RDP 2003-06: The Characteristics and Trading Behaviour of Dual-Listed Companies 3. Examples of Dual-listed Companies and Puzzles in Their Pricing

Of the six large DLCs existing in early 2003, three involved companies from the United Kingdom and the Netherlands (Royal Dutch Shell, Unilever and Reed Elsevier) and three involved companies from the United Kingdom and Australia (Rio Tinto, BHP Billiton, and Brambles Industries). We refer henceforth to these as the Anglo-Dutch and Anglo-Australian DLCs.

The concentration of UK, Australian and Dutch companies in this group raises the question of whether there is something peculiar to these countries to encourage DLCs. No obvious explanation appears to exist, though one possible factor may be that a listing on the London equity market is viewed as particularly attractive, and that given the choice between a single listing on another market and a dual listing that also includes London, companies may choose not to give up their London listing.

Given that Froot and Dabora concentrated on two of the Anglo-Dutch cases, we begin our discussion of the continuing DLCs with a presentation of some basic facts about the more recent Anglo-Australian DLCs. The first of these resulted from the 1995 merger of Australian mining company CRA and UK-listed RTZ, which already held a 49 per cent stake in CRA. The two companies have subsequently been renamed Rio Tinto Limited (which is traded on the Australian Stock Exchange) and Rio Tinto PLC (which is traded on the London Stock Exchange). The sharing agreement stipulates that the dividend and capital rights of each PLC share relative to each Limited share are on a 1:1 basis.^[6]

Given that the two classes of Rio Tinto shares entitle the holder to exactly the same flow of dividends, one might have expected that they should have traded at the exact same price. An examination of the share prices shown in Figure 1 shows that they are highly correlated.^[7] However, significant and persistent price divergences have existed, even after using a 20-day moving average to mitigate any impacts from asynchronous trading. Each company has traded at a significant premium at particular times, and the average of the price differential over the full seven-year period has been a premium of the UK listing over the Australian listing of around 2 per cent.

BHP, the large diversified resource company, was the second Australian company to enter into a DLC structure when it merged with Billiton, a UK/South African resources company in July 2001. The equalisation ratio is 1:1, such that a UK share has the same economic value and voting rights of an Australian share.^[8] From the outset, the relative value of the Australian scrip has been higher than its UK counterpart (Figure 2) with the premium averaging 8 per cent.

The most recent Anglo-Australian DLC was formed in August 2001 when Brambles, the Australian industrial firm, merged with the industrial services arm of UK-listed GKN. Just as there had been pre-existing ownership links between the Rio Tinto companies, Brambles and GKN had an existing relationship, including joint ventures. Similar to the other two Australian DLCs, the equalisation ratio is 1:1.^[9] Figure 3 shows the sizeable premium, averaging 9 per cent, at which the Australian share has traded relative to the UK share.

The price differentials of the three Anglo-Australian DLCs are shown in Figure 4. The premia have at times moved together, however, there have also been times when they have moved in opposing directions. Although the premium for Rio Tinto has changed sign over the seven-year period of the DLC, in the cases of BHP Billiton and Brambles (for which only around 18 months of data exist), the Australian twin has consistently traded at a premium. Data for the median absolute price differentials are shown in Table 2.

Royal Dutch Petroleum and Shell, Unilever NV/PLC, and Reed Elsevier NV/PLC are the three other examples of continuing DLCs on overseas markets.^[10] Created in 1907, Royal Dutch/Shell is the oldest example of a DLC. Both companies trade on a number of exchanges, but Royal Dutch is incorporated in the Netherlands while Shell is incorporated in the United Kingdom. The Unilever group was formed in 1929 from the merger of a Dutch margarine company, Margarine Unie and Lever Brothers, a British soap maker. Unilever NV and Unilever PLC are listed on the Dutch and UK stock exchanges respectively. Finally, Reed Elsevier was formed from the January 1993 merger of Reed International PLC, a UK-listed publishing and information company, and Elsevier NV, a Dutch-listed publishing company.

The long-run behaviour of the price differentials for the three Anglo-Dutch DLCs is shown in Figure 5. As has been documented by Froot and Dabora (1999), the price differentials for Royal Dutch/Shell and Unilever are surprisingly large and variable. It is, however, noteworthy that the extreme price differentials seen in the early 1980s have not been repeated, which may reflect the greater integration of capital markets and the reduction of transactions costs over the last two decades. Interestingly, there is some evidence of correlation across the three DLCs. At one level this might not appear entirely surprising if the excess comovement result of Froot and Dabora is an extremely persistent phenomenon rather than just a short-run one. However, the fact that there is substantial variance in the proportion of trading of the Dutch twins that occurs on different markets implies that the correlation might not be so easily attributed to common influences from the relative performance of national markets.^[11]

If there is a tendency for anomalies documented by researchers to be reduced or eliminated after their publication, one might have expected to see a decline in the magnitude of DLC price differentials following the publication of Froot and Dabora's work. Although the sample is too short to draw firm conclusions, the data for median absolute price differentials in Table 2 appear to provide only limited evidence for this. (Further, the evidence would be weaker if the comparison instead used the date of the publication of the working paper version of the article). In particular, although the mean absolute deviation for Shell has fallen substantially relative to historical levels, the declines in the other two cases are much less obvious.

Just as Froot and Dabora were unable to identify ‘fundamental’ factors that could explain the price differentials that they identified in the Anglo-Dutch cases, so too do fundamentals-based explanations appear unable to explain substantial price differences between the Australian and UK arms of the three more recent DLCs. For example, the stocks in each of these DLCs are all actively traded and appear in benchmark market indices, suggesting that liquidity differences are unlikely to be able to explain substantial price differences.^[12] Furthermore, tax factors do not appear to be able to justify the differential, since investors from third countries do not obtain any major tax advantage from investing in a particular twin.^[13]

Given that the ongoing large and variable price spreads in both the Anglo-Dutch and Anglo-Australian DLCs are difficult to explain based on fundamentals, they represent something of an anomaly. The reason why the price spread has not been eliminated by investors is presumably related to the lack of fungibility (or exchangeability) between the scrips. In particular, the different listings of a DLC are distinctly different companies, with no fungibility that would allow instantaneous riskless arbitrage.^[14] Instead, attempts by investors to take advantage of the price differential via a long position in the discount stock and a short position in the premium stock require investors to have long horizons and to be able to withstand short-term losses should the differential widen.^[15] Indeed, one of the positions held by Long-Term Capital Management (LTCM) during its 1998 collapse was a US$2.3 billion position in Royal Dutch/Shell that incurred losses when the price differential widened sharply (see Lowenstein (2000)). This illustrates the difficulty that investors face in attempting to arbitrage away such premiums.

A less complete form of arbitrage would involve long-only investors switching out of the premium stock and into the discount stock. However, this type of activity may be limited by home biases or by mandates that limit the asset allocation of institutional investors. For instance, a manager with a mandate to invest only in Australian (UK) stocks may be prevented from purchasing the UK (Australian) scrip, even though the two scrips offer the same set of dividends and have highly correlated returns. An example of the existence of these home biases or mandate restrictions can be seen in the share registry of the BHP Billiton twins, where the majority of the largest 20 shareholders in BHP Billiton Ltd in late 2002 were Australian institutions, although none of the top 20 shareholders in BHP Billiton PLC were Australian institutions.^[16]

One interesting attempt to circumvent the constraints imposed by country-based mandates was the introduction by an Australian broker of warrants, traded on the Australian Stock Exchange on the UK arms of BHP Billiton and Rio Tinto.^[17] The intention was to provide Australian managers with mandates to invest only in Australian securities with a means of effectively investing in foreign assets. However, the low volume of trading in these warrants suggests limited arbitrage activity of this nature.

Of course, switching between DLC twins should be more feasible in the case of large institutional investors with a global mandate. Indeed, newspaper reports suggest that there are instances of institutional investors switching between DLC twins. For example, the US-based Capital Group, which had been the largest investor in BHP Billiton Ltd, was reported to have switched in 2002 into BHP Billiton PLC.^[18] However, the implication of the substantial price differences that are observed on an ongoing basis is that this type of behaviour is fairly limited.

In principle, the data for the average price premia for these six DLCs, plus the average premia for other cases prior to their unification, might offer some hope for understanding what factors are relevant in determining which (if any) company will trade at a premium. Some preliminary analysis failed to offer any systematic relationship, so we conclude that the sample of DLCs is too small to differentiate between explanations for the direction of the premia. However, one interesting observation comes from the Anglo-Australian DLCs, where the Australian twin has traded consistently at a substantial premium in two of the three cases. This specific evidence about how different national markets value the same set of equity cash flows can be viewed as refuting claims that are sometimes made that companies listed on smaller markets are at an inevitable cost-of-capital disadvantage and can increase shareholder value by simply shifting their primary listing to larger overseas markets.

Footnotes

The RTZ holding in CRA has since been reduced to less than 40 per cent. Under the terms of the merger, in cases where the companies did not share a common interest, the RTZ stake in CRA was not to be used to cast votes, implying that PLC (Limited) shareholders hold 76.5 (23.5) per cent of votes on joint decisions. [6]

Indeed, the standard tests suggest that the two price series for each of the three Anglo-Australian DLCs and Anglo-Dutch DLCs (when expressed in a common currency) are cointegrated. Data sources for the stock prices and exchange rates used in this section are provided in Section 4. [7]

Shareholders in the Australian (UK) arm hold 60 (40) per cent of the combined company. [8]

Shareholders in the Australian (UK) arm hold 57 (43) per cent voting interest in the combined group. [9]

The groups' interests are split respectively as follows: 60:40 in favour of Royal Dutch; 50:50 for Unilever; and 52.9:47.1 in favour of Reed Elsevier PLC. [10]

In particular, a substantial fraction of trade in Royal Dutch occurs in the US market, whereas almost none of the trade in Reed Elsevier NV occurs in that market. [11]

The three Australian stocks are all included in the ASX 100 index, while the three UK stocks have all been included in the FTSE 100 index, except that Brambles PLC slipped from the FTSE 100 to the FTSE 250 in December 2002, in the last month of the sample studied here. [12]

For example, in the Anglo-Australian cases, Australian investors would prefer the local stock of a DLC due to the dividend taxation credits they receive (and which are not available to UK investors). However, for third-country investors who can be viewed as the marginal investors, the choice would depend on the respective tax treatment between their country and the country of listing. In many instances, including the US case, current tax treaties suggest that in most cases third-country investors would be largely indifferent between the Australian and UK stock. [13]

By contrast, price divergences between DLC twins and their respective ADRs in the New York market are far smaller. For example, both Rio Tinto and BHP Billiton have ADRs attached to each of their listings, and the prices of each ADR is invariably almost exactly equal to the price in the respective primary listing. Since investors can exchange ADRs for the underlying stock (i.e., the different scrip are fully fungible), price differentials can be arbitraged away and are limited to the very small transactions costs involved in such exchanges. [14]

The lack of fungibility between the shares exposes the investors to noise trader risk, i.e. the risk that the mispricing worsens in the short run (see De Long, Shleifer, Summers and Waldmann (1990); Shleifer and Vishny (1997)). Abreu and Brunnermeier (2002) propose an additional related risk, which they refer to as synchronisation risk, and is based on the uncertainty an arbitrageur faces about when his or her peers will exploit an arbitrage opportunity. [15]

This information on stockholdings is taken from Bloomberg. [16]

See ‘Offshore exposure with a little bit of DLC’, Australian Financial Review, 15 April 2002, p 23. [17]

See ‘Easy 10pc on BHP arbitrage’, Sydney Morning Herald, 28 August 2002, p 24. [18]