WSJ Deal Journal reports that many Chinese firms with listings on US stock markets are delisting and shifting their stock market presence to places like Hong Kong. As the author of Corporate Governance and U.S. Capital Market Competitiveness, which argues that litigation and regulatory reform remain essential if U.S. capital markets are to retain their leadership position, I was interested to note that the Chinese firm's problems in the US markets are not so much regulatory as they are market forces:
John Ma, director of China research at Roth Capital Partners, a research house that covers small Chinese companies, says the frustration is most acute for those firms that originally listed in the U.S. through a reverse takeover—a process that involves merging with a dormant shell company. The result is that the Chinese company gets a public listing in the U.S. without being subject to the same rigorous disclosures as an IPO.
But past accounting irregularities and a perceived lack of transparency have weighed on the reputation of companies that listed via a reverse takeover. Last week, The Wall Street Journal reported that the U.S. Securities and Exchange Commission has begun an investigation into reverse takeovers and is targeting individual Chinese companies for accounting violations and lax auditing practices. It isn’t clear which companies are being looked at.
“They’re so frustrated by all the negative publicity surrounding companies that went through a reverse takeover,” Mr. Ma says. “The market doesn’t differentiate between the good and the bad.”
To the contrary, I would argue here that market actors are behaving highly rationally and that the market is functioning as it should. As noted, the reverse takeover is a means of end running the disclosure and procedural protections provided investors in a traditional IPO. Instructively, the UK FSA has created a rebuttable presumption that an issuer's equity shares should be suspended from trading in the event of a reverse takeover.
The rationale underlying this approach is that in the case of a reverse takeover, the target business will form the majority of the enlarged group, so the market needs sufficient disclosure on the target business to properly price the issuer’s securities.
Here, the US capital markets are simply adopting a decision-making heuristic that Chinese firms going public in the US via a reverse takeover are more trouble than they're worth in terms of disclosure problems and lack of minority protections. Such heuristics are a logical response to information asymetries in the presence of opportunism.
To some, simple means unsophisticated; but there is a growing body of research work which suggests that simple methods of decision-making actually outperform their more complex alternatives. This certainly may seem counter-intuitive; but in a complex world where decisions have to be made with limited information and face real world time constraints, there may not be the ability to optimize over all possible alternatives. Under the real life situations faced by a trading firm, there is a premium on "fast and frugal" decision-making or heuristics. Fast decision-making is often based on just a few cues or inputs that may seem relevant. There is actually value in not using too much information. Researchers have found through testing that simple decision rules often can perform as well or better than more sophisticated forms of decision-making - especially when there is a high degree of uncertainty.