect on small firms and the current debate which call for small adjustments for some issuers is welcome and healthy and will surely lead to adjustments of the law which improve it. But nobody is calling for an abolishment of the law, which is an indirect proof that the law is useful to address and limit some potential mis-behavior by corporate managers.

If independent directors are academics or civil servants, they are likely to be well intentioned but poorly skilled. If they are business leaders, they may easily collude with company managers. What is their real contribution, then? (Camille Beaulieau, Montreal, Canada)

The definition of independent directors given by various institutions or regulatory agencies does not require them to be academic or civil servants. Most of the guidelines set rules that try to avoid conflict of interests between the directors and the shareholders of the company.

I think it is hard to argue that all academics or civil servants are poorly skilled. It is also hard to argue that all the business leaders have interests to collude with company managers. Think about large block holders with no link with the management or the controlling shareholders. Or institutional investors, who have incentives aligned with minority shareholders.

Have other countries adopted legislation similar to Sarbanes-Oxley? If so, is this the result of competition between countries for attracting companies with sound governance principles?

Yes. One has to remember that Sarbanes and Oxley Bill was partly due to the reaction to corporate scandals in the US, but the rest of the world was affected too.

In the UK incorporated companies listed on the UK Stock Exchange (not AIM) are subject to the Combined Code on Corporate Governance. The most recent (2003) version of the Code combines the Cadbury and Greenbury reports on corporate governance, the Turnbull Report on Internal Control (revised and republished as the Turnbull Guidance in 2005), the Smith Guidance on Audit Committees and elements of the Higgs Report. These changes occurred at very similar time as SOX.

Furthermore, in similar spirit as SOX, the UK’s Companies Act of 2004 placed a statutory duty on officers and employees (including ex-employees) to provide auditors with information (other than legally privileged information) and explanations in respect of any issue related to their audit of the company’s accounts. The directors are required to make a statement that they have disclosed (having taken appropriate steps to ascertain it) all relevant information to the auditors and making a false statement will be a criminal offence.

In 2004 the EU issued a “Directive on Statutory Audit” (this directive is often called “Europe’s SOX”) which will replace, when it is adopted, the existing EU 8th Company Law Directive of 1984. Overall, there is an increasing pressure for introducing sound governance rules. The extent to which legislators succeeded in doing this without imposing excessive costs to the issuers is still to hard to evaluate. I believe that small adjustments are probably needed to correct mistakes, but overall the trend is positive for the development of capital markets.

Before 2002 several research papers documented that countries with stricter governance requirements (especially the US market) attracted foreign issuers. This effect has been documented before the passage of Sarbanes-Oxley and other legislations: for example, in the 1990s, the number of foreign companies listed on the NYSE quadrupled. Recently, the US has experienced a decline in foreign IPOs. Critiques of SOX have denounced that this is the result of too strict regulation. However, a closer look at this phenomenon indicated that the decline in attracting issuers in the US market started before SOX and may be due to the fact that foreign capital markets have become more competitive (also by improving their corporate governance practices) and this has resulted in lower costs for the issuers.

It appears that Sarbanes-Oxley has increased the number of companies going private in order to to get away with it. After all, private equity funds are now capable of providing as much funding as stock markets. I see this as an efficient answer to overregulation. What is your opinion? (Armando Cardinali, Milano, Italy)

I actually think that this point has been overlooked in recent analysis of the effect of regulation. While it may be true that regulation may have imposed excessive costs to small issuers, it is also true that in part the recent trend of using alternative sources of capital, may be due to more availability of these alternative sources.

To put your question in focus, between 2002 and 2006 private-equity buyouts represented 11% of all mergers and acquisitions in the U.S. and 10% in the rest of the world. This fraction is much higher than the equivalent numbers for the period 1996-2002 (respectively 2% and 3%). Part of this change may be due to regulation, part to the simple fact that private equity firms have so much more cash from investors, banks, and hedge funds.

The good news is that even if regulators may make the mistake of over-regulating some markets, the existing competition (from private equity but also from foreign exchanges) may limit the damages from the point of view of the issuers. If foreign markets and private equity have become better at providing funds than the US stock market, we do not need to worry too much about the consequences of over-regulation in the US.

Well-functioning capital markets are crucial for the functioning of the economy. The good news is that it does not matter where they are located, or what fraction runs through Wall Street.

Those few CEOs who steal shareholders' money cast a bad light on the whole profession. Does this discourage the most talented people from becoming business leaders?

I doubt it. On the contrary, if you are smart and honest you can really have an impact.