Sarbox Not Responsible for Decline in New York Market Competitiveness

Although I haven’t followed the debate over New York-London market competitiveness that closely, it was clear when the study on the US’s standing was commissioned, the sponsors already knew what answers they wanted to report, and emasculating Sarbanes-Oxley (Sarbox or SOX) was an idee fixe.

It didn’t seem to occur to people like Hank Paulson and Chuck Schumer that leadership in the international markets is not only not a God-given right of the US, but actually has to do with, among other things, the relative size and growth rates of countries and their locations. You can’t solve for geography, and London is geographically advantaged, since it overlaps with the Asian and US workdays. Plus as the US becomes smaller in size relative to the global economy, our advantage of having a large domestic capital market becomes less powerful. And the fact that we are not terribly welcoming to foreigners these days doesn’t help either.

Before the 1980s, London was a bigger financial center than New York (and that despite Frankfurt being a trading hub of some importance). London’s foreign exchange market was considerably bigger than New York’s, and a lot of business keys off of FX.

The Harvard Law School Corporate Governance Blog, in “Has SOX Made New York Less Competitive in Global Markets?” by Rene Stulz debunks the idea that Sarbox has much, if anything, to do with New York’s supposed decline:

In a paper entitled Has New York Become Less Competitive in Global Markets? Evaluating Foreign Listing Choices Over Time, Craig Doidge, G. Andrew Karolyi, and I show that Sarbanes-Oxley (”SOX”) cannot be blamed for the decrease in foreign listings on the New York Stock Exchange and NASDAQ. A recent revision of the paper, posted here, provides additional supporting evidence for our conclusions. Before reviewing that additional evidence, I summarize the main results of the paper below.

A popular explanation for the decrease in foreign listings on the exchanges in New York is that the passage of SOX has made U.S. listings significantly less attractive to foreign companies–so much so, it is argued, that many listed firms would delist and deregister if it were easy to do so. (That explanation, among others, is set forth in a recent report entitled Sustaining New York’s and the US’s Global Financial Services Leadership, prepared for Senator Charles Schumer of New York.) ….

For this popular explanation to be correct, it would have to be that firms that would have chosen to list in the U.S. before SOX are no longer willing to do so. Our paper shows that:

(1) Foreign listings have fallen in London as well as in New York, except for listings on the AIM exchange in London. This decrease in London listings is inconsistent with the view that SOX made London more attractive for listings in comparison with the New York exchanges.

(2) The growth in listings on the AIM exchange cannot be attributed to foreign firms choosing to list on AIM instead of in the U.S. because the typical firm listing on AIM is very small compared to firms listing on U.S. exchanges.

(3) If SOX had made it unattractive for some firms to list on exchanges in the U.S., we would expect that the characteristics of firms listing in the U.S. would have changed. They have not.

(4) Using a benchmark model which explains foreign listings in the 1990s, there is no evidence that there are fewer firms listed after SOX than we would expect had SOX not become law.

(5) Foreign firms listed on U.S. exchanges are valued more highly than comparable firms not listed on U.S. exchanges. There is no evidence that this valuation premium has changed since SOX.

Cross-listing in the U.S. has a governance benefit for foreign firms because they are subjected to U.S. laws and regulations and are monitored by U.S. capital market intermediaries. The evidence in the paper shows that cross-listing in London has no equivalent governance benefit.

The revision of the paper recently uploaded to SSRN adds three important new results:

(1) The paper shows that a listing on AIM is in no way equivalent to a listing on NASDAQ. For a subset of 88 AIM-listed firms for which detailed data could be obtained, only 25% of those firms met the NASDAQ listing criteria that could be checked. As a result, the typical firm listing on AIM is one that could not list on NASDAQ–and the typical listing on AIM does not come at the expense of NASDAQ or the NYSE.

(2) Our earlier version only estimated a benchmark model for the number of existing listings. A number of colleagues remarked that our approach ignored the possibility that firms listed in the U.S. might not have found it worthwhile to delist because deregistration was almost impossible. This criticism could not explain why London had too few listings relative to the prediction of the benchmark model for London, but it could explain why the U.S. had too many listings. The revision estimates a benchmark model for new listings. Since firms are completely free not to acquire a listing if they do not have one, the benchmark model for new listings is not subject to the criticism that applies to the model for existing listings. It turns out that there is no deficit of new listings using the benchmark model.

(3) Some colleagues wondered whether the absence of a change in the valuation premium of exchange-listed firms in the U.S. masked a decrease in the valuation premium for the firms for which the governance benefit from listing in the U.S. was the least valuable–namely, firms from countries with laws and regulations that provide high levels of investor protection. We find that this is not the case. There is no evidence that the valuation premium has fallen for firms from such countries.

The revised version of the paper is available for download here.

Where Sarbox does appear to have a damaging effect is in its annual compliance costs, which has raised the threshold at which it is economically attractive for a young company to go public. However, a former general counsel told me that 85% of the provisions in Sarbox were already a part of general corporate law. It was the fact that they weren’t being adhered to that led to Sarbox (and I will admit that I haven’t gotten the GC to clarify what the new 15% was, aside from having the CEO and CFO certify corporate financial statements and the establishment of the Public Company Accounting Oversight Board).