Essay About Foreign Firms And Attractiveness Of Us Capital Markets

An Examination Of The Impact Of The Sarbanes-Oxley Act
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An Examination of the Impact of the Sarbanes-Oxley Act
on the Attractiveness of US Capital Markets for Foreign Firms*
Peter Hostak
Charlton College of Business
University of Massachusetts at Dartmouth
Emre Karaoglu
Leventhal School of Accounting
University of Southern California
Thomas Lys**
Kellogg School of Management
Northwestern University
Yong (George) Yang
School of Accountancy
The Chinese University of Hong Kong
April 30, 2007
* Financial support from the Research Grants Council of the Hong Kong Special Administration Region, China
(Project No. CUHK4623/06H), Charlton College of Business, and the Accounting Research Center at The Kellogg
School is gratefully acknowledged. We thank Mingyi Hung, Bin Ke, Jim McKeown, Gordon Richardson, Katherine
Schipper, TJ Wong, and workshop participants at The Chinese University of Hong Kong, Northwestern University,
and Pennsylvania State University for valuable comments.
** Corresponding author. (847) 491-2673, [email protected]
An electronic copy of this paper is available at:
An Examination of the Impact of the Sarbanes-Oxley Act
on the Attractiveness of US Capital Markets for Foreign Firms
Abstract
We document that the passage of the Sarbanes-Oxley Act (SOX) coincided with an increase in
voluntary delistings of foreign firms traded as American Depository Receipts (ADRs) from US
stock exchanges. We examine the extent to which these delistings were motivated by firms’
costs of complying with SOX or by managers’ or controlling shareholders’ (MCOs) loss of
control rents that resulted from corporate governance mandates of SOX. We show that
compared to foreign firms that maintained their ADRs, foreign firms which voluntarily delisted
have weaker corporate governance, had a less negative stock market reaction when SOX was
passed, and suffered a significant price decline in their home-markets when they announced their
intention to delist. Taken together, our results are consistent with our hypothesis that foreign
firms with weaker corporate governance delisted to avoid complying with the corporate
governance mandates of SOX. In contrast, our evidence is not consistent with the delistings
being motivated by firms’ (as opposed to MCO’s) compliance costs with SOX.
An Examination of the Impact of Sarbanes-Oxley Act on the
Attractiveness of US Capital Markets for Foreign Firms
1. Introduction
Congress passed the Sarbanes-Oxley Act of 2002 (SOX) with the main objective of
restoring investors’ confidence (including the accuracy and reliability of corporate disclosures)
in US capital markets following the governance failures occurring in the preceding decade. To
this end, SOX established more stringent standards for internal controls, auditing, disclosure, and
management conduct and accountability. However, while proponents argue that SOX was
necessary,1 the evidence to date suggests that the expected net benefits of SOX are negative
purportedly as a result of large direct and indirect compliance costs (Zhang, 2006 and DeFond,
Hung, Karaoglu, and Zhang, 2006). We use a sample of foreign-domiciled firms (henceforth,
foreign firms) traded in the US as American Depository Receipts (henceforth ADRs) to analyze
the tradeoff between the cost of compliance with SOX and governance benefits of SOX.
Foreign firms can avoid complying with US listing requirements by delisting. However,
the associated costs (e.g., due to the loss of liquidity) are likely to be much smaller than those of
US firms (which must either comply with SOX, go private, or trade on the “pink sheets” see
Engel, Hayes, and Wang (2006) and Leuz, Triantis, and Wang (2006)) because after delisting,
foreign firms are still publicly traded in their home countries (and hence do not incur costs due to
loss of liquidity). As a result, voluntary delisting decisions constitute a lower hurdle for foreign
firms and thus, can more clearly reflect the trade-off between the costs of compliance with SOX
and the benefits of improved governance. Although not perfect (because by delisting, foreign
firms still forgo the benefits of being listed in the US), the delisting decisions by foreign firms
1 See, for example, opening statement of Candice Miller, Chairman, Subcommittee on regulatory affairs, April 5,
2006.
provide a more transparent metric by which to study the impact of SOX as the significant costs