RDP 2003-06: The Characteristics and Trading Behaviour of Dual-Listed Companies 1. Introduction

The phenomenon of substantial price differences between dual-listed (or ‘Siamese twin’) companies has been very widely cited following the influential work of Froot and Dabora (1999). Dual-listed company (DLC) structures are effectively mergers between two companies in which they agree to combine their operations and cash flows and make similar dividend payments to shareholders in both companies, while retaining separate shareholder registries and identities. In this respect a dual listing is quite different to a cross listing. Whereas a dual listing involves the quasi merger of two separate entities, a cross listing occurs when an individual company establishes a secondary listing on a foreign stock exchange, the most prominent arrangement being via American Depositary Receipts (ADRs).^[1]

Apart from the work of Froot and Dabora and Rosenthal and Young (1990), there appears to be no other work looking at this interesting phenomenon. Yet DLC structures are not an archaic structure, and this paper documents 12 DLC structures put in place over the last 15 years, in addition to 2 longstanding cases (Royal Dutch/Shell and Unilever) made prominent by these earlier papers. Indeed, in the recent battle to take over UK-listed P&O Princess Cruises Plc, both US suitors (Royal Caribbean Cruises Ltd and Carnival Corporation) proposed to merge via a DLC structure. The rationale for DLC structures appears to have been that the structure has been a key element for some companies in facilitating cross-border mergers or international expansion. However, many of the recently formed DLCs have not proved durable, with 6 of the 12 recent DLCs already unified into a more conventional single share structure.

DLCs are an interesting phenomenon because of the insights they can yield about both corporate structure and asset pricing. Although the shares of the two companies represent identical claims on the future cash flows of the group, substantial divergences in the pricing of these claims are observed. Rosenthal and Young document the persistent mispricing of Royal Dutch/Shell and Unilever throughout the 1980s but find that transactions costs would have precluded trading rules designed to take advantage of these price differentials. Froot and Dabora (1999) investigate whether stock returns of DLCs are affected by the location of trade. They find that the return of each ‘twin’ appears to be correlated with the market on which it is most actively traded. For example, when the New York market rose relative to the UK market, they found that the price of Royal Dutch (which traded relatively more in New York over their sample) increased compared to the price of Shell (which traded relatively more in London).

Accordingly, the mispricing of DLCs is frequently cited as representing an anomaly to the efficient market hypothesis (Mullainathan and Thaler 2000; Barberis and Thaler 2002). In particular, Froot and Dabora's evidence is interpreted as evidence that stock prices reflect in part the sentiment and behavioural biases of investors and market-makers that dominate trading in the asset in question. The findings are not unique in this respect. A related example is the case of closed-end mutual funds which often trade at substantial premia or discounts to their net asset value, a result that Lee, Shleifer and Thaler (1991) and Shleifer (2000) attribute to small-investor sentiment.

This paper presents new evidence into four aspects of DLCs. First, since DLCs can now be said to be a reasonably widely used corporate structure, we document the formation of 12 new DLC structures over the last 15 years and outline the reasons that have been cited for the adoption of such structures, and for the subsequent unification of the share structure where this has occurred.

Second, we show that excess comovement and substantial price divergences between DLC twins have remained pervasive phenomena in six large remaining DLCs. If the large price divergences identified by Rosenthal and Young and Froot and Dabora did represent a source of arbitrage profit, we would expect arbitrage activity to have occurred and resulted in a reduction in the size of the typical price gap. We note several instances where particular institutions have attempted to find ways to arbitrage the price differences, but conclude that the ongoing price differences suggest little success in this regard.

Third, we study what happens to the betas or market exposures of DLC companies in cases where the structure is abandoned in favour of a single entity with one primary listing. In particular, we identify four cases where such unifications were not accompanied by other changes in the underlying business of the companies and examine if the betas of the combined company change as a result of it changing from a dual listing on two exchanges to a single primary listing on one exchange. A traditional view of asset pricing would suggest there should be no change in the betas of the combined company following such a change. By contrast, the model of trading-induced comovement proposed by Barberis, Shleifer and Wurgler (2002) would suggest an increase in the beta with respect to the market which is the new primary listing of the unified company, and a decrease in the other market where there is no longer a primary listing. Since the unifications result in compositional changes in the international equity indices produced by major index providers – there is an increase in the stock's index weight in the former market and a deletion from the index of the latter market – our test is related to the tests of Barberis, Shleifer and Wurgler (2002) who examine changes in betas following inclusions or exclusions from the US S&P 500 index. Our results suggest that the betas do indeed change in the manner predicted by a model of trading-induced comovement. Our results are also consistent with the results of Chan, Hameed and Lau (2003) who show that the exposures of four prominent Hong Kong companies in the Jardine Group experienced large changes in their market exposures following the change of their primary listing to the Singapore Exchange. Together with the earlier evidence for excess comovement in DLCs, this result is consistent with a range of related evidence that the market prices of assets depend not only on fundamentals, but also on the location of trade and the investors that hold the assets.

Finally, we conduct an event study into the behaviour of the market value of DLCs in cases where the share structure is unified. Not surprisingly, the pricing of the twins converges following the announcement of unification, but it is of interest to ask if this occurs via an increase in the share price of the company that is trading at a discount or a fall in the share price of the twin that is trading at a premium, and if there is any impact on overall company value. The tests suggest a rise in the price of the twin trading at a discount, with some modest evidence of a fall in the company trading at a premium. On average, there is little change in total firm value, implying that we can say little from this event study about the way that markets view DLC structures versus conventional mergers.

The rest of this paper is arranged as follows. Section 2 provides an introduction to DLCs, a listing of DLC structures, and discusses some of the reasons cited for and against such a structure. Section 3 documents the price differentials existing in the cases of the six large continuing DLCs, and discusses some of the reasons why they are not eliminated. Section 4 outlines the data used in the three empirical sections of the paper. Sections 5, 6, and 7 contain the results from the tests for excess comovement and for changes in market exposures following the unification of DLCs, and from the event study for changes in market values following unification announcements. Our conclusions are presented in Section 8.

Footnote

Karolyi (1998) provides a survey discussion of cross listings and Pagano, Röell and Zechner (2002) examine the motives for cross listings. [1]