Question

I'm studying International Capital Structure and Cost of Capital. What are the benefits for firm to globalize the source of equity markets? What are the risk and how does the company adjust for such risk? Thank you.

Answer 1

Globalization of equity markets & cost of capital

Over the last fifty years, barriers to international investment have crumbled among developed economies as well as the emerging markets. Hence, U.S. investors can buy the securities of a large number of foreign countries with almost no restrictions.Corporations can choose where to raise funds and have access to both offshore and onshore markets.

The increasing integration of global capital markets now makes it easier for firms to access capital outside of their home countries. Firms access international capital markets through a variety of means such as initial public offerings (IPO), seasoned equity offerings (SEO), cross-listings, depository receipts, special purpose acquisition companies (SPACS), shelf offerings, private equity and other informal equity capital channels.   Firms can also access debt resources outside their home country market through bank loans from foreign banks, and foreign bond issues. Finally, cross border flows of venture capital (VC) is also increasing rapidly.
Venture capital and private equity through globalization take many forms such as cross-border investment, foreign acquisitions, VC firms opening offices overseas, and influencing their portfolio firms to enter and exit international stock exchanges. Foreign firms raise significantly more debt than equity in the U.S.. Indeed, the largest component of the international capital market is the bond market.

Benefits of globalizing the source of equity capital are as follows:-

• Larger pool of capital.
• Lower costs due to the potential segmentation and saturation of domestic markets.
• Diversification of country risk (and associated economic risks).
• Potential to hedge foreign exchange risk
• Increased global recognition.
• Tax reduction/avoidance and Lower interest rates.
• Provide stability and predictability.
• Provide access to more resources.

Global Financing Options:-

• Equity Financing:– Cross-listing – e.g. a Canadian firm on the NYSE , Global Depositary Receipts – e.g. ADR’s, Euro-equity market
• Debt Financing:– Foreign bank loans, Foreign bonds – e.g. Yankee Bonds, Euromarket bonds – e.g. EuroCanadianDollar bonds
• Derivatives:– Using futures, options or swaps to change cashflows and thus economic exposure.

To list shares on a foreign stock exchange companies must:

1. Qualify for listing according to the standards set for overseas companies by the stock exchanges.
2. Register with the local securities commission therefore they must conform to local GAAP etc. and pay the necessary fees.

For example, for a foreign co. to list on Nasdaq, it must have at least 1,250,000 publicly traded shares (not including those owned by directors with more than a 10 percent stake in the company), with a bid price greater than $5, have at least 550 shareholders, have an average trading volume of 1.1 million shares over the last 12 months and follow Nasdaq's corporate governance rules.

Historically, the US market has been a more attractive environment for technology companies, with better valuations and a more knowledgeable investor base, attracting the lion’s share of Chinese technology IPOs, including Alibaba’s recordbreaking US$25bn IPO in 2014.
The United States currently has highly liquid and highly automated capital markets
Although Greater China remains the primary Asian market, India has seen significant increases in IPO activity for the last few years.

Cross-listing refers to the listing of a company’s ordinary shares on a different exchange other than its original stock exchange. For example, a company might list its equity shares on a foreign stock exchange in addition to its domestic exchange.

Benefits of cross-listing/ globalizing the source of equity capital market :-

1)Increased Market Liquidity - Cross-listing enables companies to trade its shares in numerous time zones and multiple currencies. This increases the issuing company’s liquidity and gives it more ability to raise capital. Foreign companies that cross-list in the USA do so through American depository receipts. This term applies to foreign companies that seek to list their stocks on United States-based exchanges.

2)Market Segmentation - Market segmentation is the practice of dividing a large market into clear segments with similar needs. Cross-listing enables firms to divide foreign investor markets into segments which are easy to access. Companies seek to cross-list because they anticipate gaining from a lesser cost of capital. This arises because their stocks become more available to foreign investors. Their access to these stocks may otherwise be restricted due to international investment barriers.

3)Disclosure - Cross-listing can decrease the cost of capital via improving the company’s information environment. Cross-listing is associated with better media awareness which increases the quality of accounting information. Listed companies can use cross-listing on markets with strict disclosure requirements to indicate their quality to foreign investors and to supply better information to potential suppliers and customers.

4)Helps overcome mispricings due to illiquid capital markets, governance concerns or market segmentation.

5) Increases visibility of the company in foreign markets/ Increased global recognition.

6) Establishes a market for shares to perform transactions such as acquisitions in the host market.

7) Establishes a secondary market to compensate management and employees of subsidiaries in the foreign country.

8) Higher returns and cheaper borrowing costs. These allow companies and governments to tap into foreign markets and access new sources of funds. Many domestic markets are too small or too costly for companies to borrow in. By using the international capital markets, companies, governments, and even individuals can borrow or invest in other countries for either higher rates of return or lower borrowing costs.

9) Diversifying risk. The international capital markets allow individuals, companies, and governments to access more opportunities in different countries to borrow or invest, which in turn reduces risk. The logic behind is that not all markets will experience contractions at the same time.

10) Companies sell their stock in the equity markets. International equity markets consists of all the stock traded outside the issuing company’s home country. Many large global companies seek to take advantage of the global financial centers and issue stock in major markets to support local and regional operations.
For example, ArcelorMittal is a global steel company headquartered in Luxembourg; it is listed on the stock exchanges of New York, Amsterdam, Paris, Brussels, Luxembourg, Madrid, Barcelona, Valencia.

Risks of globalizing the source of equity capital

The major global investment risks include:

1) Currency Risk

This risk is associated with fluctuations in a foreign currency relative to the U.S. dollar. For example, a foreign company may report 25 percent earnings growth, but if its local currency depreciates by 10 percent relative to the U.S. dollar, the real growth rate is just 15 percent when the profits are converted back into U.S. dollars.

2) Political Risk

This risk is associated with foreign governments poliicies and the geopolitical conditions. For example, Brazil nationalized part of its largest oil company — Petroleo Brasileiro — in a move that caused many investors to lose money. A subsequent corruption scandal involving the company pushed shares even lower.

3) Interest Rate Risk

This risk consists of unfavorable changes to monetary policy. For instance, an emerging market economy may decide that it is growing too quickly and act to contain inflation by hiking interest rates. These dynamics could have a negative impact on the value of financial assets that are priced based upon those interest rates.

4) Raising money in a foreign country is expensive for new firms
The time it takes to conclude a deal isn't any shorter than it is in the U.S., and if a co. representatives must stay there to complete the process, it will cost the entrepreneur even more money than if he/she had tried it at home.

5) Investors in foreign countries are highly suspicious of any new outside co. coming to their country to raise money.

6) In many countries where one would think the opportunity are good (in Europe, for instance), entrepreneurs have found that the infrastructure wasn't as well developed and clear as it is in the U.S. For example, angel networks aren't as well organized or even that easy to find, and venture capital firms are almost nonexistent. So, unless the entrepreneur has a clear plan on where to go and who to see, he/she is probably wasting time.