Sourcing Equity Globally

1
Chapter 15

• Sourcing Equity Globally

2
The Goals of Chapter 15
0

• This chapter first introduces the sequence of
  strategies to source both equity and debt capital
  globally
• It then describes issuing American depositary
  receipts (ADRs) or GDRs, which are the most
  important instruments of cross-border equity
  financing
• In addition, the firms motives to acquire global
  equity are discussed, and the barrier for issuing
  global equity are analyzed as well
• Finally, alternative instruments, including
  private placements or strategic alliances, to
  source equity in global markets are discussed

3
Sourcing Equity Globally

• A focus of this chapter is on how firms resident
  in less liquid or segmented markets attain the
  global cost of capital and availability of
  capital
• To implement the goal of gaining access to global
  capital markets, a firm must begin by designing a
  strategy that will ultimately attract
  international investors
• In addition to choose alternative paths to access
  global markets, this would also require some
  restructuring of the firm, improving the quality
  and level of its disclosure, and making its
  accounting and reporting standards more
  transparent to potential foreign investors

4
Designing a Strategy to Source Equity Globally

• Designing a capital sourcing strategy requires
  that management agree upon a long-run financial
  objective and then choose among alternative paths
  to get there
• Often, this decision making process is aided by
  an early appointment of an investment bank as an
  official advisor to the firm
• Investment bankers are in touch with potential
  foreign investors and know what they currently
  require, and can also help navigate the numerous
  institutional requirements and barriers that must
  be satisfied
• Investment bankers usually prepare the required
  stock prospectus if an equity issue is desired,
  help to price the issue, and maintain the share
  price to prevent it from falling below its
  initial price after the issue date

5
Designing a Strategy to Source Equity Globally

• Alternative paths to globalize the cost and
  availability of capital are discussed as follows
• Most firms raise their initial capital in their
  own domestic market
• However, most firms that have only raised capital
  in their domestic market are not well known
  enough to attract foreign investors
• Incremental steps to bridge this gap include
  conducting an international bond offering and/or
  cross-listing equity shares on more highly liquid
  foreign stock exchanges (see Exhibit 12.1)

6
Exhibit 12.1 Alternative Paths
? Most firms should start sourcing abroad with an
international bond issue in less liquid markets
and then in target (or highly liquid) market ?
The next step might be to cross-list and issue
equity in less liquid market to attract
international investor attention ? The next step
could be cross-list shares in a highly liquid
markets ? The ultimate step is a direct equity
issue in a liquid target market or a Euroequity
issue (a term used to describe an IPO occurring
simultaneously on more than one national market)
in global equity markets
7
Depositary receipts

• Depositary receipts (depositary shares) are
  negotiable (transferable) certificates issued by
  a bank to represent the underlying shares of
  stock, which are held in trust at a foreign
  custodian bank
• Global depositary receipts (GDRs) refer to
  certificates traded outside the U.S., and
  American depository receipts (ADRs) are
  certificates traded in the U.S. and denominated
  in U.S. dollars
• In a word, ADRs are certificates traded in U.S.
  markets that represent ownership in shares of a
  foreign company (for example, ADRs of TSMC)

8
Depositary receipts

• Each ADR represents some multiple of the
  underlying foreign share, that allows for ADR
  pricing to resemble conventional U.S. share
  pricing between 20 and 50 per share, e.g. one
  ADR of TSMC can exchange for 5 shares of TSMC
  common stock
• ADRs are registered, issued, and traded in the
  U.S. in the same manner as any share of stock
• ADRs were created to make it easier for foreign
  firms to satisfy U.S. security registration
  requirements
• ADRs provides an easier way for foreign firms to
  raise money in the U.S
• On the other hands, ADRs provide the most common
  way for U.S. investors to invest in and trade the
  shares of foreign corporations

9
Exhibit 12.2 Mechanics of American Depositary
Receipts (ADRs)
? ADRs can be exchanged for the underlying
foreign shares, or vice versa, so arbitrage keeps
foreign and US prices of any given share the same
after adjusting transfer costs ? Suppose one
share of TSMC is NT60, one share of its ADR is
US10, and the exchange rate is NT32/US. It is
profitable to buy 5 shares of TSMC, exchange them
into one share of ADR of TSMC, and sell this
share of ADR in the U.S. market ? In Taiwan, this
strategy is only feasible for large
equityholders, because the conversion is allowed
once per year, and there is a minimum number of
shares for each conversion
10
Depositary receipts

• ADRs also convey certain technical advantages to
  U.S. shareholders
• Due to highly developed capital markets in the
  U.S., trading costs of ADRs are lower than when
  buying or selling the underlying shares in their
  home market
• In addition, settlement is usually faster in the
  U.S.
• Dividends paid by a foreign firm are passed to
  its custodial bank and then to the bank that
  issued the ADR
• Withholding taxes (????) for dividend incomes is
  simpler, because withholding is handled by the
  depositary bank

11
Depositary receipts

• Sponsored or unsponsored
• Sponsored ADRs are created at the request of a
  foreign firm wanting its shares traded in the
  U.S., so the foreign firm pays all costs of
  creating such sponsored ADRs
• Unsponsored ADRs are initiated by a U.S.
  securities firm, but the SEC requires that this
  kind of unsponsored ADRs still need the approval
  of the firm itself
• The characteristics of ADRs in the U.S. have
  three levels of commitment, distinguished by the
  necessary accounting standards, SEC registration
  requirement, time to completion, and cost, see
  Exhibit 12.3

12
Depositary receipts

• ? Level I is the easiest way and it facilitates
  trading in foreign securities that are required
  by U.S. investors but not registered with the SEC
• ? It is the least costly approach because it is
  not necessary to satisfy the accounting standards
  in the U.S. and to experience the SEC
  registration process
• ? It is might have minor help on liquidity
  because ADRs are traded only over the counter
• ? Levels II and III apply to firms that want to
  list shares on the NYSE, Amex, or NASDAQ markets,
  so they must reconcile their financial accounts
  with those used under U.S. GAAP and meet the full
  registration requirements of the SEC
• ? Level III is the most expensive alternative,
  but it is the most likely to improve the stocks
  liquidity and escape from home market
  segmentation

13
Depositary receipts

• Rule 144A
• One type of directed issue with a long history as
  a source of both equity and debt is the private
  placement market
• A private placement is the sale of a security to
  a small set of qualified institutional buyers
  (QIB)
• QIB is an entity that owns and invests 100
  million on a discretionary basis in securities of
  nonaffiliates, e.g. insurance companies,
  investment companies, pension fund etc. (Banks
  and savings and loans must satisfy an additional
  criterion of having a minimum net worth of 25
  million)
• Since the securities are not registered for sale
  to the public, OIBs have typically followed a
  buy and hold policy
• The SEC approved Rule 144A in 1990, which permits
  QIBs to trade privately place securities without
  the previous holding period restrictions and SEC
  registration

14
Depositary receipts

• The SEC also modified it Regulation S to permit
  foreign issuers to tap the U.S. private placement
  market through an SEC Rule 144A issue, also
  without SEC registration
• A screen-based automated trading system called
  PORTAL was established by National Association of
  Securities Dealers (NASD) to support the
  distribution of primary issues and to create a
  liquid secondary market for these unregistered
  private placements
• Since SEC registration has been identified as the
  main barrier to foreign firms wishing to raise
  funds in the U.S., SEC Rule 144A placements are
  proving attractive to foreign issuers of both
  equity and debt securities

15
Foreign Equity Listing and Issuance

• The objectives of cross-listing shares on a
  well-developed foreign stock exchange
• 1. Improve the liquidity of its existing shares
  and support a liquid secondary market for new
  equity issues in foreign markets
• 2. Increase its share price by overcoming
  mis-pricing in a segmented and illiquid home
  capital market
• 3. Increase the visibility and political
  acceptance
• 4. Create a secondary market for shares
• ? We will explain the above objectives point by
  point in the following paragraphs

16
Foreign Equity Listing and Issuance

• 1. Improve the liquidity of its existing shares
  and support a liquid secondary market for new
  equity issues in foreign markets
• Even though a firms shares are not listed on
  foreign exchanges, foreign investors can purchase
  the shares through brokerages (usually adopt the
  buy and hold strategy)
• If the firm cross-list its shares on foreign
  exchanges, it creates a secondary market for
  existing shares, and encourages foreign investors
  who owns the shares to continue to trade these
  shares, thus improving secondary market liquidity
• In addition, due to arbitrage transactions
  between the foreign and the home markets, it is
  also possible to enhance the liquidity of the
  stock shares in the home market
• Compare the liquidity of selected stock exchanges
  in Exhibit 12.5

17
Exhibit 12.5 Comparisons of Stock Exchange Size
Characteristics and Market Liquidity in 2002
Exchanges Domestic Firms Foreign Firms Value of Share Trading (million of US)
NYSE 1894 472 10,311,156
NASDAQ 3268 381 7,254,594
LSE 1892 382 4,001,340
Euronext 1114 na 1,988,359
Tokyo 2119 34 1,564,244
Deutsche Börse (Ger) 715 219 1,212,302
Spain 986 29 653,229
Italy 288 7 634,635
Swiss Exchange 258 140 599,749
Taiwan 638 3 633,632
Korea 679 0 596,632

• ? Using Value of Share Trading as the
  indicator, the NYSE, NASDAQ, and LSE are the most
  liquid market
• ? The NYSE, NASDAQ, and LSE have the largest
  number of foreign listings
• ? Although the NYSE is with the highest value of
  share trading and largest number of foreign
  listing, the total trading volume of the foreign
  firms listed on the LSE was higher than that for
  foreign firms listed on the NYSE (not shown in
  the exhibit)

18
Foreign Equity Listing and Issuance

• Since the NYSE and LSE are two most important
  markets for cross-listing of foreign firms, the
  comparisons between these two exchanges are
• For both markets, liquidity in the most actively
  traded shares is similar, but the NYSE is a more
  liquid market for the less-popular shares
• Transaction costs as measured by spreads are
  lower on the NYSE
• The LSE spreads are roughly comparable to the
  spreads on NASDAQ
• In term of fairness, the NYSE is superior,
  because orders are executed chronologically,
  whereas on the LSE, one has to shop from dealer
  to dealer

19
Foreign Equity Listing and Issuance

• Market-making activities and crisis management by
  specialists has been more effective in practice
  on the NYSE than on any other exchange, including
  LSE
• The cost of listing, disclosure requirements, and
  required reporting frequency are less onerous on
  the LSE than on the NYSE
• So, for those firms have trouble overcoming the
  barriers of cross-listing, the LSE is a better
  choice
• For those firms that are willing to pay the
  price, a listing on the NYSE should improve the
  liquidity for their shares more than could be
  achieved with a similar listing elsewhere

20
Foreign Equity Listing and Issuance

• 2. Increase its share price by overcoming
  mis-pricing in a segmented and illiquid home
  capital market
• According to the international market
  segmentation hypothesis, the effect of
  cross-listing on a foreign stock exchange is more
  significant for firms resident in a more
  segmented home markets
• Alexander, Eun, and Janakirmanan (1988) found a
  positive share price effect for foreign firms
  that listed on the NYSE, AMEX, or NASDAQ from
  1969 to 1982
• Sundaram and Logue (1996) found that share prices
  increased for foreign firms that cross-listed
  their shares in ADR form on the NYSE and AMEX
  from 1982 to 1992
• Doidge, Karolyi, and Stulz (2004) found that at
  the end of 1997, foreign companies with shares
  cross-listed in the U.S. had Tobins q ratios
  that were 16.5 higher than those of
  non-cross-listed firms from the same country

21
Foreign Equity Listing and Issuance

• The findings in Miller (1999)
• Positive abnormal returns are found around the
  announcement date of a cross-listing in ADR form
  in the U.S.
• Abnormal returns are largest for firms that list
  on major US exchanges such as NYSE or NASDAQ and
  smallest for firms that list on PORTAL
• This study prove that the abnormal return from
  the combined effect of new equity issue and a
  cross-listing (Level III ADRs) is higher than the
  abnormal return for only cross-listed firms
  (Levels I and II)
• Firms located in emerging markets have larger
  abnormal returns than those in developed markets
• Foreign firms that enter US capital markets to
  raise new equity capital in a public offering
  experience a positive change in shareholder
  wealth. Those in a private offering experience a
  negative change in shareholder wealth
• Even U.S. firms can benefit by issuing equity
  abroad as increased investor recognition and
  participation in the primary and secondary markets

22
Foreign Equity Listing and Issuance

• 3. Increase the visibility and political
  acceptance
• Commercial objectives for MNEs listing in the
  foreign market where they have substantial
  physical operations are to enhance corporate
  image, advertise trademark and products, get
  better local press coverage, and become more
  familiar with the local financial community in
  order to raise working capital locally
• Political objectives for MNEs listing in foreign
  markets might include the need to meet local
  equityholders requirement for a multinational
  firms foreign joint venture
• 4. Create a secondary market for shares
• Shares can be used to compensate local management
  and employees in foreign subsidiaries, or shares
  can be used to acquire other firms through a
  share swap arrangement
• Since the shares listed on foreign liquid
  exchanges creates a secondary market and let
  shares become more liquid and thus more valuable,
  the compensation or the acquisition becomes more
  attractive

23
Barriers to Cross-Listing and Selling Equity
Abroad

• There are serveral barriers to cross-listing
  and/or selling equity abroad
• The most serious barriers for U.S. markets
  includes the commitment to providing full,
  transparent, and regular disclosure of operating
  results and balance sheets as well as a
  continuous program of investor relations
• One of the U.S. school of thought is that the
  worldwide trend toward requiring fuller, more
  transparent, and more standardized financial
  disclosure of operating results and balance sheet
  positions may have the desirable effect of
  lowering the cost of equity capital
• The other school of thought is that the U.S.
  level of required disclosure is an onerous,
  costly burden, which chases away many potential
  firms, thereby narrowing the choice of securities
  available to U.S. investors

24
Alternative Instruments to Source Equity in
Global Markets

• Alternative instruments to source equity in
  global markets are summarized as follows
• Sale of a directed public share issue to
  investors in a target market
• Sale of a Euroequity public issue to investors in
  more than one market (foreign and domestic
  markets)
• Private placements under SEC Rule 144A
• Sale of shares to private equity funds
• Sale of shares to a foreign firm as part of a
  strategic alliance

25
Alternative Instruments to Source Equity in
Global Markets

• Sale of directed public share issues
• A directed public share issue is defined as one
  that is targeted at investors in a single country
  and underwritten in whole or in part by
  investment institutions from that country
• The U.S. share issue by Novo in 1981 is a good
  example of successful directed share issue. In
  fact, issuing ADR is also a kind of directed
  public share issue
• The issue might or might not be denominated in
  the currency of the target market
• The shares might or might not be cross-listed on
  a stock exchange in the target market (with
  cross-listing, the liquidity for shares can be
  improved)

26
Alternative Instruments to Source Equity in
Global Markets

• Sale of Euroequity public issues
• The gradual integration of the worlds capital
  markets and increased international portfolio
  investment has spawned the emergence of a very
  viable Euroequity market
• Today, a firm can issue equity underwritten and
  distributed in multiple foreign equity markets,
  sometimes simultaneously with distribution in the
  domestic market
• The Euro market (a generic term for
  international securities issues originating and
  being sold anywhere in the world), was created by
  the same financial institutions that had
  previously created an infrastructure for the
  Euronote and Eurobond markets
• Euroequity public issues are usually applied to
  privatizations of government-owned enterprises
  because most of the firms are very large

27
Alternative Instruments to Source Equity in
Global Markets

• Euroequity public issues for privatizations of
  government-owned enterprises are popular with
  international portfolio investors, because most
  of the firms are with excellent credit ratings
  and profitable quasi-government monopolies at the
  time of privatization
• Megginson, Nash, and Randenborgh (1994) studied
  the privatization cases from 1961 to 1990, and
  they found that the privatized firm showed strong
  performance improvements, e.g. the firms
  increased real sales, raised capital investment
  level, improved efficiency and profitability,
  lowered debt levels, and increased dividend
  payments

28
Alternative Instruments to Source Equity in
Global Markets

• Private placement under SEC rule 144A
• Please refer to Slides 12.13 and 12.14
• Sales of shares to private equity funds
• Private equity funds (????) are usually limited
  partnerships of institutional and wealthy
  individual investors that raise their capital in
  large capital markets
• Private equity funds invest in mature,
  profitable, and small firms located in emerging
  markets (usually these firm is too small to
  conduct a globalization strategy)
• The investment objective is to help these firms
  to restructure and modernize in order to face
  increasing competition and the growth of new
  technologies
• Private equity funds may be content with the
  improved profitability of the firm through better
  management or harvest the investment via mergers
  with other firms

29
Alternative Instruments to Source Equity in
Global Markets

• Private equity funds operate in many countries,
  invest in many industry sectors, and often have a
  longer time horizon for exiting
• Private equity funds differ from traditional
  venture capital funds (????)
• Venture capital funds typically invest in high
  technology startups with the goal of exiting the
  investment with an initial public offering (IPO)
  in highly liquid markets
• Very little venture capital is available in
  emerging markets, partly because it would be
  difficult to exit with an IPO in an illiquid
  market

30
Alternative Instruments to Source Equity in
Global Markets

• Sale of shares to a foreign firm as part of a
  strategic alliance
• Strategic alliance are normally formed by firms
  that expect to gain synergies from one or more of
  the following joint efforts
• They might share the cost of developing
  technology or pursue complementary marketing
  activities
• They might gain economies of scale or scope or a
  variety of other commercial advantage
• The strategic alliance may bring financial
  assistance between firms, i.e. helping a
  financially weak firm to lower its cost of
  capital through attractively priced debt or
  equity financing