Financial leverage and competitive strategy of cross-listing firms

Abstract

This study investigates the relationship between financial leverage and competitive strategies based on the investigation into the cross-listing announcements, through which the financial condition of a firm might shape the competition outcome. The empirical evidence shows that cross-listing announcements normally attract positive market responses to cross-listed firms but incur negative market responses to rival firms, especially upon the strategic substitutes competition. Cross-listed firms obtain more positive market responses if their financial leverage is lower, but the firms have no advantages when they are financially constrained. Less leveraged rival firms could weaken the negative impact and even gain positive market responses upon the strategic complements competition.

JEL classification: G14, G32, M16

Keywords

Competitive strategy cross-list event study financial leverage firm value

1. Introduction

Capital structure and its relationship with firm value remain one of the most researched corporate finance issues (Gleason et al., 2000; Marchica and Mura, 2010; Schoubben and Hulle, 2011). Theories that provide the rationale for internal/external financing and debt/equity financing decisions have been controversial and always led to totally different predictions (Jensen and Meckling, 1976; Masulis, 1980; Modigliani and Miller, 1958; Myers, 1984; Myers and Majluf, 1984). The findings of current research produce conflicting results: some indicate that lower financial leverage makes firms more aggressive and valuable (Chevalier, 1995), whereas others predict otherwise (Brander and Lewis, 1986). Most of the empirical evidence, nevertheless, seems to indicate that highly leveraged firms often have poor market prospects and easily lose market shares to their less-leveraged counterparts (Arping and Loranth, 2006; Opler and Titman, 1994). Despite the importance of this research stream, there is few, if any, analysis of the relationship between financial leverage and firm value from a competitive perspective in extant business and economic literature.

Firms cross-list their shares on foreign exchanges to enhance firm value, mainly through enhanced operational and financial performance (Charitou and Louca, 2009; Dodd, 2013). The value of cross-listing in more prestigious markets, for example, the United States, can be identified as the positive effect of stock price reactions in the home market, which is relatively smaller and less stringent (O’Conner, 2009). Information-based theories like signaling, equity liberalization, information disclosure, legal bonding, and investor recognition advocate that firms may experience an improvement in their information environment through cross-listing.

Signaling theory is fundamentally concerned with conveying information about a firm’s future prospects and quality and thus precluding the growth of an information asymmetry problem, in which different parties involved in a transaction possess different amounts of information (Janney and Folta, 2003; Sorescu et al., 2007; Spence, 1984). Cross-listing behavior reflects information flows in the sense that managers signal firms’ commitment and quality to the capital market through cross-listing, allowing them to protect minority investors, raise capital at lower cost and hence exploit growth opportunities in the home market (Charitou and Louca, 2009; Dodd, 2013). However, the equity liberalization literature emphasizes the benefits of cheap capital cost (Martell and Stulz, 2003). Information disclosure theory holds that firms which cross-list shares in foreign markets must meet additional mandatory disclosure requirements of the foreign market, encouraging trading and leading to higher market valuations of the firms (Dodd, 2013). Legal bonding theory further argues that compliance with strict listing requirements of the foreign market improves investor protection. Firms are forced to do things right, hence enhancing corporate governance and business reputation and increasing firm value and financial performance (Mittoo, 1992; Pagano et al., 2002). Investor recognition theory suggests that cross-listing also increases investor awareness in the countries where firms cross-list. The greater the visibility of the firms in the foreign markets, the more likely they attract greater investor bases both in the home country and in the foreign country. The firms can accordingly access greater opportunities for growth (Charitou and Louca, 2009; Eng and Ling, 2012).

This research explores the effects of cross-listing announcements on firms with different financial leverage levels and strategic orientations in competitive dyads. It is definitely worth studying because the strategic/competitive interactions among firms can not only shape the outcomes of their financial policy but also influence firm value (Gertner et al., 1988). In the research, the competitive interactions include two scenarios: strategic substitutes (SS) and strategic complements (SC). The payoff of any competitive interaction is operationalized by measuring a firm’s profits in relation to changes in its rivals’ revenues. An information economics approach to international cross-listing is adopted because both financing and cross-listing behaviors of firms presume information asymmetry between the insiders and outsiders, that is, managers, shareholders, and creditors (Gertner et al., 1988; Myers and Majluf, 1984). This research may well shed some light on the performance implication for firms laden with varying financial leverage levels to cross-list their shares in foreign exchanges and compete domestically and internationally.

Prior studies provide evidence that cross-listing positively influences firm growth, especially through external financing (Dodd, 2013). Legal bonding theory predicts that cross-listed firms are more likely to use equity financing due to the increased transparency of the host countries accounting system (Burns et al., 2007). In terms of cross-listing decisions, equity finance seems to be a better source of finance as opposed to debt finance. A lower financial leverage decreases the probability of financial distress. Firms carrying less debt have easier access to capital and lower capital costs than those carrying more debt do. The lower leveraged firms tend to become more aggressive in the market, which may explain why financial leverage affects market competition. In a similar vein, less financially leveraged cross-listed firms can easily raise capital, by which they become more competitive in the market. The cross-listing announcements of less financially leveraged firms accordingly have a positive impact on firm value, whereas their competitors that use more financial leverage would be negatively affected. Moreover, less financially leveraged cross-listed firms with SS enjoy a significantly positive boost; more financially leveraged competitors receive a significantly negative impact. Less financially leveraged firms are equipped with financing resources that are potentially available to substitute for the competition of the product market. In contrast, less financially leveraged cross-listed firms with SC enjoy a significantly positive effect. So do their less financially leveraged competitors. Both of these firms expand the market together and complement each other.

The rest of this article is organized as follows: section 2 reviews the literature on financial leverage and develops certain relevant hypotheses; section 3 describes the sample selection procedure, defines variables, explains the methodology, and provides summary statistics; section 4 presents the empirical results; section 5 discusses implications; and section 6 concludes this research.

2. Literature and hypotheses

2.1. Financial leverage and firm performance

Telser (1966) indicates that a lower level of financial leverage enables a firm to sustain losses until it succeeds in excluding competitors. Indebted firms have periodic needs for refinancing, making them appear risky and thereby discouraging investors from approving their refinance requests (Bolton and Scharfstein, 1990; Fudenberg and Tirole, 1986; Schoubben and Hulle, 2011). Highly financially leveraged firms only have access to costly capital, and their abilities to respond to market competition are thus limited. The following three studies provide evidence for this phenomenon. Zingales (1998) finds that highly leveraged trucking firms are less likely to survive deregulation. Khanna and Tice (2000) consider that highly leveraged firms in retailing tend to be passive in resisting Walmart’s entry into their markets. Firms that increase their leverage levels may limit their abilities to raise additional capital (Grullon et al., 2006). They become financially constrained and restricted in their market actions. Furthermore, managers prefer to keep debt ratios low to protect their undiversified human capital (Fama, 1980) or to alleviate the pressure that comes with interest payment commitments (Jensen, 1986). Increasing leverage signals potential risks, which refrain highly leveraged firms, as opposed to less leveraged counterparts, from behaving aggressively due to the lack of sufficient financial resource for competition. Evidence shows that firms experiencing a larger increase in leverage before the global financial crisis have a worse growth performance during the financial crisis period than firms without the increase in leverage.

2.2. Financial leverage and competitive strategy

Gertner et al. (1988) probe the competitive strategy between rivals. The concept of SS refers to the interaction that occurs when a firm executes strategic actions and its competitors react either inactively or unresponsively. SC, on the contrary, connotes that competitors match a firm’s strategic move actively. Competitive strategy is generally analyzed in a dyadic scenario where firm A is in the home market and firm B is in the US market. Such an analysis emphasizes financial leverage from a competitive perspective because cross-listing announcement acts as a market signal, which refers to “any action by a competitor that provides a direct or indirect indication of its intention, motive, goal, or internal situation” (Porter, 1980: 75). A firm with less financial leverage is likely to get access to cheaper capital for implementing its competitive strategy. When firm A decides to be cross-listed on the foreign exchange, firm B listed on the foreign exchange is likely to either be substituted by, or substitute for, products from firm A. In such a dyad, the profit of firm A could rise, while the actual profit of firm B depends on how it reacts to the cross-listing behavior of firm A. If firm B decides to stay put, that is, to produce the same outputs or make no additional response, then the action of cross-listing is likely to increase both the profit and market share of firm A (Spence, 1984). That is, firm A’s profits might increase but firm B’s might be reduced since the production quantity of firm A displaces that of firm B. Notably, when firm A is less leveraged, its lower financial leverage makes it easier for firm A to raise funds to meet the competition and act aggressively. Firm B is likely to suffer more if it has relatively higher financial leverage and cannot easily find financing to maintain the current production plan. The adoption of SS by firm B predicts that firm A will generate profits and firm B will suffer losses. Under this competitive scenario, the cross-listing has a positive effect on the value of firm A and negative effect on the value of firm B. Therefore, we hypothesize the following:

H1a. The cross-listing announcement of less leveraged firms with competitive responses as SS will have positive effects on firm value.

H1b. High leveraged rival firms adopting SS in response to the cross-listing announcements of less leveraged firms will suffer from negative impacts on their value.

On the other hand, the accommodating strategy might not be adopted by firm B and therefore firm B will employ the identical strategy of firm A in return, especially when both firms A and B are ex ante identical. In this SC competition scenario, the total output of both firms might increase, and the market shares of firms A and B could grow. In this scenario, firms A and B might enjoy rises in profits as the marginal profits would increase. However, firm B might not continue on to match the behavior of firm A if firm B is highly leveraged, while firm A is less leveraged. If firm B could not match the behavior of firm A, firm A would still have an increase in the profit but not for firm B. Under such a circumstance, the cross-listing brings a positive effect on the announcing firms’ value but an insignificant or a negative impact on rivals. Thus, we assume the following:

H2a. The cross-listing announcements of less leveraged firms with competitive responses as SC will have positive effects on firm value.

H2b. High leveraged rival firms adopting SC in response to the cross-listing announcements of less leveraged firms might experience an insignificant impact on their value.

When firm A is more financially constrained, such greater constraints will lead firm A to suffer from serious funding problems. Firm B, with relatively fewer financial constraints, can easily raise capital and make a response to the market behavior of firm A. The relatively higher financial constraint prevents firm A from financing itself and reduces its competitive ability and therefore results in more serious competition or substitution from firm B’s products. In this SS scenario, firms A and B are predicted to be likely to have insignificant profits. In short, the cross-listing may not impose a significant effect on the value of firm A because the higher financial constraint limits the profits derived from SS. The value of firm B may have any significant change due to its response because the advantage of lower financial constraints nullifies the losses from SS. Therefore, we hypothesize the following:

H3a. The cross-listing announcements of more leveraged firms with competitive responses as SS will have insignificant effects on firm value.

H3b. Lower leveraged firms adopting SS in response to the cross-listing announcements of higher leveraged firms will have insignificant impacts on their value.

If firm A is more constrained and firm B is less constrained, it means that firm B can easily respond to A in an SC manner. If firm B attempts to counterattack the behavior of firm A, then the use of SC predicts that firm A might have an insignificant increase in profits and even have profits reduced, while firm B will have healthy profits. Under the circumstances, cross-listing does not significantly affect the value of firm A because the higher financial constraint limits the profits from the use of SC. The response of firm B is positive for its value because the smaller financial constraint supports profits from the use of SC. Thus, we hypothesize the following:

H4a. The cross-listing announcements of more leveraged firms with competitive responses as SC will have insignificant effects on firm value.

H4b. Lower leveraged firms adopting SC in response to the cross-listing announcements of more leveraged firms will have positive impacts on their value.

3. Sample selection, CSM, variable definition, methodology, and summary statistics

3.1. Sample selection

The sample consists of the stocks of 215 non-US companies announcing their first ADR programs that would be listed on the US exchanges, such as NYSE, NASDAQ, and AMEX, during the period of 2000–2009. This 10-year period was deliberately chosen to align with and compare to extant literature in financial leverage that used the observations between 2000 and 2009, which covers the global financial crisis of 2008 (e.g. Cheng and Tzeng, 2011; Kalemli-Ozcan et al., 2012). Evidence has been found that low leverage ratios of countries and low leverage levels of firms are key to survival or success particularly after the global financial crisis (Glick and Lansing, 2010; Tong and Wei, 2010).

This sample is constructed from data compiled by the Bank of New York and consists of all existing ADR programs. Each company must have an identifiable announcement and listing date before it can be included in the sample. In addition, return data on the underlying stock must be available for a time period starting 150 days before the announcement date and ending at least 150 days after the listing date. Return data for each stock and the corresponding national market index have been compiled from the Datastream international database. The daily closing price and dividend data have been used to compute daily total returns for each underlying security, while index returns are taken directly from Datastream (Miller, 1999).

Announcement dates are collected from the Lexis/Nexis database. The search algorithm uses keywords to find preliminary sample announcements. These include terms for the instrument, such as “American Depositary Receipts” and “ADR” since the first announcement is often for the initial application to SEC. The text and headlines of Lexis/Nexis articles were located through a search using the company name and these keywords. The announcement date is taken as the earliest press release written in English (Miller, 1999).

We subsequently collect a matched sample of rival firms in the US market from 2000 to 2009. A set of rival firms is defined in terms of the same four-digit SIC code as the sample firms (Chen et al., 2005; Grullon et al., 2006). Our intention is to analyze the reactions of rival firms to the cross-listing. Accordingly, we exclude those announcements without any rival firm in the cross-listed firm’s industry and those announcements of cross-listed firms that had other cross-listing announcements in the same industry during the period from 5 days before to 5 days after the initial announcement date. Finally, we exclude the cross-listed firms or their rival firms if no stock return data and financial information are available from the Center for Research in Securities Prices (CRSP) and Compustat (Chen et al., 2005).

3.2. Construction of competitive strategy measures

Competitive strategy measure (CSM) is constructed based on the concept of SS and SC, which involves capturing the effect of changes in the marginal profit of a firm in an industry on its own output with respect to a change in its competitors’ outputs (Sundaram et al., 1996). Certainly, data on the profits and outputs of the announcing firms and their competitors are needed for the construction of this measure. Following Sundaram et al. (1996), the set of competitors are all firms in the industry in which the announcing firm is by excluding the announcing firm itself. The industry is defined using four-digit primary SIC code within the Compustat. The profit of the announcing firm is defined as the net income of the announcing firm, while the net sales are considered as the output for both the announcing firm and competitors.

According to Sundaram et al. (1996), the CSM is formed by computing the correlation coefficient between a change in the announcing firm’s marginal profit and a change in the corresponding competitors’ output. Therefore, the ratio of the change in a firm’s net income $(Δ π^{f})$ to the change in its net sales (∆S^f), that is, $Δ π^{f} / Δ S^{f}$ , serves as the proxy for a firm’s marginal profit, while change in the competitors’ output (∆S^c) is proxied by the change in the competitors’ net sales. On the basis of these measures, the CSM is computed as the coefficient of correlation between $Δ π^{f} / Δ S^{f}$ against ∆S^c for 11 quarters prior to the announcement quarter. Accordingly, when the CSM is less than zero, it refers to SS, while it refers to SC when the CSM is greater than zero. When CSM equals zero, it defines neither SS nor SC (Sundaram et al., 1996).

3.3. Variable definitions

In this research context, variables, in addition to the CSM, employed in this article are constructed following the literature (Baker and Wurgler, 2002; Chan et al., 2001; Chaney et al., 1991; Chen et al., 2005; Deng et al., 1999; Hendricks and Singhal, 1997; Lang and Stulz, 1992) and described here. The financial leverage is defined as the book value of the total debt over the book value of the total assets for the fiscal year right ahead of the fiscal year of the cross-listing announcement. The firm size is computed using the natural logarithm of the book value of total assets for the fiscal year right ahead of the fiscal year of the cross-listing announcement. The advertising intensity is defined as the advertisement expenses over the sales for the fiscal year right ahead of the fiscal year of the cross-listing announcement. The R&D intensity is defined as the R&D expending over the sales for the fiscal year prior to the cross-listing announcement. Both advertising and R&D intensity represent a firm’s investment in marketing communications and technological innovation. They reflect firms’ commitment of financial resources to the building of two important value creation activities: marketing and technology. The resource-based view regards resources as sources of competitive advantage and superior performance (Bridoux, 2004; Hart, 1995). The degree of industry competition in the US market is designated by the Herfindahl index (HI) calculated as the sum of the squared respective sales proportion of industry sales by all firms in the industry for the fiscal year right ahead of the fiscal year of the cross-listing announcement. Finally, three dummy variables are defined as follows: emerging is equal to 1 if the announcing firm comes from the emerging market and zero, otherwise (Baker et al., 2002). High-tech is equal to 1 if the announcing firm follows the high-tech SIC code in Pagano et al. (2002) and zero, otherwise. Nasdaq is equal to 1 if the announcing firm is listed on the NASDAQ and zero, otherwise.

3.4. Methodology

The methodology adopted in this article is to examine the impact surrounding the firms’ initial ADR announcements, which refers to be the short-run abnormal returns (ARs). Therefore, in order to determine the short ARs, we first estimate the market model for each cross-listing announcing firm using the local currency’s daily returns based on the market capitalization weighted index for each country as the proxy for the market return. The data are retrieved from the Datastream. With the announcement day defined as day −1 and the day for the announcement news on media as 0, the market beta in the market model is estimated using the pre-announcement period from day −150 to day −26. The AR by the prediction errors from the market model and the two-day cumulative abnormal returns, CAR, from day −1 to day 0 are calculated.

3.5. Summary statistics

Table 1 lists the countries in which the ADR cross-listings are in the sample. Of the 208 announcements, 147 (71%) from NYSE, 59 (28%) from NASDAQ, and 2 (1%) from AMEX. Of the 30 countries listed in the sample, China has the largest number of firms with 68 (33%) and is followed by Brazil with 21 (10%). Table 2 shows that, in general, announcing firms have significantly smaller averages in the financial leverage ratio (15.22% vs 21.31%), advertising intensity (5.72% vs 6.81%), and R&D intensity (8.82% vs 9.07%) in comparison to those of rival firms in the US market. The relatively lower leverage ratios in the cross-listed firms indicate that those cross-listings are not in financial distress conditions but still choose to be listed in US institutional environment in which the standards of information disclosure and corporate governance are higher (Stulz, 1999). This means that cross-listings choosing to be bonded by relatively stringent institutional requirements on US markets might aim to improve their operational and research capabilities by entering the US markets with more resources in terms of reduction of cost of capital (Hail and Leuz, 2006) and better information environment (Lang et al., 2003) and additional attraction of investors.

Table 1.

The country spectrum of the cross-listed firms.

Country	Exchange and number of cross-listing				Market
Country	NYSE	NASDAQ	AMEX	Total	Market
Argentina	8	2	0	10	Emerging
Australia	3	2	1	6	Developed
Belgium	2	0	0	2	Developed
Brazil	20	1	0	21	Emerging
Chile	5	0	0	5	Emerging
China	33	35	0	68	Emerging
Colombia	1	0	0	1	Emerging
Denmark	0	1	0	1	Developed
France	3	0	0	3	Developed
Germany	4	0	0	4	Developed
Greece	1	0	0	1	Developed
Hong Kong	2	3	0	5	Developed
India	9	1	0	10	Emerging
Ireland	3	0	0	3	Developed
Israel	0	1	0	1	Emerging
Italy	2	1	0	3	Developed
Japan	7	0	0	7	Developed
Jersey	0	1	0	1	Developed
Korea	5	1	0	6	Emerging
Luxembourg	0	1	0	1	Developed
Mexico	7	3	0	10	Emerging
Netherlands	3	1	0	4	Developed
New Zealand	1	0	0	1	Developed
Norway	1	1	0	2	Developed
Russia	3	0	0	3	Developed
Spain	1	0	0	1	Developed
Switzerland	4	1	0	5	Developed
Taiwan	4	3	0	7	Emerging
Turkey	1	0	0	1	Emerging
United Kingdom	14	0	1	15	Developed
Total (30 countries)	147 (71%)	59 (28%)	2 (1%)	208 (100%)

The classification of cross-listed firms into emerging or developed markets follows Baker et al. (2002).

Table 2.

The firm characteristics of cross-listed and rival firms.

Firm characteristics	Announcing firms			Rival firms
Firm characteristics	Mean	Median	N	Mean	Median	N	Mean difference
Financial leverage (%)	15.22	15.36	208	21.31	22.82	552	−6.09**
Ln (firm size-million$)	6.55	5.79	208	6.93	6.56	552	−0.38
Advertising intensity (%)	5.72	5.48	208	6.81	6.26	552	−1.09*
R&D intensity (%)	8.82	8.35	208	9.07	7.45	552	−0.25+
Herfindahl index (%)	12.24	8.18	208	12.24	8.18	552	−

Herfindahl indices are calculated based on the industry level, which are the same for the cross-listed and rival firms within the same industry. Mean difference test is performed using the Wilcoxon Signed-Rank test.

, *, and + indicate significance levels at the 1%, 5%, and 10%, respectively.

Table 3 lists the descriptive statistics of CSM values of all cross-listed firms and across industries in the examined sample. The average CSM in our sample is −0.013 (median is −0.017) and has a range from 0.147 to −0.172. Most cross-listed firms compete in SS (138 firms with CSM < 0) in comparisons to those cross-listed firms competing in SC (70 firms with CSM > 0). In other words, most rival firms, in general, tend to stay put and employ the accommodating strategies in response to the cross-listing announcements. Cross-listed firms in the industries of computers, semiconductors, pharmaceuticals, chemicals, instruments, food, medical products, office equipment, and machine/hand tools are inclined to compete on SS, while cross-listings in the industries of electronics, telecommunications, leisure products, peripherals, and personal care lean toward to SC competition.

Table 3.

Average CSMs for cross-listing announcements.

	Panel A: The whole sample
	N	Mean	Median	Maximum	Minimum
All	208	−0.013	−0.017	0.147	−0.172
CSM > 0	70	0.041	0.042	0.147	0.003
CSM < 0	138	−0.041	−0.047	−0.002	−0.172
Industry	Panel B: Across industries
Industry		N	Mean	N CSM > 0	N CSM < 0
Chemicals	18	−0.076	2	16
Computers	32	−0.031	3	29
Electronics	31	0.043	24	7
Food	8	−0.124	0	8
Instruments	12	−0.003	2	10
Leisure products	6	0.082	6	0
Machine/hand tools	5	−0.087	0	5
Medical products	7	−0.032	0	7
Office equipment	5	−0.049	0	5
Peripherals	3	0.118	3	0
Personal care	4	0.076	4	0
Pharmaceuticals	21	−0.014	3	18
Semiconductors	30	−0.034	2	28
Telecommunications	26	0.014	21	5
Total	208	−0.013	70	138

The competitive strategy measure (CSM) is the correlation coefficient between a change in the cross-listed firm’s marginal profit and a change in the corresponding rival firms’ output.

4. Empirical results

In this section, the stock price responses for the cross-listing announcing firms and their corresponding rivals will be discussed and then the results of the cross-sectional regression analysis of the announcement-period CARs for cross-listed firms and industrial rival firms will be presented and expounded.

4.1. Univariate results

4.1.1. Cross-listing announcement effect

Table 4 provides estimates of ARs for the announcement and surrounding days. In general, the ARs of the cross-listed firms on the announcement days (day −1) are significantly positive (0.07%, p < 0.10). Additionally, the two-day accumulated ARs, CARs, of cross-listed firms around the announcement period (day −1 to day 0), CAR (−1, 0), are significantly positive (0.13%, p < 0.10) as well. These empirical results are consistent with previous studies and clearly show that cross-listing announcements experience a positive response from investors (Doidge et al., 2004; Miller, 1999; Pagano et al., 2002).

Table 4.

Average ARs and CARs of cross-listed and rival firms around the announcement day.

Event day	Announcing firms			Rival firms
Event day	Mean AR (%)	Median AR (%)	Wilcoxon Signed-Rank Statistic	Mean AR (%)	Median AR (%)	Wilcoxon Signed-Rank Statistic
[–25, −4]	−0.03	−0.03	−0.93	−0.02	−0.02	−0.65
−3	0.02	0.02	0.61	0.02	0.02	0.63
−2	0.04	0.03	1.14	0.01	0.02	0.43
−1	0.07	0.06	1.91+	−0.05	−0.04	−1.45
0	0.06	0.07	1.76+	−0.04	−0.04	−1.33
[–1, 0]	0.13	0.13	1.84+	−0.09	−0.08	−1.54
1	0.02	0.03	0.79	−0.03	−0.02	−0.98
2	0.01	0.01	0.45	0.02	0.01	0.68
3	−0.01	−0.02	−0.44	0.01	0.01	0.39
[4, 25]	0.04	0.05	1.23	0.05	0.04	1.39

AR: abnormal return; CAR: cumulative abnormal return.

+ indicates the significance level at the 10%.

On the other hand, the corresponding rivals experience both negative ARs on announcement days (−0.04%) and negative two-day accumulated returns (−0.09%) around the announcement period (day −1 to day 0) although results are insignificant. This indicates that rivals generally receive adverse market responses once their corresponding counterparts make their ADR announcements.

4.1.2. Financial leverage

Before proceeding to explore the strategic competition results, the behavior of ARs from financial leverage conditions is presented first to have a fundamental picture of market reactions to cross-listed firms and their corresponding rivals upon the announcements. As shown in Panel A of Table 5, the cross-listings with low financial leverage enjoy a significantly positive average CAR (0.13%, p < 0.10), while those cross-listings with high financial leverage have an insignificantly positive average CAR (0.08%) for the two-day announcement period. In contrast, rival firms, in general, have an insignificantly negative average CAR. Furthermore, rival firms with high financial leverage have a relatively more negative average CAR (−0.08%) in comparison to those low-leveraged rivals with a negative average CAR (−0.06%). The evidence shows that, upon cross-listing announcements, cross-listings usually gain, while the rivals lose in average. Additionally, less leveraged cross-listed firms receive an advantage of experiencing significantly positive market responses due to less financially constrained. On the contrary, rival firms suffer from their incoming competition, inevitably leading them to have negative market responses, especially for those with high leverage.

Table 5.

Announcement effect categorized by financial leverage and CSM.

	Announcing firms			Rival firms
	N	CAR	Wilcoxon Signed-Rank Statistic	N	CAR	Wilcoxon Signed-Rank Statistic
Panel A: Financial leverage category
High financial leverage	65	0.08	1.58	363	−0.08	−1.53
Low financial leverage	143	0.13	1.98*	189	−0.06	−1.39
Difference		0.05	1.45		0.02	0.79
Panel B: CSM category
SS	155	0.12	1.97*	369	−0.08	−1.57
SC	53	0.08	1.51	183	−0.05	−1.43
Difference		0.04	1.40		0.03	1.14

SS is the strategic substitutes. SC is the strategic complements. Panel A shows cumulative abnormal return, CAR, results of cross-listed firms and rival firms by financial leverage in which the classification is based on the mean financial leverage ratio. Panel B presents CAR results of cross-listed firms and rival firms by CSM.

indicates the significance level at the 5%.

4.1.3. Strategic substitution and SC

The market responses of cross-listing announcements to announcing and rival firms due to competition strategies are reported in Panel B of Table 5 in which the sample firms are classified into SS and SC categories based on CSM values. The results show that the CARs of cross-listed firms usually are positive regardless of competition strategies and those cross-listings with SS have a significantly positive average CAR (0.12%, p < 0.10). However, rival firms with SS have a negative average CAR (−0.08%) for the two-day announcement period, as do rival firms with SC (−0.05%). Thus, cross-listed firms gain a significant advantage from SS and experience a positive market response, while rival firms suffer losses from SS.

4.1.4. Financial leverage and competition strategy

The empirical results in the previous analyses already gave us fundamental ideas regarding the impact of financial leverage and competition strategies on the market responses to cross-listing announcements. This section provides the analyses of market responses impact caused by the interplay between financial leverage and competition among cross-listing announcing firms and corresponding rivals. Table 6 lists the empirical results of SS and SC for the cross-listing and rival firms according to their respective financial leverage conditions.

Table 6.

The CARs of cross-listed and rival firms based on the financial leverage and CSM.

Rival’s financial leverage	SS	SC
Panel A: Low financial leverage of cross-listed firms
High financial leverage
ACAR (%)	0.13**	0.10+
RCAR (%)	−0.13**	−0.04
Low financial leverage
ACAR (%)	0.18**	0.12*
RCAR (%)	−0.04	0.10+
Panel B: High financial leverage of cross-listed firms
High financial leverage
ACAR (%)	0.04	0.03
RCAR (%)	−0.17**	−0.02
Low financial leverage
ACAR (%)	0.04	0.03*
RCAR (%)	−0.06	0.08+

SS is the strategic substitutes. SC is the strategic complements. The classification of financial leverage is based on the mean financial leverage ratios. ACAR represents the cumulative abnormal returns of cross-listed firm. RCAR represents the cumulative abnormal returns of rival firms. The test is performed using the Wilcoxon Signed-Rank test.

, *, and + indicate significance levels at the 1%, 5%, and 10%, respectively.

Panel A of Table 6 presents the empirical results for the cross-listed firms with lower financial leverage. Empirical evidence shows that the market responses are all significantly positive to the cross-listed firms, especially for SS cases in which the market responses are larger than SC when the cross-listings have lower financial leverage. The rival firms have significantly negative market responses in general except for those rival firms with lower financial leverage and adoption of SC. This indicates that rival firms with lower financial constraints could resort to the non-accommodating strategies and might obtain positive market responses since the lower financial leverage allows rivals to gain resources to implement the non-accommodating strategies. It also indicates that firms with lower financial constraints could enjoy the positive market responses when they make cross-listing announcements. Consequently, the hypotheses of H1a, H1b, H2a, and H2b are supported.

The empirical results for the cross-listing firms with higher financial leverage are reported in Panel B of Table 6. As shown in Panel B, when the cross-listed firms have higher financial leverage, the market responses are all positive but not significant under both SS and SC. On the other hand, for rival firms with lower financial leverage, the market responses are insignificantly negative if SS is employed, while the market responses are significantly positive with the adoption of SC. Therefore, coupled with the results in Panel A of Table 6, it pays to use the non-accommodating strategies against the cross-listed firms for the rival firms if rival firms have lower financial constraints. In contrast, the cross-listed firms with higher financial constraints might not be able to remain in this competition campaign to gain positive market responses since the financial resources could be draining off without any further support. Therefore, the hypotheses of H3a, H3b, H4a, and H4b are supported.

4.2. Regression results

4.2.1. Cross-listed firms

The cross-sectional regression analyses of the two-day announcement-period CARs of the cross-listed firms are performed here to understand whether the findings in the previous sections still sustain with consideration of other possible determinants. The empirical results are reported in Table 7.

Table 7.

Regression analysis of cross-listed firms.

	Model
	1	2	3	4	5	6	7
Intercept	1.54 (1.32)	2.66 (1.42)	2.64 (1.38)	2.72 (1.43)	2.71 (1.39)	1.87 (1.42)	3.37 (1.29)
AFL	−0.24* (−1.96)	−0.26* (−1.97)	−0.22* (−1.98)	−0.23* (−1.99)	−0.24* (−2.01)	−0.22+ (−1.89)	−0.23+ (−1.78)
CSM	−0.43+ (−1.82)	−0.42+ (−1.86)	−0.41+ (−1.79)	−0.44+ (−1.86)	−0.45+ (−1.90)	−0.38+ (−1.77)	−0.37+ (−1.75)
AFL ×CSM						0.46* (1.99)	0.44* (1.96)
AS	0.24 (1.08)	0.26 (1.09)	0.22 (1.03)	0.25 (1.08)	0.23 (1.06)	0.28 (1.12)	0.26 (1.05)
AADI	0.43+ (1.81)	0.45+ (1.84)	0.41+ (1.79)	0.42+ (1.79)	0.44+ (1.83)	0.41+ (1.76)	0.44+ (1.81)
ARDI	0.67* (1.98)	0.65* (1.97)	0.67* (1.98)	0.66* (1.96)	0.68* (1.99)	0.63+ (1.95)	0.66* (1.96)
HI		−0.45 (−0.74)					−0.41 (−0.68)
Emerging			0.51+ (1.73)				0.49+ (1.71)
High-tech				0.86* (2.05)			0.82* (1.99)
Nasdaq					0.47+ (1.68)		0.43+ (1.67)
Year fixed effect	Yes	Yes	Yes	Yes	Yes	Yes	Yes
Industry fixed effect	Yes	Yes	Yes	Yes	Yes	Yes	Yes
Number	208	208	208	208	208	208	208
Adj-R² (%)	15.72	16.23	16.38	16.88	16.54	16.36	19.25
F-value	6.86**	6.93**	6.97**	7.18**	7.07**	6.89**	8.13**

The dependent variable is the two-day [–1, 0] cumulative abnormal returns of cross-listed firms. AFL is the financial leverage of cross-listed firms. CSM is the competitive strategy measure. AS is the firm size of cross-listed firms. AADI is the advertising intensity of cross-listed firms. ARDI is the R&D intensity of cross-listed firms. HI is the Herfindahl index. Emerging is the emerging country dummy. High-tech is the high-tech dummy. Nasdaq is the Nasdaq dummy. The year and industry effects are considered. The standard errors of estimated coefficients are adjusted for clustering effects of industries and years (Petersen, 2009). The t-statistics appear in the parentheses.

, *, and + indicate significance levels at the 1%, 5%, and 10%, respectively.

The Model 1 in Table 7 demonstrates a significantly negative relationship between the cumulative ARs, CARs, and the financial leverage, AFL, with a coefficient of −0.24 (p < 0.05). This lends the support to the argument that a less leveraged cross-listed firm has a significantly positive effect on firm value upon cross-listing announcements. The significantly negative correlation between the CSM and the CAR (−0.43, p < 0.1) suggests that SS engenders a positive impact on the value of cross-listings, while SC exerts a negative impact on the value of cross-listings. This indicates that cross-listings enjoy more positive market responses from SS than SC. The lower financial constraints in the cross-listings could alternatively gain the positive market response when SC happens. Furthermore, the cross-listings with the higher advertising intensity, AADI (the coefficient is 0.43, p < 0.10), and higher R&D intensity, ARDI (the coefficient is 0.67, p < 0.05), could have higher ARs, indicating that the cross-listed firms with more reputation and more R&D capabilities will receive more positive market responses. Nevertheless, the sizes of cross-listed firms do not matter in the determination of ARs on the cross-listing announcements.

As shown in Models 6 and 7 of Table 7, the cross-listings with less financial leverage coupled with SS will enjoy more positive market responses. This is corroborated with significantly positive coefficients of the interaction term between financial leverage and CSM measures in Model 6 (0.46, p < 0.05) and Model 7 (0.44, p < 0.05). On the contrary, the cross-listings with higher financial leverage could slash the positive market responses caused by SS. Additionally, this finding is robust to the consideration of other possible influential factors on CARs, such as the HI, firms from emerging countries (Emerging), high-tech firms (High-Tech), and firms listed on the NASDAQ (Nasdaq), even if the coefficients associated with Emerging (0.49, p < 0.10), High-Tech (0.82, p < 0.05), and Nasdaq (0.43, p < 0.10) are significant. Therefore, the financial leverage plays an important role in the impact of competitive strategies on the market response to cross-listed firms on the cross-listing announcements.

4.2.2. Rival firms

The corresponding cross-sectional regression analyses of the two-day announcement-period CARs of the rivals are implemented in Table 8. The empirical results in Model 1 of Table 8 show that the market responses to rivals are significantly adverse when the cross-listing announcing firms have higher cumulative abnormal returns (ACAR; −1.74, p < 0.10). Moreover, the lower (higher) the financial leverage of cross-listing announcing firms, the more negative (positive) the market responses to rivals (AFL; 0.52, p < 0.10). This indicates that the cross-listing announcements in general damage the corresponding rival firms more from announcing firms with more positive market responses and less financially constrained.

Table 8.

Regression analysis of rival firms.

	Model
	1	2	3	4	5	6	7	8
Intercept	1.67 (1.15)	1.69 (1.18)	1.72 (1.21)	1.71 (1.19)	1.78 (1.22)	1.58 (1.09)	1.61 (1.12)	2.03 (0.98)
RFL	−0.56 (−1.14)	−0.58 (−1.15)	−0.59 (−1.17)	−0.57 (−1.15)	−0.58 (−1.18)	−0.61 (−1.21)	−0.68+ (−1.69)	−0.51+ (−1.66)
AFL	0.52+ (1.88)	0.55+ (1.91)	0.54+ (1.90)	0.56+ (1.92)	0.55+ (1.89)	0.58+ (1.92)	0.61+ (1.93)	0.53+ (1.85)
CSM	0.82 (1.52)	0.83 (1.53)	0.85 (1.56)	0.84 (1.55)	0.88 (1.61)	0.89+ (1.68)	0.91+ (1.73)	0.88+ (1.69)
ACAR × CSM						−0.62+ (−1.69)		−0.59+ (−1.67)
RFL × CSM							−0.60+ (−1.72)	−0.62+ (−1.74)
ACAR	−1.74+ (−1.85)	−1.76+ (−1.91)	−1.77+ (−1.93)	−1.78+ (−1.94)	−1.76+ (−1.90)	−1.75* (−1.97)	−1.78* (−2.01)	−1.68* (−1.97)
RS	0.38 (0.74)	0.35 (0.76)	0.37 (0.78)	0.39 (0.81)	0.41 (0.92)	0.44 (0.95)	0.47 (1.02)	0.51 (1.12)
RADI	0.54 (0.88)	0.57 (0.91)	0.56 (0.92)	0.58 (0.95)	0.61 (1.02)	0.60 (1.01)	0.61 (1.03)	0.58 (0.98)
RRDI	0.72 (1.33)	0.73 (1.35)	0.74 (1.37)	0.75 (1.39)	0.71 (1.30)	0.72 (1.33)	0.74 (1.36)	0.75 (1.38)
HI		−0.38 (−0.46)						−0.41 (−0.49)
Emerging			−0.51+ (−1.71)					−0.50+ (−1.70)
High-tech				−0.64+ (−1.72)				−0.62+ (−1.69)
Nasdaq					−0.52+ (−1.66)			−0.51+ (−1.67)
Year fixed effect	Yes	Yes	Yes	Yes	Yes	Yes	Yes	Yes
Industry fixed effect	Yes	Yes	Yes	Yes	Yes	Yes	Yes	Yes
Number	552	552	552	552	552	552	552	552
Adj-R² (%)	15.49	15.66	15.55	15.72	15.68	16.23	16.31	19.48
F-value	6.11**	6.23**	6.18**	6.31**	6.25**	6.63**	6.69**	7.38**

The dependent variable is the two-day [–1, 0] cumulative abnormal returns of rival firms. RFL is the financial leverage of rival firms. AFL is the financial leverage of cross-listed firms. CSM is the competitive strategy measure. ACAR is the two-day [–1, 0] cumulative abnormal returns of cross-listed firms. RS is the firm size of rival firms. RADI is the advertising intensity of rival firms. RRDI is the R&D intensity of rival firms. HI is the Herfindahl index. Emerging is the emerging country dummy. High-tech is the high-tech dummy. Nasdaq is the Nasdaq dummy. The year and industry effects are considered. The standard errors of estimated coefficients are adjusted for clustering effects of industries and years (Petersen, 2009). The t-statistics appear in the parentheses.

, *, and + indicate significance levels at the 1%, 5%, and 10%, respectively.

The coefficients of the interaction term between the CSM and the cumulative returns of announcers, ACAR, are significantly positive in Model 6 (−0.62, p < 0.10) and Model 8 (−0.59, p < 0.10), while the coefficient of the CSM is significantly positive in Model 8 (0.88, p < 0.10). This tells us that rival firms typically receive negative responses from SS. The market responses to rivals could become negative if the cross-listings receive higher positive market responses and the rivals take the SC strategy.

As shown in Model 8 of Table 8, the coefficient (−0.51, p < 0.10) of the financial leverage of rivals, RFL, is significantly negative and the coefficient (0.88, p < 0.10) of the CSM is significantly positive. This shows that rivals with higher financial leverage and the adoption of SS will have more negative market responses, while rival firms with higher financial leverage and the adoption of SC might ease the negative market responses resulting from the financial constraint. Therefore, the empirical evidence supports hypotheses 1b and 2b that rival firms with higher financial leverage normally suffer negative market responses but could be alleviated if SC is employed. On the other hand, rivals with low financial leverage might have positive market responses if they adopt SC but will have weakening positive market responses if they adopt SS. This corroborates a view that the low financial constraint of rival firms could have more resources to strengthen positive market responses engendered through the adoption of SC or mitigate the negative market responses if SS is adopted. Therefore, the claims in hypotheses 3b and 4b are confirmed.

Furthermore, the interaction effect (−0.62, p < 0.10) between financial leverage and the competitive strategies of rival firms is significantly negative, which is shown in Model 8 of Table 8. This means that the rival firms with lower financial leverage and by adopting SC would have attracted extra positive market responses but could have obtained additional adverse market responses if SS is chosen. In contrast, the rivals with higher financial leverage will have the mitigating effect on the impact of either SS or SC. Coupled with results found in the financial leverage and the CSM, the market responses of cross-listing announcements to rival firms are crucially influenced by the financial leverage status of rivals.

5. Theoretical and managerial implications

This research is intended to bridge the current gap in theories on financing behavior and cross-listing behavior, both of which can be explained based on information asymmetry (Gertner et al., 1988; Myers and Majluf, 1984). It advances our understanding of the strategic interaction between cross-listed firms and their rivals, with respective capital structures, by proposing and testing a dyadic model that applies signaling theory, complemented by other information-based theories, in cross-listing. In a sense, the main motive of cross-listing shares in foreign exchanges is to reduce information asymmetry and improve a stock’s information environment (Charitou and Louca, 2009; Dodd, 2013). In our model, announcements of cross-listing are regarded as the sending of signals and analyzed from the viewpoint of the signaler. The signaling approach to cross-listing behavior and its impacts on firm value, given various financial leverage levels, lies in the premise that “it is all about information” (Erdem and Swait, 1998: 131).

Information economics-based rationale of this research predicts that cross-listing positively influences firm growth mainly by the preferred use of equity financing because of transparency created as a result of the adherence to the stringent laws in the host country (Burns et al., 2007). The findings of the research are consistent with theoretical arguments that the financing behavior of firms affects their operating and investing decisions and cross-listing enhances firm value particularly in competitive contexts. Despite the importance of capital structure decisions, it is not our intention to enter into the seemingly never-ending debate over a preference for financing behavior and the existence of an optimal leverage level (Jensen and Meckling, 1976; Masulis, 1980; Modigliani and Miller, 1958; Myers, 1984; Myers and Majluf, 1984). Undoubtedly, the research seems to be positioned in favor of equity financing, instead of debt financing, which is supported by theories like pecking order theory (Jensen and Meckling, 1976). The positioning can be justified as puzzling empirical regularity has been found in the capital structure literature that firms appear to borrow less than the dominant theories predict. Our results are also in line with empirical evidence that paradoxically, large, liquid, profitable firms with low expected distress costs use debt conservatively and firms sacrifice borrowing today to enhance their ability to seize better growth opportunities in the future (Graham, 2000; Marchica and Mura, 2010).

The research also provides the basis for several managerial suggestions. First, managers should actively manage financial leverage. As a lower financial leverage provides financial resources for market competition, such as the entry of cross-listed firms into a new market, this is an important advantage. Such firms can obtain capital easily and lower capital costs. These lower leveraged cross-listed firms are then able to be aggressive in the market to ensure their subsequent performance. In other words, less financially leveraged cross-listed firms can easily raise funds to infuse the market competition. Second, the less financially leveraged cross-listed firms with SS strategy for entry into the market would be much more competitive, causing obviously negative impacts on their financially leveraged competitors. If high financially leveraged competitors are not able to easily obtain financing in the capital market, they are unable to protect their existing products from substitution by less financially leveraged cross-listed firms. This means that the cross-listed firms are able to grab the market share of competitors. Finally, if the less financially leveraged cross-listed firms utilize the SC strategy to enter the market, there is no subsequent negative effect on their financially leveraged competitors. The goal of these firms is to enlarge the market and complement their rivals, rather than a direct competition in the product market.

6. Conclusion

The question of how financial leverage and competitive strategy affect market competition has remained an open empirical issue. In this research, we carefully analyze and compare the relationships between financial leverage and competitive strategy in cross-listed firms and their competitors.

The empirical evidence shows that the announcement effect of less leveraged cross-listed firms is significantly positive both in SS and SC. Cross-listed firms are affected positively by the move because cross-listing offers a firm some key advantages, such as access to cheaper capital, risk-sharing, future growth opportunities, and financial flexibility (Schoubben and Hulle, 2011). We find similar positive cross-listing effects to those found in earlier studies (Doidge et al., 2004; Miller, 1999; Pagano et al., 2002). One reason that cross-listed firms in SS have a significantly positive response is because SS may displace the products of rival firms and take market share from these rival firms.

The announcement impact of highly leveraged rival firms in SS tends to be negative. A rival firm’s high financial leverage may reduce the intensity of market competition. In other words, high financial leverage weakens a rival firm’s competitive competence in the market because such leverage limits the use of debt and constrains a firm’s ability to raise capital and undertake competitive action. This negative impact is particularly enhanced when the competitive strategy utilized is SS. Our results show that highly leveraged rival firms in SS suffer obviously negative effects since they have no choice but to behave passively and suffer the substitute effect from SS.

Finally, the announcement impact of less leveraged rival firms in SC is significantly positive. A rival firm’s low financial leverage tends to give them a greater ability to respond effectively to market competition. In other words, the low financial leverage strengthens a rival firm’s competitive competence because such leverage provides the ability to raise capital and make more aggressive competitive actions. When SC occurs, the positive impact is increased. The low leveraged rival firms in SC experience significantly positive effects because they can react aggressively and receive a complementary effect from SC. Additionally, when the cross-listed firms come from emerging countries, are high-tech firms, or cross-list on NASDAQ, they generally have significantly positive impacts on firm value, but the effect on rival firms is negative.

Footnotes

Final transcript accepted: 11 July 2018 by Karen Benson (AE Finance).

Funding

The author(s) received no financial support for the research, authorship, and/or publication of this article.

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