Definitions

listed company

Dual-listed company

A dual-listed company or DLC (also referred to as a Siamese twin) is a corporate structure which involves two listed companies with different sets of shareholders sharing ownership of one set of operational businesses.

In a conventional takeover one business acquires the shares of another. However when a DLC is created, both companies continue to exist, and to have separate bodies of shareholders, but they agree to share all the risks and rewards of the ownership of all their operating businesses in a fixed proportion, laid out in the equalization agreement. The equalization agreements are set up to ensure equal treatment of both companies’ shareholders in voting and cash flow rights. The contracts cover issues that determine the distribution of these legal and economic rights between the twin parents, including issues related to dividends, liquidation, and corporate governance. Usually the two companies will share a single board of directors and have an integrated management structure. A DLC is somewhat like a joint venture, but the two parties share everything they own, not just a single project.

Examples

Some major dual-listed companies are listed in Dual-listed companies; they include:

Other companies were formerly dual-listed:

Motivations for adopting a DLC structure

A dual-listed company structure is effectively a merger between two companies in which they agree to combine their operation and cash flows and make similar dividend payments to shareholders in both companies, while retaining separate shareholder registries and identities. In virtually all cases the two companies are listed in different countries. There are often tax reasons for companies from different jurisdictions to adopt a DLC structure instead of a regular merger where a single share is created. A capital gains tax could be owed if an outright merger took place, but no such tax consequence would arise with a DLC deal. Differences in tax regimes may also favor a DLC structure, because cross-border dividend payments are minimized. In addition, there may be favorable tax consequences for the companies themselves. Once companies have chosen a DLC structure there can be major tax obstacles to cancelling the arrangement. Issues of national pride may sometimes also be involved; where both parties to a proposed merger or takeover are in a strong position and don't need to merge or accept a takeover, it can be easier to push it through if the country with the smaller business is not "losing" its corporation. A third motive is the reduction of investor flow-back, which would depress the price of the stock of one of the firms in their own market if the merger route were used instead. That is, some institutional investors cannot own the shares of firms domiciled outside the home country or can only own such shares in limited quantity. In addition, in a merger, the non-surviving firm would be removed from all indices. Index tracking funds would then have to sell the shares of the surviving company. With the DLC structure, all of this would be avoided. A fourth motive is that DLCs do not necessarily require regulatory (anti-trust) consent and may not be constrained by the requirement of foreign investment approval. Finally, the access to local capital markets may be reduced when a quotation disappears in a regular merger. This is based on the idea that local investors are already familiar with the company from the pre-DLC period. However, the DLC structure also has disadvantages. The structure may hamper transparency for investors and reduce managerial efficiency. In addition, issuing shares in a merger and capital market transactions (such as SEOs, share repurchases, and stock splits) are more complex under the DLC structure.

Dual-listings versus cross-listings

Sometimes the term dual-listing is used to refer to a single company having stock listings on more than one stock exchange. Usually the shares on each exchange are all in the same company; this is quite different from the dual-listed company structure described above. A more common term for this construction is a cross-listing. Generally such a company's primary listing is on a stock exchange in its country of incorporation, and its secondary listing(s) is on an exchange in another country. The key difference between cross-listed and dual-listed stocks is that the shares of dual-listed companies are not convertible into each other. In other words, DLCs involve two different stocks rather than one stock listed on different exchanges. Cross-listing is especially common for companies that started out in a small market but grew into a larger market. For example, numerous large Canadian companies are listed on the New York Stock Exchange or NASDAQ as well as the Toronto Stock Exchange. The term can also be used to refer to the listing of a company on more than one stock exchange in the same country: as an example, there are a handful of companies in the United States that are listed on both the New York Stock Exchange and the NASDAQ. Some organizations, such as Liberty Media, have multiple listings reflecting different underlying assets, called tracking stocks.

Mispricing in DLCs

The shares of the DLC parents represent claims on exactly the same underlying cash flows. In integrated and efficient financial markets, stock prices of the DLC parents should therefore move in lockstep. In practice, however, large differences from theoretical price parity can arise. For example, in the early 1980s Royal Dutch NV was trading at a discount of approximately 30% relative to Shell Transport and Trading PLC. In the academic finance literature, Rosenthal and Young (1990) and Froot and Dabora (1999) show that significant mispricing in three DLCs (Royal Dutch Shell, Unilever, and Smithkline Beecham) has existed over a long period of time. Both studies conclude that fundamental factors (such as currency risk, governance structures, legal contracts, liquidity, and taxation) are not sufficient to explain the magnitude of the price deviations. Froot and Dabora (1999) show that the relative prices of the twin stocks are correlated with the stock indices of the markets on which each of the twins has its main listing. For example, if the FTSE 100 rises relative to the AEX index (the Dutch stock market index) the stock price of Reed International PLC generally tends to rise relative to the stock price of Elsevier NV. De Jong, Rosenthal, and van Dijk (2008) report similar effects for nine other DLCs. A potential explanation is that local market sentiment affects the relative prices of the shares of the DLC parent companies. Because of the absence of "fundamental reasons" for the mispricing, DLCs have become known as a textbook example of arbitrage opportunities, see for example Brealey, Myers, and Allen (2006, chapter 13).

Arbitrage in DLCs

The mispricing in dual-listed companies has not gone unnoticed in the financial industry. There are a number of known cases of financial institutions that have tried to exploit the mispricing by setting up arbitrage positions in DLCs. These arbitrage strategies involve a long position in the relatively underpriced part of the DLC and a short position in the relatively overpriced part. For example, in the early 1980s an arbitrageur might have built up a long position in Royal Dutch NV and a short position in Shell Transport and Trading PLC. This position would have yielded profits when the relative prices of Royal Dutch and Shell converged to theoretical parity. An internal document of Merrill Lynch investigates arbitrage opportunities in six DLCs. Lowenstein (2000) describes arbitrage positions of Long-Term Capital Management (LTCM) in Royal Dutch/Shell. LTCM established an arbitrage position in this DLC in the summer of 1997, when Royal Dutch traded at an 8 to 10 percent premium. In total $2.3 billion was invested, half of which long in Shell and the other half short in Royal Dutch (Lowenstein, p. 99). In the autumn of 1998 large defaults on Russian debt created significant losses for the hedge fund and LTCM had to unwind several positions. Lowenstein reports that the premium of Royal Dutch had increased to about 22 percent and LTCM had to close the position and incur a loss. According to Lowenstein (p. 234), LTCM lost $286 million in equity pairs trading and more than half of this loss is accounted for by the Royal Dutch/Shell trade.

The example of LTCM is a good illustration of why arbitrage by financial institutions has not succeeded in eliminating the mispricing in DLCs. An important characteristic of DLC arbitrage is that the underlying shares are not convertible into each other. Hence, risky arbitrage positions must be kept open until prices converge. Since there is no identifiable date at which DLC prices will converge, arbitrageurs with limited horizons who are unable to close the price gap on their own face considerable uncertainty. De Jong, Rosenthal, and van Dijk (2008) simulate arbitrage strategies in 12 DLCs over the period 1980-2002. They show that in some cases, arbitrageurs would have to wait for almost nine years before prices have converged and the position can be closed. In the short run, the mispricing might deepen. In these situations, arbitrageurs receive margin calls, after which they would most likely be forced to liquidate part of the position at a highly unfavorable moment and suffer a loss. As a result, arbitrage strategies in DLCs are very risky, which is likely to impede arbitrage.

Notes

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