Which Firms Choose to List as American Depositary Receipts (ADRs)?: Evidence from Mexican Cross Listings

Abstract

This study provides evidence that Mexican firms that choose to trade in the U.S. as exchange-listed American Depositary Receipts (ADRs) have significantly weaker ex post (subsequent to cross listing) financial performance compared with Mexican firms that are eligible to list in the U.S., but do not. The study provides evidence related to two streams of international research. First, global equity offerings studies, e.g., Foerster and Karolyi (2000), based on large, multi-country samples, show that ADR firms substantially underperform local market benchmark company returns in years following issuance. A second stream of research examines accounting characteristics of ADR firms. For example, Lang, Raedy and Yetman (2001) employ a multi-country sample and conclude that ADR firms perform better, are less risky and less aggressive in terms of earnings management. They also find that ADR firms report accounting data that are more strongly associated with share prices. The above studies have the advantage of using relatively large samples. However, such studies tend to mask individual country differences in the degree of market efficiency, legal protections for shareholders, disclosure environment and shareholder class features that make generalizations tenuous. We show for Mexican firms that, on average, ADR firms are smaller, more highly levered and less profitable than non-crosslisted (NCL) firms. Further, logistic regression models for classifying various ADR and NCL groupings of firms, using financial and other firm characteristics, are highly significant. While supplemental tests of earnings quality suggest that NCL firms exhibit nominally smoother earnings, that evidence is not sufficient to explain the stronger reported financial performance of those firms relative to ADR firms. Finally, our tests of value relevance, using book value and earnings to explain price, show significantly higher explanatory power for the ADR firms and generally non-significant explanatory power for the NCL firms. The value-relevance results may indicate that investors in Mexican ADR firms benefit from U.S. regulation and that reported market inefficiency in Mexico may result in low demand for financial statements of NCL firms. This study has the advantage of focusing on a single, emerging-market economy in contrast to most previous ADR research that used multi-country samples dominated by developed market countries. It is also one of the first ADR studies to deal with selection bias issues by comparing cross-listed and non-crosslisted firms. These advantages are obtained at the cost of having to conduct tests on and draw conclusions from relatively small samples.