How the Globalization of Capital Markets Has Affected the Listing Behavior of Foreign Issuers
The Case of Daimler's Listing on the NYSE
Seminar Paper 2011 49 Pages
TABLE OF CONTENTS
II LISTING ON THE NYSE AND ITS CONSEQUENCES
A. DAIMLER’S ADR LISTING
B. CONSEQUENCES FOR DAIMLER
C. DAIMLER’S REASONS FOR LISTING
4. DAIMLER’S NEED FOR RESTRUCTURING
III. LEGISLATIVE CHANGES IN GERMANY AND THE U.S
A REFORM OF THE GERMAN FINANCIAL MARKETS
1. THE SECURITIES TRADING ACT (1994)
2. THE TAKEOVER ACT (2002)
C. SARBANES-OXLEY AND ITS GERMAN COUNTERPARTS
1. SOX’S CORE PROVISIONS
2. INCONSISTENCIES/CONFLICTS WITH GERMAN LAW
3. DUAL COMPLIANCE COST
IV. TRADING IN DAIMLER SHARES TODAY
A DELISTING REQUIREMENTS
B. CHANGED INVESTOR BEHAVIOR
C. ADR PROGRAM
APPENDIX A. HISTORY OF GERMAN COMPANIES ON THE NYSE
APPENDIX B. DELISTINGS BY FOREIGN COMPANIES IN NUMBERS
APPENDIX C. DOMESTIC AND FOREIGN DELISTING RATES
APPENDIX D. CROSS-HOLDINGS IN GERMAN PUBLIC COMPANIES IN 1996 AND 2002
APPENDIX E. FOREIGN OWNERSHIP OF DAX 30 COMPANIES (AS OF 2005)
When Daimler-Benz AG’s American Depository Receipts (ADRs) began trading on the New York Stock Exchange (NYSE) on October, 5, 1993, Daimler’s management was jubilant. “This is the greatest thing I’ve done in my career,” said Gerhard Liener, Daimler’s CFO.1 Hilmar Kopper, the chairman of Daimler’s supervisory board, added: “I view this step as absolutely positive.”2
While many other foreign companies had already listed on the NYSE, Daimler was the first German company on the Big Board. Three years of negotiations with the Securities and Exchange Commission (SEC) had preceded Daimler’s decision to register its securities with the SEC and thus subject itself to the U.S. disclosure regime. Until then, approximately 200 German companies had registered for trading only on the over-the-counter (OTC) market, which exempted them from U.S. reporting and disclosure rules.3 In the U.S., Daimler’s listing was perceived as a victory for the SEC, which had resisted NYSE chairman William Donaldson’s repeated calls to ease access for foreign issuers. Daimler was expected to, and ultimately did, serve as a role model for other major German companies to follow.4
Initially, Daimler’s decision received criticism from executives of other big German companies, such as Siemens, Bayer, and BASF. Daimler was seen to be “breaking ranks” with the united front of German companies against the imposition of unacceptable disclosure requirements on foreign issuers. At the core of the dispute was the SEC’s insistence on financial statements that are reconciled with U.S. GAAP. For German firms, this meant a significant departure from lenient German accounting principles which allowed for the creation of so-called “hidden reserves” to smooth earnings. Despite the initial resistance, more and more German companies followed Daimler’s example in subsequent years. In 1996, SGL Carbon, Pfeiffer Vacuum, Fresenius, and Deutsche Telekom followed Daimler to the NYSE. Until the end of 2000, eleven more obtained a listing, including global players such as SAP, BASF, Allianz, Siemens, Deutsche Bank, and Bayer, bringing the total number of German companies listed on the NYSE to 16. Common advantages named for a cross-listing in the U.S. included higher valuations in the U.S.’s liquid market, prestige, the ability to represent compliance with the U.S.’s rigorous disclosure standards (bonding), the potential use of U.S. securities for future acquisitions, and an increased analyst following.
However, Daimler announced on May 14, 2010 that it would delist its shares5 from NYSE and apply to the SEC for deregistration of its securities.6 Delisting became effective on June 7, 2010, and deregistration with the SEC on September 7, 2010. Daimler stated changed investor behavior and consistently low trading volumes as the principal reasons for its decision. According to CFO Bodo Uebber, the trading center for Daimler shares, both for German and international investors, was Frankfurt and the step was designed to enhance Daimler’s overall efficiency.7 Instead, Daimler returned to a sponsored ADR program, but this time to be traded on the OTC market, thus avoiding SEC oversight.
Daimler is not the only German company to end its term on the NYSE: The retreat of German companies began in 2007 with delistings of SGL Carbon, E.on (successor of Veba), and Bayer, which used the introduction of more lenient delisting requirements to leave the NYSE. Deutsche Telekom’s decision to delist preceded Daimler’s by only a couple of weeks, leaving now only four German companies on the Big Board: Fresenius, SAP, Siemens, and Deutsche Bank.8 While these companies have denied similar plans to delist, many analysts believe that delistings will occur once the trading volume in their shares drops under the 5%, a perquisite for delisting.9
This trend in recent years is not limited to issuers from Germany. Delistings by foreign issuers peaked dramatically in 2007, with a total number of 72, 10 or 16% of all listed foreign companies,11 leaving the NYSE. This sharp increase coincided with the ease in delisting restrictions that was announced by the SEC in 200712 and delistings dropped back to roughly 5% in 2008 and 2009. However, the number of foreign companies taking their shares off the Big Board increased again in 2010 to 41, or 7.5% of all listed foreign companies,13 indicating that the drop in 2008 and 2009 was largely due to the vacuum left behind by the large number of firms who had left in 2007, and confirming the trend of delistings by foreign issuers on the NYSE.
What happened between Daimler’s enthusiastic listing in 1993, and the decision to retreat from the public markets in the U.S. in 2010? Commentators cite several reasons for the decline in appeal of a U.S. cross-listing. First, other capital markets have become just as liquid and U.S. investors increasingly trade directly in issuers’ home countries, making a listing in New York unnecessary. Second, other countries have significantly improved their regulatory regime for securities, thus limiting the benefit of bonding. And third, high compliance costs for foreign issuers, in particular caused by the Sarbanes-Oxley Act (SOX), make a U.S. listing significantly less attractive.
This case study on Daimler’s NYSE history aims to illustrate how global equity markets have evolved in the past two decades and what the reasons are for companies to raise capital in these global markets. In doing so, the case study will proceed as follows: Part II will describe the initial listing of Daimler ADRs on the NYSE in October 1993 and its consequences for Daimler’s financial reporting, followed by the reasons that motivated Daimler to come to New York. Part III provides an overview of the legislative and regulatory changes that took place both in Germany and the U.S., and how these developments affected Daimler’s decision to terminate its listing on the NYSE in 2010. Part IV investigates how investors today are able to invest in foreign issuers such as Daimler. Finally, the case study concludes by summarizing the reasons for Daimler’s delisting and its meaning for the competitiveness of the U.S. public markets in Part V.
This case study will not, however, go into the details of the Daimler-Chrysler merger in 1998. The merger was a very significant event in the history of both Daimler and Chrysler, making the new DaimlerChrysler one of the largest corporate conglomerates worldwide, and its strategic implications and subsequent negative outfall could easily be the subject of its own case study. However, the merger did not have any direct implications for Daimler’s decision to delist from the NYSE. The only connection one could make between Daimler’s NYSE listing and the merger would be that through raising capital in the U.S., Daimler was able to create currency for acquisitions of U.S. companies.14 However, it seems that this was not one of the driving factors for Daimler. First, there is no indication that Daimler already considered such a merger in 1993. And second, Daimler ultimately did not use its ADRs as consideration in the merger. Rather, the two former corporations Daimler-Benz and Chrysler were consolidated in the new entity DaimlerChrysler AG, and shareholders received global registered shares (GRSs) in DaimlerChrysler AG which were listed in dollars on the NYSE and in euros on the Frankfurt Stock Exchange.15
II. LISTING ON THE NYSE AND ITS CONSEQUENCES
Daimler celebrated its listing on the NYSE with a display of its products. A fire engine, a helicopter, and several Mercedes-Benz cars represented Daimler’s four main operating units at the time: Mercedes-Benz, Deutsche Aerospace, electronics unit AEG, and financial-services unit Debis.16 Daimler’s Chair of the Managing Board Edzard Reuter bought the first ADRs, which began trading at $47 and closed that day at 46 ¾.17 Daimler’s listing on the NYSE constituted its sixth listing on a foreign exchange, preceded by listing in Zurich in the 1970s, London and Tokyo in 1990, and Vienna and Paris in 1991. But the listing in New York was special in many regards. Daimler’s CFO Gerhard Liener called it the “greatest thing” he had done in his career,18 saying that “[i]f we want to live up to our claim of calling ourselves a global player, we have to be listed in the world’s biggest capital market.”19 Daimler had taken this step after three years of negotiations with the SEC in which Daimler, together with other large German companies, had long refused to give in to the SEC’s demand of U.S. GAAP reconciled financial statements, and had lobbied for a system of “mutual recognition” under which each securities authority would accept reports prepared under the other’s rules. The “compromise” that Daimler ultimately reached with the SEC, and which Liener called “a very satisfactory solution,”20 was not really much of a true compromise. The SEC stood firm on requiring Daimler to reconcile its financial statements with U.S. GAAP, which meant that Daimler had to disclose its large hidden capital reserves allowed under German accounting rules. The SEC’s concessions included that Daimler would have to furnish financial reports only every half year, instead of quarterly, and only the financial statements of the past two years (instead of five) would have to be reconciled.21 Then- commissioner Mary Shapiro said that “[t]he basic premise that our disclosure standards need to be met in order list in the U.S. market still holds.”22 Another SEC official added: “[Disclosure of financial data] has always been the stumbling block, but the Germans have capitulated.”23
A. DAIMLER’S ADR LISTING
Daimler listed on the NYSE in the form of ADRs. ADRs are dollar-denominated securities that represent ownership of the underlying shares of an issuer. Instead of selling the shares directly, the issuer deposits the underlying shares with a depository bank in the U.S., which in turn issues the ADRs and remains responsible for collecting dividends from the issuer and distributing them to the ADR holders in dollars. For investors, ADRs offer the advantage that they can invest independent from currency fluctuations and that they are free from potential restrictions on the acquisition of foreign securities.24 Daimler, through Citibank N.A. acting as depository bank, issued ADRs at the price of $47, representing a ratio of roughly 1:10 to its share price in Frankfurt. Such a “stock split” is common for ADR offerings in order to bring the price of the security down to a level of comparable stocks in the U.S. Interestingly, Daimler did not issue new stock to be deposited with Citibank, N.A. Instead, Citibank bought outstanding shares in the market which it used as the underlying shares in the ADR offering.25 Daimler’s objective in taking this approach was to first create an analyst following in the U.S. through the listing before raising fresh capital through a subsequent rights offering in which ADRs would represent newly issued shares. Daimler subsequently executed such a rights offering on June 20, 1994. One right was issued per ADR and each 10 rights were exercisable for the purchase of one additional ADR at 64 deutsche marks.26
B. CONSEQUENCES FOR DAIMLER
By the decision to publicly offer ADRs, i.e., securities, on the NYSE, Daimler became subject to the Securities Act of 1933 (the 1933 Act) and the Securities and Exchange Act of 1934 (the 1934 Act). Unless exempt, all sales of foreign securities must be registered with the SEC by filing Form F-1 and sales of securities cannot be executed until the registration statement is declared effective.27 Once registered, the foreign issuer must comply with the periodic reporting requirements under the 1934 Act by filing Form 20-F. Form 20-F incorporates by reference the reporting requirements for foreign issuers promulgated under Regulations S-K and S-X. Information required to be disclosed includes a description of the business, legal matters, executive compensation, risk factors, and management’s discussion and analysis.28 More importantly, Regulation S-X required Daimler to either provide financial statements in accordance with U.S. GAAP or to disclose financial statements compliant with another comprehensive body of accounting, provided that the financial statements include a discussion of the variations with U.S. GAAP and a reconciliation of net income and stockholders’ equity according to U.S. GAAP.29
The reason why Daimler and other German companies had fought U.S. disclosure requirements for so long became apparent when Daimler filed its first Form 20-F with the SEC on September 17, 1993. Under German accounting rules, Daimler reported a profit of $68 million for the first half of 1993, representing a sharp drop from $759 million in the comparable period a year earlier. But reconciled with U.S. GAAP, the $68 million profit translated into a $556 million loss.30 For the full year, net income was $354 million under German accounting, but a $1.057 billion net loss under U.S. GAAP.31
The vast difference in net income whether reported under U.S. GAAP or German accounting rules was attributable to the availability of so-called “hidden reserves”32 under German law. To understand the complications that Daimler was facing when reconciling its financial statements with U.S. GAAP, it is important to know that the two accounting regimes have very different underlying objectives. Whereas U.S. GAAP is aimed at facilitating shareholder decision-making by offering an accurate “snap shot” of the momentary financial situation, German accounting principles are designed primarily to promote caution and creditor protection.33 This is why, unlike U.S. GAAP’s accrual accounting, German law sometimes allows for the accrual of future expenses by building off-balance sheet reserves. Such reserves can be created in three ways: (1) by making provisions for future contingencies; (2) by crediting shareholder equity accounts instead of reporting income as profit; and (3) by writing down the book values of assets.34 Significantly, companies are permitted to draw on these reserves without any particular restrictions by debiting the off-balance sheet reserves and using the credit to increase the income.35 Therefore, companies reporting under German accounting rules can build reserves out of earnings in profitable years and draw on them in years of actual losses, thus decreasing the company’s historic earnings volatility.
Under U.S. GAAP, however, a loss contingency against earnings is permissible only when the loss is probable and the amount of the loss can be estimated.36 Thus, when Daimler was required to reconcile its financial statements with U.S. GAAP in order to obtain registration from the SEC, it had to disclose the hidden reserves by crediting the shareholder equity accounts and using the corresponding debit against its earnings, turning a slight profit into a huge loss.
Naturally, the SEC received criticism from German companies seeking a listing on the NYSE. Daimler’s departure from traditional German accounting practices was seen as a challenge to the German corporate and social governance system, and as undermining the prospects for negotiating mutual recognition.37 German scholars claimed that reconciliation with U.S. GAAP undermined the promotion of creditor protection under German accounting principles, and that adopting a system of quarterly reports would lead managers to adopt a shorter horizon in their decision-making that focused only on short-term profits.38 The SEC, however, remained on its standpoint that national treatment of any foreign issuer listed in the U.S. was required to uphold fairness among U.S. and foreign issuers and to enhance the efficiency of the overall market through high standards of transparency.39
C. DAIMLER’S REASONS FOR LISTING
Considering the cost of disclosure and the negative publicity associated with the disclosure of its hidden reserves, one might ask why Daimler decided to pursue the U.S. listing. In particular, it seems puzzling why Daimler decided to give in to the SEC’s demands after three years of negotiations specifically in a year in which it knew U.S. disclosure rules would cause the company to report a loss for the first time in its more than 100-year history.
The primary reason named for a cross-listing is commonly the access to a broader investor base and in particular to the deep liquidity in the U.S. capital markets.40 According to Managing Board Chairman Edzard Reuter, Daimler’s active presence in the United States made it “all the more vital that American stockholders be able to participate in [the] firm.”41 The goal was to increase the share of American investors from 3% to about 10% of Daimler’s outstanding shares.42 At the time, the listing gave Daimler direct access to 51 million U.S. investors and more than 10,000 institutional investors.43 Empirical evidence shows that broadening the company’s shareholder base diversifies risk exposure, which usually leads to a positive share price effect following a listing in the U.S.44 Additionally, Germany had a very small public securities market compared to the U.S. At the end of 1995, exchange-traded stock constituted less than 40% of its GDP, whereas U.S. market capitalization amounted to $6.9 trillion, representing nearly 60% of its GDP.45 Thus, Daimler gained access to a much more liquid market and raised many hundreds of millions in subsequent years.46
1 Benz Starts Its Ride on the Big Board, Chicago Tribune (Oct. 6, 1993), BUSINESS at 3.
2 Daimler-Benz Premieres On Wall Street, PR Newswire (Oct. 5, 1993).
3 Ray Ball, Corporate Governance and Financial Reporting at Daimler-Benz (DaimlerChrysler) AG: From a
Stakeholder toward a “Shareholder Value” Model, in The Economics and Politics of Accounting (Christian Leuz, Dieter Pfaff & Anthony Hopwood eds., 2005) 103, 127.
4 See Susan E. Woodward, Benz Opens Its Books for U.S. Investors, N.Y. Times (May 30, 1993), at 3-11.
5 Since the merger with Chrysler in 1998, Daimler’s shares had been trading on the NYSE directly as global
registered shares (GRSs).
6 Press Release, Daimler plans to discontinue stock-exchange listing in New York, Daimler AG (May 14, 2010).
8 See Appendix A for a complete list of all German companies formerly or presently listed on the NYSE.
9 See Eric Kelsey, German Giants Flee Wall Street, Spiegel Online (July 22, 2010), http://www.spiegel.de/international/business/0,1518,706321,00.html.
10 See Appendix B.
11 See Appendix C.
12 See infra Part IV.A.
13 Appendix B and C.
14 Hal S. Scott, International Finance 48 (2010).
15 Id. at 67; Daimler Chrysler AG’s GRSs were initially listed on 21 exchanges in 8 countries, including New York, Frankfurt, London, Paris, Zurich, and Tokyo. A GRS is a globally traded share that trades and transfers freely across national borders, with trades settled through a link between the clearing houses in the countries of the respective exchanges; see G. Andrew Karolyi, DaimlerChrysler AG, The First Truly Global Share 6-8, (Dice Center Working Paper No. 99-13, Feb. 07, 2000), available at http://ssrn.com/abstract=185133.
16 Benz Starts its Ride on the Big Board, supra note 1.
19 Daimler-Benz to Apply for NYSE Listing by Year-End, Bloomberg News (Mar. 30, 1993).
20 Daimler to meet U.S. rules: German auto maker wants shares traded on NYSE, Globe and Mail (Apr. 1, 1993), at B18.
21 See Foreign Firms Adapt Accounting to List in U.S., L.A. Times (Nov. 1, 1993), at 4.
22 Daimler-Benz to Comply with SEC Listing Rules, J. Comm. (Mar. 31, 1993), at 3A.
24 James L. Cochrane, Are U.S. Regulatory Requirements for Foreign Firms Appropriate, 17 Fordham Int’l L.J. 58, 60 (1994); see infra Part IV.C.
25 Dennis E. Logue & James K. Seward, Anatomy of a Governance Transformation: The Case of Daimler-Benz, 62 L. & Contemp. Probs. 87, 93 (2000).
26 Daimler-Benz AG Begins Rights Offering, Standard & Poor’s Daily News (June 21, 1994), available at 1994 WLNR 542707.
27 15 U.S.C. § 77e.
28 Eric M. Sherbet, Bridging the GAAP: Accounting Standards for Foreign Registrants, 29 Int’l Law. 875, 880 (1995).
29 Id. at 881.
30 Floyd Norris, Daimler Says Profits Fell in First Half, N.Y. Times (Sept. 18, 1993).
31 Daimler-Benz AG, Annual Report 1993, 3, available at http://www.daimler.com/Projects/c2c/channel/documents/1364421_1993_Daimler_Benz_Annual_Report.pdf.
32 The literal translation of “Stille Reserven” would be “silent reserves,” a term that then Daimler CFO Gerhard Liener said he preferred to use, probably because of its less accusatory connotation; see Floyd Norris, Daimler-Benz paves the way for other German companies, N.Y. Times (Mar. 31, 1993), at D8.
33 Ball, supra note 3 at 120.
34 Id. at 128.
35 Id. at 129.
36 Id. at 130.
37 Id. at 132.
38 Id. at 132-33 (pointing out that German accounting principles generated contracting costs and led to inefficient financial reporting).
39 See Richard C. Breeden, Foreign Companies and U.S. Securities Markets in a Time of Economic Transformation, 17 Fordham Int’l L.J. 77, 88 (1994).
40 Kyle W. Pine, Lowering the Cost of Rent: How IFRS and the Convergence of Corporate Governance Standards Can Help Foreign Issuers Raise Capital in the United States and Abroad, 30 Nw. J. Int’l L. & Bus. 483, 484 (2010).
41 Daimler-Benz Becomes First German Stock Listed in U.S., Bloomberg News (Oct. 5, 1993).
42 Daimler-Benz Premieres on Wall Street, PR Newswire (Oct. 5, 1993).
44 Karolyi, supra note 15 at 11.
45 Logue & Seward, supra note 25 at 93.