In recent years, the popular press and academic commentators have expressed a concern that controlling shareholders of foreign issuers with a cross-listing in the United States (and especially Chinese issuers) are exploiting U.S. investors by paying unfairly low prices in freezeout transactions – that is, transactions in which the controlling shareholder buys the remaining shares of the corporation for cash or stock. The basic idea is that freezeouts of foreign cross-listed issuers are not subject to the same rules and enforcement mechanisms that apply to U.S. companies, which facilitates the underpricing. Fried (2021), for instance, states:

Over the past decade, controlling shareholders of more than 90 China-based, US-traded firms have arranged confiscatory “take-private” transactions. The goal: delist U.S. shares at a low buyout price and then relist in China at a much higher valuation (…) Investors in US-listed Chinese companies are more vulnerable to this tactic than investors in public U.S. companies. Financial statements are unreliable and most companies … incorporate[d] in the Cayman Islands. This jurisdiction affords investors less protection than Delaware, home to most U.S. companies. Neither U.S. nor Cayman court judgments can be enforced in China, where insiders and assets are based. When American investors are hurt, [state-secrecy laws are] invoked to shield audit papers from the PCAOB, [which makes] it difficult for shareholders and regulators to get to the bottom of things.

But despite the political and economic significance of these claims, there is no systematic evidence on whether investors in Chinese cross-listed issuers in fact receive lower gains than domestic U.S. issuers in freezeouts. In fact, there is no empirical evidence on whether investors in any type of foreign cross-listed issuer (not just Chinese companies) fare worse than investors in domestic issuers. We therefore address those questions by examining all freezeouts of domestic and foreign cross-listed issuers during the period 2000-2021. Our sample includes all deals in which the buyer held at least 30% of the shares in the target prior to the announcement of the transaction because the Delaware courts (where most public U.S. companies are incorporated) has held that a 30% shareholding is enough to trigger control. However, we repeat the analysis with a 50% threshold and obtain similar results.

Our results indicate that investors in fact receive approximately 6-11% lower returns in freezeouts of issuers located in “Restrictive Markets” (i.e., jurisdictions that U.S. authorities have flagged as posing a particularly high risk of exploitation) than investors in domestic companies. In addition, we show that this difference is predominantly driven by Chinese issuers.

We measure the gains of the target shareholders as the cumulative abnormal returns (CARs) of the company around the announcement of the freezeout, and we define the CARs as the difference between the daily return for the stock of the target relative to the return of the Center for Research in Securities Pricing (CRSP) index. We use two alternative windows to compute the CARs: a short window of five days around the date of the announcement of the transaction, and a long window of 30 days around the announcement.

The main independent variables of interest in our regressions are location indicators for the issuers. We classify firms into one of three categories: “Restrictive Market,” “Non-Restrictive Market,” or “Domestic.” Similar to the definition adopted by Nasdaq, the “Restrictive Market” category includes issuers located in jurisdictions that did not allow the PCAOB to conduct inspections of auditors located in that jurisdiction during the sample period. We think these inspections are a minimum level of protection for U.S. investors, so we use the “Restrictive Market” category as the baseline proxy for countries that expose investors to a particularly acute risk of exploitation. During our sample period, China and Hong Kong were classified as Restrictive Markets, but given the high number of Chinese issuers in the sample, those issuers are the most important jurisdiction in the category. The “Non-Restrictive Market” category includes all other foreign issuers with a U.S. cross-listing (mostly, Canadian, European, and Israeli companies), and the “Domestic” category includes U.S. companies. Freezeouts of U.S. companies are the benchmark for the analysis.

The remaining independent variables are controls for characteristics of the transaction and the target company. We mitigate the concern that the differences in the gains of the target shareholders may result from financial characteristics rather than the freezeouts’ legal regime not only by controlling for all these variables, but also by running the regressions using a matched sample of domestic and foreign cross-listed issuers.

These results have important policy implications. The law that governs a freezeout is the law of the country in which the target company is incorporated, which implies that, leaving aside some disclosures mandated by federal securities law, domestic investors are left with little protection if the home country of the foreign issuer does not have a judiciary that actively polices conflicted deals and a strong doctrinal regime. For example, freezeouts of U.S. companies are typically subject to demanding judicial scrutiny in the form of entire fairness review, under which courts will examine whether the negotiation and economic terms of the transaction were fair; the controlling shareholder only receives significant judicial deference if the transaction was conditioned on approval by independent directors and the majority-of-the-minority shareholders. In contrast, minority shareholders in foreign cross-listed issuers do not necessarily receive equivalent protections, and this problem is compounded by procedural hurdles imposed by the home jurisdiction of the target company. The results presented in this paper suggest that controlling shareholders seem to exploit this regulatory discrepancy, which in turn calls for greater protections for domestic investors.

The paper is available here: https://ssrn.com/abstract=4838226