The Impact of Sarbanes-Oxley on Cross-listed Companies*

Philip G. Berger Graduate School of Business, University of Chicago, 5807 S. Woodlawn Ave., Chicago, IL 60637

Feng Li University of Michigan Business School, 701 Tappan St., Ann Arbor, MI 48109

and

M. H. Franco Wong

Graduate School of Business, University of Chicago, 5807 S. Woodlawn Ave., Chicago, IL 60637

January 8, 2005

Extremely preliminary draft – Please do not cite without permission. Comments welcome.

* Berger gratefully acknowledges financial support from the Neubauer Family Faculty Fellows program at the University of Chicago Graduate School of Business.

Abstract

We use the unexpected application of the Sarbanes-Oxley Act (SOX) of 2002 to cross-listed companies to examine how an exogenous improvement in investor protection affects shareholder wealth and the monitoring and disclosure environment. We find that the stock market reaction to SOX is more positive for firms from countries with weak private enforcement of investor rights. This finding is consistent with SOX improving investor protection and with such improvements enhancing firm value. We also document changes in the behavior of institutional blockholders and sell-side analysts after SOX that are consistent with SOX enhancing investor protection for foreign private issuers and, as a result, altering the incentives of monitoring and disclosure intermediaries. We find decreases in analyst following and in percentage ownership by outside blockholders after passage of SOX. The cross-sectional variation in the change in analyst following is weakly positively associated with several measures of investor protection. These results provide modest evidence of SOX substituting for the monitoring role of analysts. The cross-sectional variation in the change in percentage ownership by outside blockholders is strongly positively associated with several measures of investor protection. These findings support the hypothesis that SOX’s direct regulation of corporate governance at cross-listed firms substitutes for the monitoring role of outside institutional blockholders.

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1. Introduction

This paper uses the unexpected application of the Sarbanes-Oxley Act (SOX) of 2002 to

cross-listed companies to examine how corporate governance and securities laws affect both firm

value and external monitoring activities.1 As the legislative process leading to the adoption of

SOX was concluding, it was realized that the language being used in the new law would cause it

to apply to foreign firms with U.S.-listed securities. Perino (2003) investigates why Congress

applied Sarbanes-Oxley to foreign private issuers and concludes that in its rush to legislate

Congress “simply failed to give much consideration to the issue.” Although the SEC had limited

discretion to relax some of SOX’s requirements for foreign private issuers (particularly to reduce

conflicts with home-country law), little relief from SOX’s provisions ended up being provided

by the SEC. Thus, for foreign private issuers, the passage of SOX appears to have been an

exogenous and extreme change in both corporate governance requirements and securities law.

A vast literature addresses corporate governance problems and the mechanisms used to

address them. Corporate governance problems relate to the separation between outside investors

and managers. Dispersed ownership increases these problems by giving rise to conflicts between

claimholders and by creating a collective action (free rider) problem among investors. In most

countries, but not the U.S., the favored mechanism for reducing the collective action problem

among shareholders is concentrated control by large shareholders.2 However, this solution gives

rise to two significant costs: i) the potential for large shareholders to collude with managers

against minority shareholders and ii) reduced liquidity of secondary markets. Many foreign

1 By cross-listed companies, we mean firms that are legally defined as “foreign private issuers” in the U.S. Under U.S. securities laws, a “foreign private issuer” is defined as any issuer, other than a foreign government, that does not have more than 50 percent of its outstanding voting securities held by U.S. residents and that does not satisfy any one of three conditions: (i) the majority of directors or executive officers are U.S. citizens or residents; (ii) more than 50 percent of the issuer’s assets are located in the U.S.; or (iii) the issuer’s business is administered principally in the U.S. (17 C.F.R. § 240.3b-4(c) (2003)).

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firms with dominant shareholders have in recent years cross-listed their shares on the U.S. equity

markets, perhaps in an attempt to reduce these costs of concentrated control.

While prior research provides strong evidence that cross-listing does indeed improve

liquidity (Domowitz, Glen, and Madhavan (1998) and Foerster and Karolyi (1998)), a debate is

ongoing about the extent to which cross-listing actually improves minority shareholder

protection. The legal bonding (or functional convergence) hypothesis, most broadly developed

by Coffee (1999, 2002a, 2002b), argues that American laws covering U.S.-listed foreign firms

can potentially deter insiders from engaging in extraction of private benefits. Using agency

theory, Coffee, as well as Fuerst (1998) and Stulz (1999) predict that U.S. laws could protect

minority shareholders. Recent studies by Reese and Weisbach (2002), Mitton (2002), Doidge,

Karolyi and Stulz (2004), and Doidge (2004) provide empirical support for the legal bonding

benefit of U.S. cross-listing.

Others have questioned the interpretation of this evidence and called for more direct tests of

the legal bonding hypothesis (Cheung and Lee (1995), Licht (2000), and Leuz et al. (2003)).

MacNeil (2001) finds that the legal commitments made by foreign firms listing in London are

not as strong as prior work had argued. La Porta et al. (2000) contend that cross-listing in New

York would improve disclosure, but would not give minority shareholders many effective rights.

Fanto (1996) goes even further in arguing that SEC disclosure requirements are effectively

meaningless. Licht (2000, 2003) argues that managerial opportunism might lead insiders to take

advantage of poor U.S. enforcement.

Siegel (2004) finds support for these arguments using a detailed analysis of behavior by

insiders of Mexican American Depository Receipt (ADR) firms. He finds that U.S. laws and

2 Black (1990) provides a detailed description of the legal and regulatory limits on the exercise of power by large shareholders in the U.S.

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regulations did not deter Mexican firm insiders from engaging in illegal asset taking, and that

only minimal penalties were imposed on the insiders by U.S. legal and regulatory institutions

after the alleged asset taking occurred. Siegel does find, however, that financial markets

responded unfavorably in their willingness to provide subsequent capital to the offending firms.

He thus concludes that there is not a pooling equilibrium in which all cross-listed firms obtain a

(legal) bonding benefit, but rather there is a separating equilibrium in which some cross-listed

firms obtain a (reputational) bonding benefit through their good behavior during home-country

economic downturns.

Our research contributes to the ongoing debate about the legal bonding hypothesis because

our predictions represent joint tests of whether legal bonding was an important motive for cross-

listing prior to SOX and what the impact of SOX is on the extent of legal bonding. For the

population of foreign private issuers with available data, we investigate shareholder wealth

effects and changes in the behavior of external monitors surrounding passage of SOX in 2002.

We estimate stock price effects overall and examine the factors that explain the cross-sectional

variation in these effects.

We find that the value-weighted portfolio of foreign private issuers had a significantly more

negative stock price reaction to SOX than did the value-weighted U.S. market. We interpret the

negative reaction of the foreign issuers as indicating that any incremental legal bonding benefit

provided by SOX for cross-listed firms was exceeded by SOX’s incremental costs.

Nevertheless, because our interest is in SOX’s incremental bonding benefits (and because the

indirect costs are difficult to measure), our cross-sectional stock price reaction tests focus on

whether the bonding benefits can explain the variation in foreign private issuers’ reaction to

SOX.

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The cross-sectional event study results provide some support for the notion that the stock

market reaction of foreign issuers is increasing in the legal bonding benefits provided by SOX.

We find that SOX is more beneficial to foreign issuers from countries with high judicial

efficiency, which presumably helps to enforce investor rights derived from cross-listing, and

from countries with weak private enforcement. We find the private enforcement result to be

attributable to disclosure standards on governance and ownership information and burden of

proof on investors seeking to recover damages in civil liability cases. In contrast, investor

protection derived from corporate law (anti-director rights) and public enforcement has no power

in explaining the impact of SOX on foreign issuers. La Porta et al. (2005) also find that private

enforcement, rather than public enforcement and anti-director rights, plays a role in the

development of financial markets around the world. Our results are consistent with SOX being

particularly useful in helping foreign issuers from countries with weak private enforcement to

capture their growth opportunities. The cross-sectional event study results are thus suggestive of

SOX affecting foreign private issuers differentially based on the home-country investor

protections they faced at the time of SOX’s passage.

The cross-sectional event study results are somewhat supportive of the joint hypothesis that

firms cross-list, at least in part, to obtain legal bonding benefits and that SOX enhanced the

extent of legal bonding obtained by cross-listed firms. In other words, these results are

consistent with cross-listing reducing the costs of concentrated control on minority shareholders

and with SOX reducing these costs even further.

Because cross-listed firms typically have both a controlling shareholder style of corporate

governance and access to U.S. securities law and securities markets, other governance issues

arise. In stock market economies, outside block shareholders are often viewed as monitors of

firm management because, by virtue of the size of their stake in the firm, they have an incentive

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to actively oversee management. In stock market economies, dispersed small shareholders can

face free-rider problems in monitoring firm management if monitoring is costly (Grossman and

Hart (1980), Shleifer and Vishny (1986)). The empirical evidence for the U.S., while somewhat

mixed, appears to support the importance of large shareholders in increasing firm value.3

What the U.S. evidence on outside blockholders implies about their impact on cross-listed

firms is, however, far from clear. Outside blockholders might be so powerful that they monitor

the controlling shareholders, reducing their extraction of private benefits of control. On the other

hand, outside blockholders who are able to extract significant private benefits may collude with

controlling shareholders against the interests of minority shareholders. In order to focus on the

monitoring role of outside blockholders we restrict our attention to outside institutional

blockholders, who are unlikely to be able to extract large private benefits from arrangements

such as artificially priced business contracts with the foreign private issuer. If enactment of SOX

increases minority shareholder protection and thus lowers the benefit of outside monitoring, it

seems likely to reduce the benefit of being an outside institutional blockholder.

The preceding discussion suggests that the incentives of monitors (such as blockholders) of

foreign issuers are altered by SOX. In addition, the incentives of disclosure intermediaries for

foreign issuers (such as analysts) may also be altered by SOX. On one hand, Ribstein (2003)

argues that SOX reflects a shift from the traditional philosophy underlying U.S. securities laws

of requiring disclosure to also attempting to substantively regulate corporate governance. The

shift away from an exclusive emphasis on disclosure may result in less demand for disclosure

intermediaries. On the other hand, recent evidence by Lang, Lins and Miller (2004) finds that

analysts are less likely to follow firms with insider controlling shareholders and that this relation

3 See Demsetz and Lehn (1985), Mikkelson and Ruback (1985), Holderness and Sheehan (1988), Barclay and Holderness (1991), and Zeckhauser and Pound (1990).

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is stronger for firms from low-shareholder-protection countries. SOX likely shifts upward the

level of investor protection for cross-listed firms from these countries, which may increase

analyst following. We pursue the impact of SOX on monitoring and disclosure intermediaries by

examining whether the extent of blockholder and analyst interaction with foreign private issuers

changed after SOX as a function of the extent to which SOX affected the particular issuer’s

monitoring environment.

We find significant decreases in industry-adjusted analyst following and in percentage

ownership by outside blockholders for the period from September 30, 2001 to September 30,

2003. The decrease in analyst following can be viewed from either a disclosure or a monitoring

perspective. From a disclosure perspective, it is consistent with the improved public disclosure

that resulted from SOX substituting for private information acquisition by analysts. From a

monitoring perspective, our finding contrasts with Lang, Lins and Miller’s (2004) conclusion

that analysts are less likely to follow firms with insider controlling shareholders and that this

relation is stronger for firms from low-shareholder-protection countries. The decrease in

percentage ownership by outside blockholders is consistent with SOX increasing minority

shareholder protection and, as a result, reducing the benefit of being an outside blockholder.

The cross-sectional variation in the industry-adjusted change in analyst following is weakly

positively associated with several measures of investor protection. These results provide modest

support for SOX substituting for the monitoring role of analysts. The cross-sectional variation in

the industry-adjusted change in percentage ownership by outside blockholders is strongly

positively associated with several measures of investor protection. These findings offer strong

support for the hypothesis that SOX’s direct regulation of corporate governance at foreign

private issuers substitutes for the monitoring role of outside institutional blockholders.

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The remainder of the paper is organized as follows. Section 2 develops our hypotheses

and section 3 provides sample selection and descriptive information. Our empirical tests are

developed and results are presented in section 4. Section 5 concludes, appendices A – C provide

event dates related to SOX, and appendix D describes the investor protection and control

variables used as explanatory variables in our tests.

2. Hypothesis Development

Predictions about stock market reaction

Our predictions represent joint tests of the motive underlying the foreign private issuer’s

decision to cross-list in the U.S. prior to SOX and the impact of SOX on the costs and benefits of

being cross-listed given that motive. Our maintained hypothesis is that legal bonding is an

important motive for firms that cross-list. There are other theories of cross-listing (related to

market segmentation, investor recognition, and liquidity), but they do not have clear implications

for SOX event reactions because in these theories cross-listing is not motivated by the level of

home-country investor protection.

The bonding explanation for cross-listing presumes that large foreign firms are the ones with

the potential to cross-list and that such firms are generally controlled by large shareholders (see,

e.g., Coffee 1999, Stulz 1999, Reese and Weisbach 2002). These large shareholders exploit their

position to extract private benefits of control through such actions as asset transfers, excessive

perquisite consumption, or even outright theft. By cross-listing, these controlling insiders

commit to extract lower private benefits of control because of “renting” U.S. securities laws and

disclosure standards via the cross-listing. The commitment facilitates lower cost access to global

capital markets. Consistent with this hypothesis, Reese and Weisbach (2002) find an increase in

equity issuance both in the U.S. and abroad by foreign firms cross-listed in the U.S., especially

for those from countries with weak investor protection.

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Controlling insiders who select to cross-list do so with the expectation that the private

benefits they are foregoing as a result are smaller than their share of the increase in firm value

that results from the lower cost access to capital. This is more likely when the controlling

shareholder’s firm has valuable growth opportunities that cannot be financed internally or with

riskless debt. Doidge et al. (2004) show that the increase in firm value (premium) from cross

listing is positively related to the firm’s growth opportunities. They also find the cross-listing

premium is inversely related to home country investor protection, consistent with bonding to

U.S. law being more valuable when it adds more to the level of investor protection.

If bonding is an important motive for cross-listing, then any impact of SOX on bonding will

be incremental to what was already achieved by cross-listing. Recent studies support the legal

bonding benefit of U.S. cross-listing (Reese and Weisbach (2002), Mitton (2002), Doidge et al.

(2004), and Doidge (2004)). Other studies, however, indicate that the legal bonding achieved by

cross-listing is only partial (MacNeil (2001), La Porta et al. (2000), Fanto (1996), Licht (2000,

2003), and Siegal (2004)). On balance, the literature indicates that cross-listing prior to SOX

raised the level of investor protection for foreign private issuers, but did not raise it all the way to

the level that applied to domestic U.S. issuers. The application of SOX to foreign private issuers

may therefore have further raised the level of investor protection and thus created additional

bonding benefits for the shareholders of foreign private issuers. Thus, we predict that the stock

price response to SOX is inversely related to the level of investor protection in the issuer’s home

country and positively related to the foreign private issuer’s growth opportunities.

We use several country-level variables to characterize the quality of investor protection of

the foreign issuers’ home jurisdictions. The anti-director rights index captures the strength of

corporate law in protecting the rights of minority shareholders against management and majority

shareholders with respect to the decision-making and voting processes. Judicial efficiency

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measures the “efficiency and integrity of the legal environment as it affects business, particularly

foreign firms” and is used by LaPorta et al. (1998) to capture the quality of law enforcement.

LaPorta, Lopez-de-Silanes, Shleifer, and Vishny (1998) show that the indices for both anti-

director rights and judicial efficiency are highest in common-law countries, while French-civil-

law countries have the lowest measures for these investor protections.

While one can view judicial efficiency as simply another indicator of investor protection, it

might also measure the relaxation of a barrier to effective bonding. This is because the home

country’s judicial system may be required to enforce investor rights obtained from cross-listing.

Doidge et al. (2004) find evidence consistent with judicial efficiency capturing the relaxation of

a barrier to effective bonding. Because enforcement of some aspects of SOX requires

cooperation from the home-country legal system, we expect judicial efficiency to also facilitate

SOX’s ability to achieve incremental legal bonding. Therefore, we predict a positive association

between the stock price response to SOX and judicial efficiency.

Securities law also provides investor protection. LaPorta, Lopez-de-Silanes, and Shleifer

(2005) examine the role of securities laws in the development of financial markets. They

analyze the specific rules in securities laws governing security issuance and measure how these

rules facilitate the private and public enforcement of investor rights. The disclosure

requirements and burden of proof indices capture the private enforcement aspect of securities

law. They measure the extent to which standardized disclosures and clarification of liability

rules help reduce the costs of private contracting and of enforcing those contracts. The

supervisor characteristics, investigative powers, orders, and criminal sanctions indices measure

the ability of the public enforcers (e.g., the SEC) to implement securities law and, hence, they

capture the public enforcement aspect of securities law.

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Together, anti-director rights, judicial efficiency, and private enforcement and public

enforcement (and their sub-indices) measure the quality of corporate and securities laws and the

quality of law enforcement in protecting minority investors.

We measure growth opportunities as the two-year sales growth rate of the foreign issuer.

Finally, we use the logarithm of the market value of equity to control for size and we measure

leverage as the ratio of long-term debt to total assets. We expect that the net benefit of SOX is

increasing in firm size if the implementation cost of SOX is fixed. We cannot predict the effect

of leverage, as it might facilitate bonding or tempt insiders to expropriate minority shareholders

(instead of bondholders) in weak investor protection environments.

Predictions about changes in the behavior of external monitors

Because SOX regulates the governance of foreign issuers, it might have the effect of

changing the equilibrium level of other governance mechanisms. In particular, SOX could have

a real effect on the incentive of external monitors to oversee management and the controlling

shareholders. A large body of literature emphasizes the monitoring role of external

blockholders. If the value of this source of external monitoring is presumably greater when the

firm’s other sources of investor protection are weaker, ownership in a foreign private issuer by

external blockholders should be negatively related to the quality of the foreign issuer’s corporate

governance. Presumably, institutional investors take on this role because there are gains from

doing so. The new governance regulation imposed by SOX might lower the value of external

monitoring to the minority shareholders and thus lower the gains to the institutional blockholders

from monitoring. Therefore, we predict that the changes in the number of external blockholders

and in blockholder percentage ownership following SOX are inversely related to the extent to

which SOX increases investor protection. We capture investor protection and other firm

characteristics using the same set of variables we use in the market reaction tests.

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Predictions about changes in the behavior of disclosure intermediaries

Changes in a firm’s governance environment could affect the behavior of the disclosure

intermediaries who interact with the firm. Because disclosure is itself an important monitoring

mechanism, other changes in corporate governance could affect the monitoring value of a fixed

level of disclosure intermediary informativeness. In addition, changes in corporate governance

may change the level of disclosure intermediary informativeness by affecting the intermediary’s

cost of accessing reliable information from the firm.

The value of monitoring by a disclosure intermediary is presumably increased when the

governance environment is weaker. Scrutiny from disclosure intermediaries should increase

transparency and thus make it more difficult for managers to extract private benefits of control.

However, the cost for a disclosure intermediary to provide a given level of monitoring may also

be higher when the governance environment is weaker because the firm being followed is less

likely to be forthcoming with reliable information. Lang and Lundholm (1996) and Healy,

Hutton, and Palepu (1999) find that analyst following is positively associated with disclosure

quality for U.S. firms. Internationally, Bushman, Piotroski, and Smith (2004a) find that both

disclosure quality and investor protection are positively correlated with analyst following.

Bushman, Piotroski, and Smith (2004b) show that both the intensity and breadth of analyst

coverage increase after a country enforced its insider-trading laws. These findings are consistent

with Leuz, Nanda, and Wysocki’s (2003) contention that controlling shareholders can reduce the

likelihood of outside intervention by reducing the information content of financial statements via

earnings management. Under this view, one would expect analyst following to increase post

SOX.

On the other hand, if the monitoring role of a disclosure intermediary diminishes following

SOX, investors are likely to value its services less. This, in turn, would lower the compensation

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for the intermediary’s services. If the net gain to the disclosure intermediary is negative, it

would drop its coverage of the firm and divert its time to other activities. In other words, SOX

crowds out the disclosure intermediary as a monitor. Under this veiw, one would expect analyst

following to decrease in the post-SOX period. Hence, the real effect of SOX on analyst

following is an empirical question.

3. Descriptive Information

3.1 Event History

We start with the list of key events leading to the passage of SOX identified by Li, Pincus,

and Rego (2004). Appendix A describes the key events and the corresponding event dates. We

include these event dates in the estimation of the foreign issuers’ stock price reactions to SOX.

Next, we search for any events in the deliberation process that indicate the applicability of

SOX to foreign issuers. Perino (2003) argues that SOX was never meant for foreign issuers and

the only mention of foreign issuers during congressional deliberations occurred on the last day of

the Senate debate when Senator Enzi (R-WY) commented on the finalized bill. To ensure that

we correctly identify all the related events, we search the legislative history of the House Bill

number H.R. 3753, Senate Bill number S 2673, and Public Law 107-204, using the

Congressional Information Services (CIS) index in the Lexis Nexis Congressional database. We

electronically search each document for the key words “foreign” or “issuer” and read the

resultant paragraphs to look for discussions that are related to foreign private issuers. We find

three events that are directly related to foreign issuers (see appendix B).

The full Senate began debate on bill number S. 2673 on July 8, 2002. Senator Sarbanes (D-

MD) submitted an amendment to clarify the definition of “issuers” in the bill. While the legal

definition does not directly mention the term “foreign issuers,” it effectively states that the

proposed law would apply to all “reporting companies.” Hence, it implies that the foreign

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private issuers we study (i.e., those that are traded on U.S. exchanges) would be subject to the

new law. The Senate agreed to the Amendment (No. 4173).

On July 12, 2002, Senator Dorgan (D-ND) submitted Amendment No. 4215 to clarify that

the requirement that certain officers certify financial reports applies to domestic and foreign

issuers. The amendment was agreed to in the Senate.

On July 25, after the Congress passed the Conference Report that reconciled the House and

Senate bills, Senator Enzi (R-WY) commented on the applicability of the Act to foreign private

issuers:

In addition, I believe we need to be clear with respect to the area of foreign issuers and their coverage under the bill's broad definitions. While foreign issuers can be listed and traded in the U.S. if they agree to conform to GAAP and New York Stock Exchange rules, the SEC historically has permitted the home country of the issuer to implement corporate governance standards. Foreign issuers are not part of the current problems being seen in the U.S. capital markets, and I do not believe it was the intent of the conferees to export U.S. standards disregarding the sovereignty of other countries as well as their regulators… Under the conference report, section 3(a) gives the SEC wide authority to enact implementing regulations that are ‘necessary or appropriate in the public interest.’ I believe it is the intent of the conferees to permit the Commission wide latitude in using their rulemaking authority to deal with technical matters such as the scope of the definitions and their applicability to foreign issuers. I would encourage the SEC to use its authority to make the act as workable as possible consistent with longstanding SEC interpretations. (148 Congressional Record S7356, July 25, 2002)

We also search the website of the Organization for International Investment (OFII), which

keeps track of SOX events that would affect their member firms (mainly foreign private issuers).

We do not find any SOX-related news before the signing of the SOX on July 31, 2002.

Hence, we believe that the three events listed in appendix B are the only ones during which

information about the applicability of SOX to foreign issuers was made available to stock market

participants. We note that the first two events overlap with event nine identified by Li et al.

(2004). Within this event window (July 8 to July 17), seven events occurred (see appendix A).

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Hence, the stock price reactions of the ADR sample firms in this event window should be

interpreted with this in mind. Our third event took place in the same window as event eleven in

Li et al. (2004), in which the House and Senate passed the Conference Report on July 25.

On July 30, 2002, President Bush signed the bill into law and two sections of the Act became

effective immediately. We keep track of subsequent events and the SEC implementation of the

Act’s provisions (see appendix C). In the post-SOX period, the foreign private issuers and,

especially, OFII actively lobby the SEC to provide exemptions or accommodation to the foreign

issuers, when the proposed rules are inconsistent with the laws or practices of foreign issuers’

home jurisdictions (OFII wrote two comment letters to the SEC). We collect the SOX-related

press releases on the SEC’s website (http://sec.gov/spotlight/sarbanes-oxley.htm), which

provides the full text of the proposed and adopted rules, as well as the comment letters received

during the rulemaking process.

We control for these subsequent events in the market reaction estimation to control for the

possibility that these events lead to stock price reactions for the ADR firms and affect the

estimation of the market reactions on the event days of interest. An alternative way to control for

the potential market reactions to these subsequent events is to restrict our estimation period to the

end of July 2002, thereby avoiding these subsequent events. We choose the first approach as it

allows us to cover the entire event history of SOX.

3.2 Sample and Data

We focus on foreign private issuers that are listed in one of the U.S. stock exchanges via

ADRs or direct listing (i.e., Level-II and Level-III ADRs). Unlike those cross-listed by way of

OTC listings (Level-I ADRs) or Rule 144a private placement offerings (Level-IV ADRs), the

exchange-traded foreign issuers are subject to SEC rules, exchange requirements, and U.S. laws.

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Therefore, they are more likely to be cross-listed in the U.S. for bonding reasons, which is the

maintained assumption for our analysis.

We first get the ADR (Level-II and Level-III) sample using information from CRSP,

Compustat, and Bank of New York. In particular, we use the CRSP share code between 30 and

39 to identify all publicly-traded ADRs as of February 1, 2002. Next, we use the Compustat

country codes 9 and 49 to identify all Canadian and Israeli firms that are directly listed in the

U.S. We verify this sample and obtain the country of origin for these companies using

information from the Bank of New York Depositary Receipt Services, NYSE, and NASDAQ.

This procedure produces 662 foreign private issuers.

We obtain daily stock price and return data from CRSP, financial statement data from

Compustat, and country-level data from La Porta et al. (2005). Appendix D details the

construction of the country-level variables. We require the sample firms to have no missing

daily stock returns during the period from December 1, 2001 to June 30, 2003 (the estimation

period for the stock price reaction tests). We also require that the sample firms have country-

level investor protection and firm-specific characteristic variables. These two requirements

reduce the sample size to 490 foreign issuers.

3.3 Descriptive Statistics

Table 1 reports summary statistics for the 490 foreign private issuers. The variables used to

capture investor protection are measured at the country level. Panel A in table 1 shows that the

median Anti-director rights and Judicial efficiency are 5.0 and 9.25, respectively. Hence, the

median firm is subject to a high level of investor protection. The range of Private enforcement is

between 0.18 and 0.958. The ranges for the other country-level variables are also very large.

Hence, the sample spans a wide range of countries with different levels of investor protection

laws and legal enforcement. Sales growth, leverage, and the logarithm of the market value of

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equity are firm-specific variables and they are winsorized at the 1% and 99% levels. Median

two-year sales growth is 20% and median leverage is 14.3%.

Table 1, panel B, presents the correlation matrix for the explanatory variables. In general, the

country-level variables are highly correlated. For example, the correlation between Anti-director

Rights and Private enforcement is 0.752 and that between Private and Public enforcement is

0.631. The high correlations are consistent with those documented in La Porta et al. (2003) at

the country level.

Panel C details the country-level variables by legal origin and country. We also report the

number of foreign issuers from each country in the second column. In general, the number and

distribution of our sample firms in each country is similar to those of the samples used by Reese

and Weisbach (2002) and Doidge et al. (2004).

4. Empirical Tests

4.1 Stock price reaction tests

The stock price reaction tests proceed in two steps. First, we estimate stock price effects

associated with the foreign private issuer SOX event(s) for the entire sample of foreign private

issuers. We then examine whether the impact of the Act is related to variables capturing the

bonding hypothesis as well as to control variables. We do this using a multivariate analysis

based on the approach of Sefcik and Thompson (1986).

To estimate the average stock price reaction of the sample to the relevant SOX events, we

use the following augmented market model to estimate the stock price reaction of the portfolio of

ADR firms on the event days:

, ,1

k

t M t s s ts

r r d tα β γ=

= + + +∑ ε , (1)

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where rt is the daily value-weighted portfolio return of our ADR firms, rM,t is the daily return on

the CRSP value-weighted index, and the ds,t’s are indicator variables that take the value of one

on days surrounding event s and zero otherwise (see appendices A to C for the event dates). The

intercept, α, in equation (1) represents the average stock return across all non-event days for a

value-weighted portfolio consisting of the entire sample of foreign private issuers. The unknown

γs to be estimated capture the stock price response of the ADR portfolio on the event window s

and β is the beta of the portfolio with respect to the CRSP value-weighted index (which excludes

ADR firms).4

We use a market model in order to capture the incremental stock price impact SOX had on

foreign private issuers relative to its impact on U.S. firms. In addition, the market index captures

the impact of macroeconomic events that move the U.S. market on the SOX event days we

study. The returns of the foreign private issuers may also be affected by home-country

macroeconomic events not captured by the CRSP market index. However, when such events

occur they presumably are not highly correlated across countries.

We estimate equation (1) using 395 trading days of return data during the period from

December 1, 2001 to June 30, 2003. The results are qualitatively similar if we restrict the

estimation period to 2002, as in Li et al. (2004).

We use regression analysis to estimate the cross-sectional relation between returns on event

days and explanatory variables that capture bonding motives for cross-listing as well as controls

for other firm-specific characteristics. In particular, we test whether the home country investor

4 Note that the standard deviation used in the OLS estimation of equation (1) is based on the time-series regression estimated over 395 trading days, with one observation (the portfolio return) for each day. Hence, the analysis does not suffer from cross-sectional correlation, as would result from estimating the standard deviation across firms on an event date. Also, we find the autocorrelation of portfolio returns is not significant at the .10 level.

17

protection mechanisms and the growth opportunities of the firm can explain the variation in the

stock price reaction across firms.

For expositional purposes, we describe the research design as a two-stage procedure. An

estimated coefficient from the first stage time-series regression becomes the dependent variable

of the second stage cross-sectional model. Because the time-series coefficients are estimated

over the same time period for all sample firms, the residuals in the second stage regression model

will be cross-correlated. To obtain correct standard errors, we use the portfolio time-series

regression approach of Sefick and Thompson (1986) to account for cross-correlation, as well as

heteroskedasticity, in the second stage regression. This method does not alter the estimated

coefficients. It can thus be viewed as an adjustment to the covariance matrix of the OLS

estimates.

In the first step, the stock price reactions to the identified events are estimated for each firm j

(=1, ..., J) using an augmented market model:

, , , ,1

k

j t j j M t j s s t j ts

r r d ,α β γ=

= + + +∑ ε , (2)

where rj, rM, and ds,t are firm j’s equity return, the market return, and event indicator variables,

respectively. In the second step, we use a cross-sectional model to explain the variation in the

estimated market reaction coefficients for event s using K ( < J) firm characteristics:

γj,s = Fj p , (3)

where Fj is a 1 by K vector of firm characteristics and p is a vector of K coefficients to be

estimated that are assumed to be constant across all J firms. Replacing γj,s by its estimate ,j sγ (=

γj,s + ej) and stacking up the J equations results in:

18

1, 1 1

1,

s

JJ s

γ

γ

⎡ ⎤ ⎡ ⎤ ⎡ ⎤⎢ ⎥ ⎢ ⎥ ⎢ ⎥= +⎢ ⎥ ⎢ ⎥ ⎢ ⎥⎢ ⎥ ⎢ ⎥ ⎢ ⎥⎣ ⎦⎣ ⎦⎢ ⎥⎣ ⎦

F eP

F e (4)

Γ = F p + E. (5)

The OLS estimates of p is:

. (6) 1( ' ) '−=p F F F Γ

Equation (6) shows that can also be written as K linear combinations of Γ with the K sets of J

weights X = (F′F)

p

-1F′. Hence, p can be estimated from running K portfolio time-series

regressions, with the portfolios created from the K sets of weights in X. The estimated

coefficients on ds from these K regressions correspond to the K elements in . We estimate the

portfolio time-series regressions over the period from December 1, 2001 to June 30, 2003.

p

Sefcik and Thompson (1986) show that the covariance matrix of the portfolio time-series

regressions is given by:

STV = S ⊗ (Z′Z)-1, (7)

where Z = , S is a K by K covariance matrix estimated from the residuals

of the K portfolio time-series regressions, and ⊗ is the Kronecker product. If the residuals from

the portfolio time-series regressions are serially uncorrelated,

,1 1,1 ,1

, 1, ,

1

1

M k

M T T k T

r d d

r d d

⎡ ⎤⎢⎢⎢ ⎥⎣ ⎦

⎥⎥

STV is valid and the covariance

matrix of p is given by the lower right element in (Z′Z)-1 multiplied into S.

19

Results

Table 2 presents the estimations of equation (1). The four specifications in table 2 vary in

how they combine critical event days into event windows, in whether certain windows are

assigned event indicator variables, and in whether the sample consists of Level-II and Level-III

ADRs or of Level-I ADRs. Recall that because Level-I ADRs require minimal SEC disclosure,

we expect that these cross-listings are less likely to be motivated by the desire to bond to U.S.

disclosure standards.

Our focus in table 2 is on the coefficient estimates for the D9A, D9C, and D11 indicator

variables, which capture the three SOX events related to foreign private issuers. Recall from

appendix B that event D9A is a two day window beginning with Senator Sarbanes’ July 8, 2002

submission of an amendment to clarify the definition of “issuers” in a way that implicitly makes

SOX applicable to foreign private issuers. Event D9C is a two-day window beginning with

Senator Dorgan’s July 12 submission of an amendment to clarify that SOX’s financial statement

certification requirements would apply to foreign issuers. Finally, event D11 is a two-day

window beginning with Senator Enzi’s July 25 comment (after Congress’s passage of the

Conference Report reconciling the House and Senate bills) on the applicability of SOX to foreign

private issuers.

The main table 2 specification, presented in the first column, assigns indicator variables to all

of the events summarized in appendices A – C and uses a single window (D9) to capture the

seven SOX events that occurred during July 8 – 17 (see appendix A), including D9A and D9C.

We emphasize the column one approach as we feel it is difficult to separate seven (sometimes

interrelated) events occurring over 10 days into multiple windows of at least 2 days in length.

The alternative specification in column two splits these seven events into four windows, D9A,

20

D9B, D9C, and D9D. Columns three and four repeat the column one and two specifications on

the sample of Level-I ADRs.

The results in columns 1 – 4 show that the portfolio of Level-II and Level-III foreign private

issuers had a significantly more positive stock price reaction than the value-weighted U.S.

market to event D9A, but significantly more negative reactions for D9C and D11. In contrast,

the stock price reactions for the portfolio of Level-I ADRs are not different from zero at

conventional levels of statistical significance. Because D11 represents the first clear indication

that SOX would apply to foreign private issuers and does not combine multiple events within

one window (as D9A and D9C do), we focus on that event and use the D11 event reaction as the

dependent variable for the cross-sectional tests that follow.

The D11 indicator is significant at better than the .01 level in both the column 1 and 2

estimations (on the Level-II and Level-III ADRs). Moreover, the coefficient estimates in both

columns 1 and 2 are –1.376 (note that all coefficient estimates in table 2 have been multiplied by

100 for expositional convenience). Thus, these estimations provide robust evidence that the

average Level-II and Level-III foreign private issuer suffered a 1.4% stock price loss (after

controlling for the U.S. market) during the 2-day window in which Congress enacted SOX and

Senator Enzi commented on its applicability to foreign issuers. Note that Li et al. (2004) find

that the market reactions for events 9 and 11 are –0.9 (t=–1.560) and 0.2 (t=0.150), respectively,

for their sample of U.S. companies.

Our interpretation of the negative reaction to SOX by the value-weighted portfolio of

foreign private issuers is that, for the average foreign issuer, the incremental bonding benefit

provided by SOX was exceeded by SOX’s incremental compliance costs (direct and indirect).5

5 The foreign issuers opted into the U.S. securities markets based on the regulatory environment in the pre-SOX period. The fact that SOX exogenously imposes tougher standards on the foreign issuers (and their U.S. counterparts) subjects them to indirect costs. For example, it might be optimal for foreign issuers to provide

21

Because our interest is in SOX’s incremental bonding benefits (and because the indirect

compliance costs are difficult to measure), our cross-sectional stock price reaction tests focus on

whether the bonding benefits can explain the variation in foreign private issuers’ reaction to

SOX.

Tables 3 and 4 present the cross-sectional results based on the estimations of equation (3)

using the method of Sefcik and Thompson (1986). In both tables, the dependent variable is the

estimated stock price reaction on event D11 (July 25-26, 2002), in which Senator Enzi

commented on the applicability of SOX to foreign issuers. Both tables also use essentially the

same set of explanatory variables – consisting of measures of home country investor protection,

growth opportunities, and controls for firm size and leverage. The difference between tables 3

and 4 is in the level of aggregation of the measures of how security issuance laws facilitate the

private and public enforcement of investor rights. Overall, these results provide mixed support

for the notion that the stock market reaction of foreign issuers to SOX is increasing in the

bonding benefits provided by SOX.

Table 3 presents the results from estimating four regression specifications, which differ in the

enforcement variables that are included: none, only Private enforcement, only Public

enforcement, or both. The results show that the coefficient estimates on Anti-director rights,

Public enforcement, Sales growth, and Log of market value are insignificant. The estimates on

Judicial efficiency and Leverage are significantly positive, and those on Private enforcement are

statistically negative.

The positive relation between Judicial efficiency and the foreign issuers’ stock price reaction

to SOX is consistent with judicial efficiency measuring the relaxation of a barrier to effective

personal loans to top executives and give them flexibility regarding insider trading. After SOX, foreign issuers have to replace these two aspects with suboptimal alternatives.

22

bonding. In other words, this finding is consistent with the judicial system being required to

enforce investor rights obtained from bonding to the U.S. legal system via cross-listing and SOX.

This interpretation is consistent with the empirical finding and interpretation placed on Judicial

efficiency by Doidge et al. (2004) in their analysis of the cross-listing premium.

The negative relation between Private enforcement and the foreign issuers’ stock price

reaction to SOX is consistent with Private enforcement capturing a dimension of investor

protection for foreign private issuers that is significantly improved by SOX. In other words, this

result is consistent with SOX being more beneficial (or less harmful) to foreign private issuers

from countries whose investor protections are weak along the dimensions of the costs of private

contracting and enforceability of those contracts. In contrast, the insignificant coefficient

estimate on Public enforcement indicates the impact of SOX is not associated with the strength

of investor protections related to the ability of public enforcement agencies to implement

securities law. These results are consistent with the evidence in La Porta et al. (2005). They find

that Private, rather than Public, enforcement plays an important role in financial market

development around the world.

The insignificant estimate on Anti-director rights is inconsistent with the stock price reaction

to SOX being associated with the strength of corporate law in protecting the rights of minority

shareholders against management and majority shareholders with respect to the decision-making

and voting processes. Moreover, the insignificant estimate on Sales growth is inconsistent with

the reaction to SOX being positively associated with the firm’s growth opportunities.

With regard to the control variables, the marginally positive estimates on Leverage provide

weak support for the notion that debt financing facilitates bonding. The insignificant estimates

on Log of market value are inconsistent with the frequently espoused view that the effects of

23

SOX will be more negative for smaller firms because some of the additional costs of complying

with SOX are fixed rather than variable (see, e.g., Holmstrom and Kaplan (2003)).

Table 4 explores the different aspects of Private enforcement and Public enforcement to shed

light on what might lead to the results documented in table 3. Specifically, the Private

enforcement variable from table 3 is replaced by each of its two components. The results

reported in columns one and two of table 4 indicate that the estimated coefficients on the

Disclosure requirement and Burden of proof components of Private enforcement are statistically

negative. This is consistent with SOX being more beneficial to foreign issuers from countries

with lax disclosure requirements on governance and ownership issues and a high burden of proof

on investors seeking to recover damages in a civil liability case for losses due to misleading

prospectus statements. Moreover, the Disclosure requirement component is more significant

than the Burden of proof component in driving the table 3 results on Private enforcement.

Columns three through six of table 4 present the analysis from replacing the Public

enforcement variable in table 3 by each of its four components. The results indicate that

Supervisor’s characteristics (independence, tenure, focus, and power), Investigative power

(supervisor’s ability to command documents and to subpoena witnesses), Orders (supervisor’s

power to issue orders to stop and do), and Criminal sanctions (against issuers, underwriters, and

accountants) have no power explaining the cross-sectional variation in the stock price reactions.

4.2 Tests of changes in analyst and institutional blockholder behavior following SOX

We examine the changes following passage of SOX in the number of analysts following, the

number of institutional blockholders, and the percentage of shares held by institutional

blockholders. The number of analysts following is retrieved from I/B/E/S International. We

count only those analysts who issued earnings forecasts for the ADR shares, but not for the

corresponding shares on the home country exchange. These reports are expressed in U.S. dollars

24

and I/B/E/S identifies these shares using the exchange ticker in the U.S., rather than that in the

home country (I/B/E/S prefixes the tickers of all foreign-based company with the “@” symbol).

Hence, these analysts are likely to be based in the U.S. and aiming their reports at U.S.-based

investors. We get the institutional holding data from the CDA/Spectrum Institutional (13F)

Holdings database provided by Thomson Financial. We define institutional blockholders as

those institutional investors that hold five percent or more of the foreign issuers’ outstanding

shares.6

We compute the changes in the variables of interest over the two-year period from September

30, 2001 to September 30, 2003. We measure the pre-SOX level as of the end of September

2001, because it is the last month in the quarter before news about Enron’s problems became

public.7 Because the changes are computed for all foreign issuers over the same two-year

window, the variables of interest might change simply because of a macro- or industry-related

shift. Moreover, analyst following might decrease because of new regulations in SOX and

elsewhere that called for analyst research to be independent of investment banking activities.

Hence, we adjust for the industry trend by subtracting the industry mean changes in these

variables from the corresponding firm-level numbers. We define industry membership according

to the industrial classifications in the I/B/E/S (SIGC 101-9999) and Spectrum (INDCODE 100-

136) databases, respectively, for the analyst and blockholder analyses.

6 There is a debate in the literature about how best to measure institutional ownership, and different measures seem to produce opposite results in some settings. The “Means method” of identifying large investors (Means (1931), Berle and Means (1932)) is based on identifying those owning at least 5% of the voting stock. Internationally, one can obtain significantly different measures of concentration depending on how disclosed holdings are treated. Using the Means method, La Porta et al. (1999) and Claessens et al. (2000) find very little ownership concentration in Japan. However, adding the ten largest holders on record in Japan in 1997 gives a concentration ratio (defined as the percentage of shares held by these shareholders) of 48.5%. Therefore, we plan to repeat our institutional ownership tests using the combined ownership of all institutions, not just those owning at least 5%. 7 On November 8th, 2001 after several weeks of SEC investigation, Enron filed restated financial results with the SEC. The investigation revealed several accounting irregularities and showed that Enron was heavily indebted and in a worse situation than had been represented in its financial statements. On December 2nd, 2001, Enron filed for bankruptcy protection.

25

We regress the industry-adjusted change in each of these variables on the proxies for the

foreign issuers’ home country investor protection, growth opportunities, and controls for size and

leverage to examine if the impact of SOX on our dependent variables is related to the level of

investor protection and growth opportunities of the ADR firms. All t-statistics are computed

using White’s (1980) heteroskedastcity-consistent standard errors and adjusted for clustering by

country (Wooldridge 2002). We adjust for clustering by country because we have multiple firms

from the same country, as shown in panel C of table 1, thereby inducing cross-correlation in the

regression residuals.

Results

Table 5 presents descriptive data on the dependent variables for these regressions. These

data show that analyst following for the average foreign private issuer in the period surrounding

SOX declined by 0.287 more analysts than the industry-average change. The table also shows

that the average industry-adjusted change in the number of institutional blockholders was

insignificant, but that the average industry-adjusted combined percentage holdings of

institutional blockholders (5% or more) declined by 1.796% in the period surrounding SOX. The

decrease in the percentage of shares owned by institutional blockholders is consistent with the

improved monitoring achieved by SOX substituting for monitoring by institutional blockholders.

The decline in analyst following is consistent with at least two possible explanations. From a

disclosure perspective, SOX likely improved the quality of public disclosure by foreign private

issuers. A decline in analyst following in the aftermath of this improvement in the quality of

public disclosure is consistent with public disclosure substituting for private information

acquisition by analysts. Although this is often the perspective taken by regulators, the empirical

evidence on this issue has been mixed.

26

From a monitoring perspective, SOX (and related initiatives by the NYSE and NASD)

created two opposing changes in terms of their influence on the role of sell-side analysts as

monitors. On one hand, SOX attempted to improve other monitoring mechanisms, which could

decrease the analyst’s role as a monitor. Conversely, another goal of SOX was to reduce

analysts’ conflicts of interest and thus to increase analyst objectivity. Such a change would

presumably increase the value of monitoring by analysts.

In any event, whether it was because the value (i.e., benefits – costs) of their private

information acquisition decreased or because the value of their monitoring role decreased,

analyst following was somewhat reduced in the wake of SOX. Of course, it is also possible SOX

did not cause this change. However, if the drop in analyst following is associated with the level

of investor protection in the pre-SOX period, the change is likely attributable to the enactment of

SOX, thus motivating the cross-sectional tests.

The assessment of the cross-sectional determinants of the change in analyst following is

made in table 6, which uses the same set of explanatory variables and the same four regression

specifications as in table 3. The results show that the coefficient estimates on Sales growth and

Judicial efficiency are always statistically insignificant and that those on Anti-director rights,

Private enforcement and Public enforcement are generally statistically insignificant. However,

the positive coefficients on Anti-director rights, Private enforcement, and Public enforcement are

consistent with SOX substituting for the monitoring role of analysts. The estimates on Leverage

are significantly negative, and those on Log of market value are significantly positive.

Overall, these results provide little, if any, indication that the change in analyst following

around the enactment of SOX is related to the pre-SOX levels of investor protection or growth

opportunities. The weak evidence might be due to the conflicting roles captured by analyst

following alluded to above. Moreover, the strongly significant results on the firm size variable

27

could indicate that the change in analyst following is associated with an omitted variable

correlated with firm size. We speculate that one such correlated omitted variable is the firm’s

pre-SOX information environment and that our investigation of the impact of SOX on analyst

following of ADR firms could benefit from the addition of disclosure-related variables.

Table 7 presents the assessment of the cross-sectional determinants of the industry-adjusted

change in the number (panel A) and percentage ownership (panel B) of institutional blockholders

(5% or more). The panel A results indicate that the number of institutional blockholders tended

to increase more post-SOX when pre-SOX Private enforcement and firm size were higher and

sales growth and leverage were lower. The positive association with Private enforcement is

consistent with the incremental bonding benefits of SOX being smaller when home country

Private enforcement was higher, and with institutional blockholders providing a substitute

monitoring mechanism to the legal bonding achieved by SOX. Similarly, the negative

association with sales growth is consistent with the incremental bonding benefits of SOX being

smaller when the firm’s growth opportunities are smaller, and with institutional blockholders

substituting for the monitoring improvements achieved by SOX. The negative estimates on

Leverage support the notion that lenders facilitate outside monitoring of the controlling

shareholder. Finally, the highly significantly positive estimates on firm size again raise the

concern that size may be capturing the effect of correlated omitted variables.

The panel B results show that the percentage ownership of institutional blockholders

increased by more post-SOX when the pre-SOX levels of Anti-director rights, Private

enforcement, and firm size were larger. The interpretations of the estimates on Private

enforcement and firm size remain the same as they were for the panel A results. The positive

estimates on Anti-director rights is consistent with the incremental bonding benefits of SOX

being smaller when home country investor protection provided by corporate law were higher.

28

The loss of significance of the estimates on the Anti-director variable in columns two and four is

attributable to the inclusion in those specifications of the Private enforcement variable. Recall

from panel B of table 1 that Private enforcement is very highly positively correlated with Anti-

director rights. La Porta et al. (2005) experience the same difficulty when they attempt to

include both Anti-director rights and Private enforcement as separate explanatory variables in the

same regression.

5. Conclusion and other areas for analysis

This paper uses the sudden and unexpected decision to apply SOX to foreign private issuers

to examine how an exogenous improvement in investor protection affects shareholder wealth and

the firm’s monitoring and disclosure environment. Although the current empirical work is

preliminary, several interesting findings have emerged.

The variation in the stock price reactions to SOX by foreign private issuers are generally

consistent with SOX improving investor protection and with such improvements enhancing firm

value. Specifically, the stock market reaction is more positive for firms from countries with

weak private enforcement of investor rights.

Our preliminary evidence on the changes in the behavior of institutional blockholders and

sell-side analysts is also consistent with SOX enhancing investor protection for foreign private

issuers and, as a result, altering the incentives of monitoring and disclosure intermediaries. We

find decreases in analyst following and in percentage ownership by outside blockholders for the

period from September 30, 2001 to September 30, 2003. From a monitoring perspective, the

decrease in analyst following after SOX contrasts with Lang, Lins and Miller’s (2004)

conclusion that analysts are less likely to follow firms with insider controlling shareholders and

that this relation is stronger for firms from low-shareholder-protection countries. The decrease in

29

percentage ownership by outside blockholders is consistent with SOX increasing minority

shareholder protection and, as a result, reducing the benefit of being an outside blockholder.

The cross-sectional variation in the change in analyst following is weakly positively

associated with several measures of investor protection. These results provide modest support

for SOX substituting for the monitoring role of analysts. The cross-sectional variation in the

change in percentage ownership by outside blockholders is strongly positively associated with

several measures of investor protection. These findings offer strong support for the hypothesis

that SOX’s direct regulation of corporate governance at foreign private issuers substitutes for the

monitoring role of outside institutional blockholders.

Our empirical work to date is preliminary and we are thus in the process of developing

additional tests. While SOX reflects a shift in the principle of U.S. securities law from mainly

regulating disclosure to also regulating corporate governance (Ribstein 2003), the quality of

governance is likely to affect the quality of corporate disclosures (Lang, Lins, and Miller 2003)

and, hence, the behavior of disclosure intermediaries who interact with the firm. The major

governance reforms in SOX include requiring CEOs and CFOs to certify SEC filings, holding

management responsible for internal controls and financial reporting, calling for independent

directors and financial experts on audit committees, and strengthening auditor independence.

These governance regulations in SOX appear likely to improve financial reporting quality. Thus,

we predict that the quality of earnings increases in the post-SOX period.

Furthermore, the resultant improvement in disclosure quality and transparency would reduce

the cost for a disclosure intermediary to acquire information. In fact, Lang, Lins, and Miller

(2003) find that the improved information environment associated with cross listing increases the

accuracy of analyst forecasts of earnings. Hence, we predict that analyst forecast accuracy

increases following SOX.

30

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Siegel, Jordon, 2004, “Can foreign firms bond themselves effectively by renting U.S. Securities laws?” forthcoming in the Journal of Financial Economics. Stulz, Rene M., 1999, “Globalization, corporate finance, and the cost of capital,” Journal of Applied Corporate Finance 12, 8-25. White, Halbert, 1980, “A heteroskedasticity-consistent covariance matrix estimator and a direct test for heteroskedasticity,” Econometrica 48, 817–830. Wooldridge, Jeffrey M., 2002, Econometric Analysis of Cross Section and Panel Data (The MIT Press: Cambridge, MA). Zeckauser, R. and J. Pound, 1990, “Are shareholders effective monitors? An investigation of share ownership and corporate performance,” In: Hubbard, G. (Ed.), Asymmetric information, corporate finance, and investment. University of Chicago press, Chicago, 149-180.

34

Appendix A Critical events in the legislative process leading to the enactment of Sarbanes-Oxley Act of 2002 Variable Date Event Event Window D1 1/17/02 S.E.C. Chairman Harvey Pitt proposes oversight board Thu 1/17 D2 2/11-12/02 Legislation to be introduced in the House Mon 2/11, 12, 2/13-14/02 Introduction of H.R. 3763 in the House 13, 14 D3 3/7/02 Bush to unveil reform plan Thu 3/7, 8 3/8/02 Introduction of S. 2004 in the Senate D4 4/22/02 Volcker to abandon reforms at Andersen Mon 4/22, 4/22/02 Committee report issued on H.R. 3763 23, 24, 25, 26 4/24/02 House considers and passes H.R. 3763 4/25/02 Senate Judiciary approves legislation

D5 6/11/02 Progress reported on Senate legislation Mon 6/10, 11, 6/12/02 Mark-up of Sarbanes bill to occur 12, 13 D6 6/15/02 Andersen convicted Mon 6/17, 18, 6/18/02 Senate Banking Committee meets and supports major

reform legislation 19 [no trading 6/15 ]

D7 6/25/02 Introduction of S. 2673 in Senate Tue 6/25, 26 6/26/02 WorldCom fraud announcement D8 7/3/02 Committee Report on S. 2673 Wed 7/3, 5 7/5/02 S.E.C. requires CEO/CFO certification D9 7/8-12/02 Senate considers S. 2673 Mon 7/8, 9, 10, 7/9/02 Bush’s Wall Street speech 11, 12, 7/15/02 Senate passes S. 2673 Mon 7/15, 16, 17 7/15/02 Introduction of H.R. 5118 7/16/02 Passage of H.R. 5118 7/16/02 Senate Appropriations Committee increases S.E.C.

budget

7/16/02 Bush wants bill before August break

D10 7/24/02 Issuance of Conference Report Wed 7/24

D11 7/25/02 House and Senate pass Conference Report; Bush reportedly will sign bill

Thu 7/25, 26

D12 7/29/02 S.E.C. to post names of CEOs and CFOs who fail to certify their firms’ financial reports

Mon 7/29, 30

7/30/02 President signs bill into law

Source: Table 2 in Li, Pincus, and Rego (2004)

35

Appendix B List of events related to foreign private issuers Variable Date Event Event Window D9 7/8/2002 Senator Sarbanes (D-MD) submitted an amendment to clarify the definition of

“issuers” in the bill. Amendment No. 4173 was agreed to. “As used in this section, the term ‘issuer’ means an issuer (as defined in section 3), the securities of which are registered under section 12, or that is required to file reports pursuant to section 15(d), or that will be required to file such reports at the end of a fiscal year of the issuer in which a registration statement filed by such issuer has become effective pursuant to the Securities Act of 1933 (15 U.S.C. 77a et. seq.), unless its securities are registered under section 12 of this title on or before the end of such fiscal year." Source: 148 Congressional Record S6327 (July 8, 2002)

7/8 (Mon), 9 (Overlapped with event #9 in Pincus et al. 2004)

D9 7/12/2002 Senator Dorgan (D-ND) submitted Amendment No. 4215 to clarify the requirement that certain officers certify financial reports applies to domestic and foreign issuers. The amendment is agreed upon in the senate by unanimous consent. Source: 148 Congressional Record S6687 (July 12, 2002)

7/12 (Fri), 15 (Overlapped with event #9 in Pincus et al. 2004)

D11 7/25/2002 Senator Enzi (R-WY) commented on the finalized bill on the last day of the debate: “In addition, I believe we need to be clear with respect to the area of foreign issuers and their coverage under the bill's broad definitions. While foreign issuers can be listed and traded in the U.S. if they agree to conform to GAAP and New York Stock Exchange rules, the SEC historically has permitted the home country of the issuer to implement corporate governance standards. Foreign issuers are not part of the current problems being seen in the U.S. capital markets, and I do not believe it was the intent of the conferees to export U.S. standards disregarding the sovereignty of other countries as well as their regulators…” Source: 148 Congressional Record S7356 (July 25, 2002)

7/25, 26 (Event #11 in Pincus et al. 2004)

36

Appendix C Post SOX events and SEC rulemaking Variable Date Event Event Window D12 7/30/2002 President Bush signed into law the Sarbanes-Oxley Act of 2002.

Final rules to implement section 304 (Forfeiture of compensation and securities-related profits) and section 402 (Prohibition on personal loans) became effectively immediately

7/30 (Overlapped with event #12 in Pincus et al. 2004)

D13 8/2/2002 SEC proposed rule to implement section 302 on CEO/CFO certification of SEC filings.

8/2 (Fri), 5

D14 8/6/2002 SEC proposed rule to implement section 403(a) on accelerated deadline for insider transaction reports.

8/6, 7

D15 8/12/2002 Delaney, Kevin, Craig Karmin, and Philip Day, “U.S. disclosure law affects European, Asian companies,” The Wall Street Journal.

8/12 (Mon), 13

D16 8/27/2002 SEC adopted rules to implement sections 302 and 403(a). SEC staff testified that it was important to include foreign private issuers in the certification requirements, but recommended exemption from new rules requiring an accelerated filing schedule for periodic reports. The SEC admitted that their inclusion of foreign private issuers may serve as a deterrent for companies that are considering listing in the future.

8/27, 28

D17 10/8/2002 In the SEC's first formal comment, SEC Chair Harvey Pitt signaled their acknowledgement of practical implementation problems for foreign private issuers and their willingness to be flexible. Much of the remarks addressed the issues raised by OFII in its August 19 comment letter. Source: Organization for International Investment (www.ofii.org) and Michaels, Adrian, “SEC could ease accounting laws for foreign companies,” Financial Times (October 8).

10/8, 9

D18 10/16/2002 SEC proposed rules to implement sections 303 (prohibits actions designed to improperly influence auditors), 404 (internal controls and procedures), 406 (code of ethics), and 407 (financial experts on audit committee).

10/16, 17

D19 10/30/2002 SEC proposed rules to implement section 306(a) on restriction of insider trading during pension fund blackout periods, section 401(a) on the disclosures of off-balance sheet transactions, and section 401(b) on the use of non-GAAP financials.

10/30, 31

D20 11/19/2002 SEC proposed rules to implement section 208(a) on auditor independence and section 802 on retention of audit workpaper.

11/19, 20

D21 12/18/2002 SEC proposed rules to implement section 403 on the electronic filing of insider ownership reports.

12/18, 19

D22 1/8/2003 SEC proposed rules to implement section 301 on listing standards rule (issuers that are not in compliance with the audit committee requirements are prohibited from listing their securities in the US).

1/8, 9

D23 1/15/2003 SEC adopted rules to implement sections 406, 407, and 306(a). 1/15, 16 D24 1/22/2003 SEC adopted rules to implement sections 401(a), 208(a), and 802. 1/22, 23 D25 4/24/2003 SEC adopted rules to implement sections 303 and 403. 4/24, 25 D26 5/27/2003 SEC adopted rules to implement section 404. 5/27, 28 Source: SEC press release (http://sec.gov/spotlight/sarbanes-oxley.htm)

37

Appendix D Data description

Variable Description Anti-director rights

This index of Anti-director rights is formed by adding one when: (1) the country allows shareholders to mail their proxy vote; (2) shareholders are not required to deposit their shares prior to the General Shareholders’ Meeting; (3) cumulative voting or proportional representation of minorities on the board of directors is allowed; (4) an oppressed minorities mechanism is in place; (5) the minimum percentage of share capital that entitles a shareholder to call for an Extraordinary Shareholders’ Meeting is less than or equal to ten percent (the sample median); or (6) when shareholders have preemptive rights that can only be waved by a shareholders meeting. The range for the index is from zero to six. Source: La Porta et al. (1998).

Judicial efficiency

Assessment of the “efficiency and integrity of the legal environment as it affects business, particularly foreign firms” produced by the country risk rating agency International Country Risk (ICR). It may be “taken to represent investors’ assessment of conditions in the country in question.” Average between 1980 and 1983. Scale from 0 to 10, with lower scores representing lower efficiency levels. Source: International Country Risk Guide.

Private enforcement

The index of private enforcement equals the arithmetic mean of: (1) Disclosure Index; and (2) Burden of proof index.

Public enforcement

The index of public enforcement equals the arithmetic mean of: (1) Supervisor characteristics index; (2) Investigative powers index; (3) Orders index; and (4) Criminal index.

Disclosure requirement

The index of disclosure equals the arithmetic mean of: (1) Prospect; (2) Compensation; (3) Shareholders; (4) Inside ownership; (5) Contracts Irregular; (6) and Transactions. These subindices capture whether the law prohibits selling securities on stock exchange without delivering a prospectus and the requirements to disclose director and officer compensation, information on shareholders who control ten percent or more of the voting rights, director and officer ownership, the existence of contracts outside the ordinary course of business, and related-party transactions.

Burden of proof The index of burden of proof equals the arithmetic mean of: (1) Burden director; (2) Burden distributor; and (3) Burden accountant. These subindices capture the procedural difficulty in recovering losses from the directors, distributor, and accountant in a civil liability case for losses due to misleading statements in the prospectus.

Supervisor The index of characteristics of the Supervisor equals the arithmetic mean of: (1) Appointment; (2) Tenure; (3) Focus; and (4) Rules. These subindices capture whether a majority of the members of the Supervisor are unilaterally appointed by the Executive branch of government, members of the Supervisor cannot be dismissed at the will of the appointing authority, separate government agencies or authorities are in charge of supervising commercial banks and stock exchanges, and the Supervisor can generally issue regulations regarding primary offerings and/or listing rules on stock exchanges without prior approval of other governmental authorities.

Investigative Powers

The index of investigative powers equals the arithmetic mean of: (1) Document; and (2) Witness. These subindices capture the power of the Supervisor to command documents or subpoena the testimony of witnesses when investigating a securities law violation.

Orders The index of orders equals the arithmetic mean of: (1) Orders issuer; (2) Orders distributor; and (3) Orders. These subindices capture whether orders to stop and do be directed at the issuer, distributor, and accountant in case of a defective prospectus.

Criminal Sanction

The index of criminal sanctions equals the arithmetic mean of: (1) Criminal director; (2) Criminal distributor; and (3) Criminal accountant. These subindices capture whether the director/officer, distributor, and accountant be held criminally liable when the prospectus is misleading.

Sales growth Two-year sales growth rate before January 1, 2002. Leverage Ratio of long-term debt to total assets for the most recent fiscal year ended before January 1, 2002. Log of market equity

Logarithm of the market value of equity, for the most recent fiscal year ended before January 1, 2002.

Source: La Porta, Lopez-de-Silanes, and Shleifer (2003).

38

Table 1 Descriptive statistics on sample firms The sample consists of 490 foreign private issuers from 35 countries. To be included in this sample, a foreign issuer must have daily stock returns from CRSP, selected financial statement data on Compustat, and country-level investor protection data. Panels A and B report statistics for the 490 sample firms. Panel C presents the country-level data. The anti-director rights index captures the quality of corporate law in protecting investor rights. The judicial efficiency index captures the quality of law enforcement. The private and public enforcement indices capture the quality of securities law. The private enforcement index comprises of the disclosure requirements and burden of proof subindices. The public enforcement index is constructed from the supervisor, investigative powers, orders, and criminal sanctions subindices. Sales growth is the two-year growth rate in sales. Leverage is the ratio of long-term debt to total assets. Appendix D describes these variables in details. Panel A: Summary statistics for the explanatory variables Variable Mean S.D. Min. 25% 50% 75% Max. Anti-director rights 3.916 1.382 0.000 3.000 5.000 5.000 5.000 Judicial efficiency 8.781 1.451 2.500 8.000 9.250 10.000 10.000 Private enforcement 0.701 0.226 0.180 0.497 0.747 0.958 0.958 Public enforcement 0.607 0.267 0.000 0.375 0.667 0.865 0.896 Disclosure requirement 0.745 0.181 0.167 0.583 0.833 0.917 1.000 Burden of proof 0.657 0.311 0.000 0.440 0.660 1.000 1.000 Supervisor 0.473 0.224 0.000 0.250 0.500 0.625 0.875 Investigative Powers 0.737 0.367 0.000 0.500 1.000 1.000 1.000 Orders 0.643 0.448 0.000 0.000 1.000 1.000 1.000 Criminal Sanction 0.575 0.255 0.000 0.417 0.500 0.833 1.000 Sales growth 0.465 0.864 -0.717 -0.002 0.200 0.573 3.126 Leverage 0.172 0.163 0.000 0.025 0.143 0.265 0.749 Log of market equity 7.109 2.335 0.588 5.490 7.228 8.924 12.081 Panel B: Pearson correlation matrix for the explanatory variables (p-value underneath coefficient)

Anti-

director Judicial

Efficiency Private

Enforce. Public

Enforce.DisclosureRequire.

Burdenof Proof Superv.

Investigat.powers Orders

Criminal Sanctions

Sales growth Leverage

Judicial Efficiency

0.393 0.001

Private Enforcement

0.752 0.001

0.481 0.001

Public Enforcement

0.624 0.001

0.219 0.001

0.631 0.001

Disclosure Requirement

0.737 0.001

0.445 0.001

0.860 0.001

0.644 0.001

Burden of Proof

0.665 0.001

0.441 0.001

0.955 0.001

0.544 0.001

0.669 0.001

Supervisor 0.102 0.024

-0.193 0.001

0.227 0.001

0.678 0.001

0.195 0.001

0.216 0.001

Investigative Powers

0.644 0.001

0.170 0.001

0.565 0.001

0.917 0.001

0.593 0.001

0.477 0.001

0.544 0.001

Orders 0.681 0.001

0.373 0.001

0.608 0.001

0.920 0.001

0.667 0.001

0.497 0.001

0.443 0.001

0.866 0.001

Criminal Sanctions

0.397 0.001

0.185 0.001

0.560 0.001

0.653 0.001

0.497 0.001

0.527 0.001

0.397 0.001

0.399 0.001

0.461 0.001

Sales growth

0.145 0.001

0.040 0.381

0.192 0.001

0.165 0.001

0.202 0.001

0.162 0.001

0.071 0.115

0.146 0.001

0.145 0.001

0.164 0.001

Leverage 0.086 0.056

-0.043 0.346

0.038 0.406

0.045 0.320

0.015 0.745

0.046 0.308

-0.024 0.603

0.059 0.194

0.050 0.273

0.037 0.410

-0.0900.047

Log of Market value

-0.186 0.001

0.009 0.846

-0.223 0.001

-0.325 0.001

-0.224 0.001

-0.194 0.001

-0.232 0.001

-0.257 0.001

-0.249 0.001

-0.347 0.001

-0.0960.033

0.143 0.002

(contiuned...)

39

Table 1 (continued) Panel C: Country-level measures of the qualities of investor protection laws and law enforcement

No. of firms

Anti- director

Judicial Efficiency

Private Enforce.

Public Enforce.

DisclosureRequire.

Burden of Proof Superv.

Investigat. powers Orders

CriminalSanctions

English legal origin: Australia 12 4.00 10.00 0.71 0.90 0.75 0.66 0.75 1.00 1.00 0.83 Canada 152 5.00 9.25 0.96 0.86 0.92 1.00 0.63 1.00 1.00 0.83 Hong Kong 7 5.00 10.00 0.79 0.88 0.92 0.66 0.50 1.00 1.00 1.00 India 8 5.00 8.00 0.79 0.72 0.92 0.66 0.38 1.00 0.67 0.83 Ireland 12 4.00 8.75 0.61 0.27 0.67 0.55 0.25 0.00 0.00 0.83 Israel 8 3.00 10.00 0.66 0.75 0.67 0.66 0.50 1.00 1.00 0.50 New Zealand 2 4.00 10.00 0.55 0.40 0.67 0.44 0.25 1.00 0.00 0.33 Singapore 2 4.00 10.00 0.83 0.88 1.00 0.66 0.50 1.00 1.00 1.00 South Africa 7 5.00 6.00 0.75 0.29 0.83 0.66 0.25 0.50 0.00 0.42 United Kingdom 70 5.00 10.00 0.75 0.67 0.83 0.66 0.25 1.00 1.00 0.42 French legal origin: Argentina 8 4.00 6.00 0.36 0.50 0.50 0.22 0.75 1.00 0.08 0.17 Belgium 1 0.00 9.50 0.43 0.19 0.42 0.44 0.00 0.25 0.00 0.50 Brazil 11 3.00 5.75 0.29 0.52 0.25 0.33 0.50 0.50 0.75 0.33 Chile 15 5.00 7.25 0.46 0.54 0.58 0.33 0.50 0.75 0.42 0.50 France 28 3.00 8.00 0.49 0.80 0.75 0.22 0.88 1.00 1.00 0.33 Greece 3 2.00 7.00 0.39 0.35 0.33 0.44 0.50 0.25 0.17 0.50 Indonesia 2 2.00 2.50 0.58 0.56 0.50 0.66 0.50 1.00 0.25 0.50 Italy 9 1.00 6.75 0.44 0.38 0.67 0.22 0.75 0.25 0.00 0.50 Mexico 20 1.00 6.00 0.35 0.25 0.58 0.11 0.25 0.25 0.00 0.50 Netherlands 17 2.00 10.00 0.75 0.38 0.50 1.00 0.50 0.50 0.00 0.50 Peru 2 3.00 6.75 0.50 0.75 0.33 0.66 0.75 0.75 1.00 0.50 Philippines 2 3.00 4.75 0.92 0.81 0.83 1.00 0.75 1.00 1.00 0.50 Portugal 3 3.00 5.50 0.54 0.50 0.42 0.66 0.75 1.00 0.25 0.00 Spain 7 4.00 6.25 0.58 0.38 0.50 0.66 0.50 0.50 0.00 0.50 Venezuela 1 1.00 6.50 0.19 0.48 0.17 0.22 0.50 1.00 0.08 0.33 German legal origin: Austria 1 2.00 9.50 0.18 0.19 0.25 0.11 0.25 0.00 0.00 0.50 Germany 17 1.00 9.00 0.21 0.25 0.42 0.00 0.25 0.25 0.00 0.50 Japan 23 4.00 10.00 0.71 0.00 0.75 0.66 0.00 0.00 0.00 0.00 Korea 6 2.00 6.00 0.71 0.29 0.75 0.66 0.25 0.50 0.08 0.33 Switzerland 10 2.00 10.00 0.55 0.21 0.67 0.44 0.50 0.00 0.00 0.33 Taiwan 4 3.00 6.75 0.71 0.44 0.75 0.66 0.50 0.25 0.17 0.83 Scandinavian origin: Denmark 3 2.00 10.00 0.68 0.27 0.58 0.78 0.25 0.50 0.33 0.00 Finland 5 3.00 10.00 0.58 0.35 0.50 0.66 0.50 0.25 0.17 0.50 Norway 4 4.00 10.00 0.51 0.40 0.58 0.44 0.00 0.25 0.33 1.00 Sweden 8 3.00 10.00 0.46 0.44 0.58 0.33 0.25 0.25 0.67 0.58 Data source: La Porta, Lopez-de-Silanes, and Shleifer (2003).

40

Table 2 Stock price reactions at events associated with the Sarbane-Oxley Act of 2002 The table reports market reactions of foreign private issuers at key event days related to the Sarbane-Oxley Act of 2002. The stock price reactions are estimated using an augmented market model over the period from December 1, 2001 to June 31, 2003 (T=395). Daily portfolio returns are computed by value weighting the daily returns of the foreign private issuers. Daily market returns are taken from the CRSP value-weighted market index, which excludes American Depository Receipts (ADRs). Columns (1) and (2) are based on 490 level–II and level–III ADRs that are traded on AMEX, NYSE, or NASDAQ; their stock prices are retrieved from CRSP. Columns (3) and (4) are based on 177 level-I ADRs that are traded over-the-counter as Pink Sheet issues; their stock prices are retrieved from Datastream. Appendices A, B, and C describe the key events and the corresponding event windows. The estimated coefficients are multiplied by 100 (t-statistics are in parentheses). Level–II and Level–III ADRs Level–I ADRs (1) (2) (3) (4) Constant 0.013

(0.400) 0.013

(0.410) 0.129** (2.540)

0.129** (2.530)

Value-weighted market return 81.012*** (36.550)

81.211*** (37.360)

17.655*** (5.030)

17.706*** (5.020)

D1 0.563 (0.970)

0.561 (0.980)

0.219 (0.240)

0.218 (0.240)

D2 0.023 (0.080)

0.022 (0.080)

0.205 (0.440)

0.204 (0.440)

D3 -0.123 (-0.300)

-0.123 (-0.310)

0.185 (0.280)

0.185 (0.280)

D4 0.049 (0.190)

0.050 (0.200)

0.499 (1.200)

0.500 (1.200)

D5 -0.307 (-1.050)

-0.306 (-1.070)

-0.333 (-0.720)

-0.333 (-0.720)

D6 -0.146 (-0.430)

-0.147 (-0.440)

-0.166 (-0.310)

-0.166 (-0.310)

D7 0.691* (1.670)

0.693* (1.710)

3.870*** (5.910)

3.871*** (5.890)

D8 0.283 (0.680)

0.279 (0.690)

-0.230 (-0.350)

-0.231 (-0.350)

D9 (July 8-12, 15-17) -0.228 (-1.090)

-0.202 (-0.610)

0.160 (0.240)

D9A (July 8-9)

0.864** (2.130)

-0.512 (-0.780)

D9B (July 10-11)

-0.911** (-2.250)

-0.360 (-0.550)

D9C (July 12, 15)

-1.242*** (-3.080)

-0.096 (-0.150)

D9D (July 16-17)

0.384 (0.950)

-1.435 (-1.520)

D10 0.414 (0.700)

0.404 (0.690)

-1.432 (-1.520)

-0.462 (-0.700)

D11 -1.376*** (-3.330)

-1.376*** (-3.410)

-0.462 (-0.710)

0.446 (0.670)

D12 0.002 (0.000)

-0.004 (-0.010)

0.447 (0.680)

0.129** (2.530)

D13 to D26 Included Yes Yes Yes Yes

Adjusted R2 0.799 0.808 0.102 0.096 *, **, *** denote statistical significance at the 10%, 5%, and 1% levels, respectively, based on a two-sided test.

41

Table 3 Cross-sectional results of regressing the stock price reactions on investor protection and growth opportunity The table reports cross-sectional regression results for 490 foreign private issuers. The dependent variable is the estimated stock-price reaction on event number 11 (July 25-26, 2002), in which Senator Enzi commented on the applicability of the Sarbanes-Oxley Act to foreign issuers (see Appendix B). Investor protection at the home countries of the foreign issuers are captured by Anti-directors rights, Judicial efficiency, Private enforcement, and Public enforcement. Growth opportunity is measured by two-year sales growth. Appendix D describes the construction of the explanatory variables. The standard errors and t-statistics are computed using the portfolio time-series regression approach of Sefick and Thompson (1986), which accounts for cross-correlation and heteroskedasticity. The estimated coefficients are multiplied by 100 (t-statistics are in parentheses). (1) (2) (3) (4) Constant -3.079**

(-2.402) -2.960**

(-2.300) -2.991**

(-2.281) -3.113**

(-2.379) Anti-director rights -0.232

(-1.535) 0.099

(0.583) -0.203

(-1.108) 0.068

(0.367) Judicial efficiency 0.328**

(2.457) 0.445***

(3.103) 0.328**

(2.456) 0.453***

(3.138) Private enforcement

-3.214**

(-2.477) -3.423**

(-2.472) Public enforcement

-0.255

(-0.292) 0.473

(0.507) Sales growth 0.145

(0.697) 0.216

(1.021) 0.150

(0.720) 0.211

(0.999) Leverage 1.554*

(1.678) 1.622*

(1.747) 1.567*

(1.689) 1.602*

(1.725) Log of market value -0.121

(-1.288) -0.153

(-1.628) -0.128

(-1.281) -0.143

(-1.448) Adjusted R2 *, **, *** denote statistical significance at the 10%, 5%, and 1% levels, respectively, based on a two-sided test.

42

Table 4 Cross-sectional results of regressing the stock price reactions on investor protection, securities regulation, and growth opportunity The table reports cross-sectional regression results for 490 foreign private issuers. The dependent variable is the estimated stock-price reaction on event number 11 (July 25-26, 2002), in which Senator Enzi commented on the applicability of the Sarbanes-Oxley Act to foreign issuers (see Appendix B). Investor protection at the home countries of the foreign issuers are captured by Anti-directors rights, Judicial efficiency, Private enforcement, and Public enforcement. Both the disclosure requirement and burden of proof sub-indices capture the Private enforcement aspect of securities law. Supervisor, Investigative powers, Orders, and Criminal sanctions capture the Public enforcement aspect of securities law. Growth opportunity is measured by two-year sales growth. Appendix D describes the construction of the explanatory variables. The standard errors and t-statistics are computed using the portfolio time-series regression approach of Sefick and Thompson (1986), which accounts for cross-correlation and heteroskedasticity. The estimated coefficients are multiplied by 100 (t-statistics are in parentheses). (1) (2) (3) (4) (5) (6) Constant -2.139

(-1.570) -3.359***

(-2.623) -3.287**

(-2.237) -3.252**

(-2.515) -3.230**

(-2.492) -2.730**

(-2.042) Anti-director rights 0.069

(0.386) -0.043

(-0.286) -0.238

(-1.570) -0.308

(-1.579) -0.141

(-0.733) -0.190

(-1.248) Judicial efficiency 0.417***

(3.145) 0.402***

(2.805) 0.338**

(2.483) 0.338**

(2.504) 0.349**

(2.574) 0.338**

(2.500) Disclosure requirement -3.652***

(-2.695) Burden of proof

-1.531*

(-1.934) Supervisor

0.245

(0.295) Investigative powers

0.449

(0.752) Orders

-0.472

(-0.869) Criminal sanctions

-0.776

(-0.957) Sales growth 0.217

(1.034) 0.183

(0.868) 0.143

(0.685) 0.137

(0.654) 0.156

(0.745) 0.167

(0.809) Leverage 1.518

(1.642) 1.634*

(1.760) 1.560*

(1.683) 1.530*

(1.652) 1.591*

(1.716) 1.633*

(1.747) Log of market value -0.149

(-1.593) -0.140

(-1.486) -0.117

(-1.198) -0.112

(-1.158) -0.134

(-1.372) -0.146

(-1.488) Adjusted R2 *, **, *** denote statistical significance at the 10%, 5%, and 1% levels, respectively, based on a two-sided test.

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Table 5 Descriptive statistics on the changes in the analyst and institutional blockholder variables The table reports descriptive statistics for 490 foreign private issuers. The number of analysts following is taken from I/B/E/S and is the number of analysts that follow the American Depository Receipt of the foreign issuers. Data on institutional blockholders are taken from the Thomson Spectrum database. Blockholders are those institutional investors that held at least five percent of the outstanding shares. The changes are computed over a two-year period from September 31, 2001 to September 31, 2003. All changes are adjusted for industry effect by subtracting the corresponding change in the industry from the unadjusted numbers. Industry membership is based on the industrial classifications in the I/B/E/S and Spectrum databases, respectively. Industry-adjusted change in Mean S.D. t-statistic Min 25% 50% 75% Max Number of analysts following -0.287 3.063 -1.990 -15.787 -1.215 -0.407 0.700 14.213 Number of institutional blockholders -0.008 0.805 -0.220 -3.153 -0.190 -0.068 0.038 5.038 Percentage ownership of blockholders -1.796 12.562 -3.170 -50.390 -1.873 -0.691 0.949 43.440

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Table 6 Cross-sectional results of regressing the changes in the number of analysts following on investor protection and growth opportunity The table reports cross-sectional regression results for 490 foreign private issuers. The dependent variable is the change in the number of analysts following over the two-year period from September 31, 2001 to September 31, 2003, adjusted for the corresponding change in the industry level. Investor protection at the home countries of the foreign issuers are captured by Anti-directors rights, Judicial efficiency, Private enforcement, and Public enforcement. Growth opportunity is measured by two-year sales growth. Appendix D describes the construction of the explanatory variables. t-statistics are in parentheses; they are calculated using heteroskedasticity-consistent standard errors (White 1980) and adjusted for clustering by country (Wooldridge 2002). (1) (2) (3) (4) Constant -3.400***

(3.45) -3.504*** (3.76)

-3.970*** (3.59)

-3.942*** (3.86)

Anti-director rights 0.267* (1.72)

0.050 (0.28)

0.083 (0.46)

-0.039 (0.20)

Judicial efficiency 0.174 (1.37)

0.105 (0.91)

0.177 (1.31)

0.127 (0.98)

Private enforcement

2.061* (1.72)

1.470 (1.29)

Public enforcement

1.661* (2.01)

1.363 (1.68)

Sales growth -0.170 (0.61)

-0.215 (0.75)

-0.203 (0.72)

-0.229 (0.80)

Leverage -1.979* (1.80)

-2.019* (1.77)

-2.119* (1.92)

-2.122* (1.89)

Log of market value 0.133*** (3.55)

0.153*** (4.23)

0.175*** (4.94)

0.182*** (5.09)

Adjusted R2

0.031

0.038

0.041 0.043

*, **, *** denote statistical significance at the 10%, 5%, and 1% levels, respectively, based on a two-sided test.

45

Table 7 Cross-sectional results of regressing the changes in the number and percentage ownership of institutional blockholders on investor protection and growth opportunity The table reports cross-sectional regression results for 490 foreign private issuers. The dependent variable is the change in the number (panel A) or percentage ownership (panel B) of institutional blockholders over the two-year period from September 31, 2001 to September 31, 2003, adjusted for the corresponding change in the industry level. Investor protection at the home countries of the foreign issuers are captured by Anti-directors rights, Judicial efficiency, Private enforcement, and Public enforcement. Growth opportunity is measured by two-year sales growth. Appendix D describes the construction of the explanatory variables. t-statistics are in parentheses; they are calculated using heteroskedasticity-consistent standard errors (White 1980) and adjusted for clustering by country (Wooldridge 2002). Panel A: Changes in the industry-adjusted number of institutional blockholders (1) (2) (3) (4) Constant -0.064

(0.27) -0.089 (0.41)

-0.065 (0.26)

-0.038 (0.16)

Anti-director rights 0.017 (0.53)

-0.052 (1.18)

0.017 (0.46)

-0.042 (0.92)

Judicial efficiency -0.018 (0.57)

-0.042 (1.25)

-0.018 (0.57)

-0.045 (1.33)

Private enforcement

0.679 (2.41)**

0.749 (2.45)**

Public enforcement

0.002 (0.01)

-0.157 (0.52)

Sales growth -0.048 (2.16)**

-0.063 (2.75)***

-0.048 (1.87)*

-0.061 (2.49)**

Leverage -0.655 (2.51)**

-0.669 (2.64)**

-0.655 (2.57)**

-0.662 (2.67)**

Log of market value 0.039 (4.17)***

0.046 (3.55)***

0.039 (3.76)***

0.042 (3.29)***

Adjusted R2

0.017

0.029 0.015 0.028

Panel B: Changes in the industry-adjusted percentage ownership of institutional blockholders (1) (2) (3) (4) Constant -7.953

(1.19) -8.403 (1.44)

-7.522 (1.12)

-7.024 (1.28)

Anti-director rights 1.417 (2.78)***

0.167 (0.17)

1.557 (2.63)**

0.444 (0.47)

Judicial efficiency -0.435 (0.62)

-0.875 (1.51)

-0.437 (0.62)

-0.948 (1.66)

Private enforcement

12.160 (2.12)**

14.036 (2.27)**

Public enforcement

-1.263 (0.48)

-4.251 (1.50)

Sales growth -0.021 (0.04)

-0.288 (0.58)

0.005 (0.01)

-0.244 (0.51)

Leverage 1.580 (0.42)

1.320 (0.36)

1.646 (0.44)

1.503 (0.41)

Log of market value 0.586 (2.26)**

0.706 (3.03)***

0.555 (2.12)**

0.620 (2.56)**

Adjusted R2

0.018

0.034 0.016 0.036

*, **, *** denote statistical significance at the 10%, 5%, and 1% levels, respectively, based on a two-sided test.

46