“Light Touch” Versus Highly Regulated Exchanges: Impact on Investors

Congratulations to Professors Tim Jenkinson and Tarun Ramadorai of the University of Oxford, who were awarded the prize for best paper last night at the “Financing Public and Private Firms: Fraud, Ethics and Regulation” conference co-sponsored by the Schulich School of Business at York University in Toronto, the Financial Analysts Journal, and CFA Institute.

Ramadorai and Jenkinson’s paper, “Does One Size Fit All? The Consequences of Switching Markets with Different Regulatory Standards,” examines the somewhat counterintuitive experience of a sample of issuers that change from being traded on the London Stock Exchange’s Main Market to its Alternative Investment Market (AIM).  Somewhat uniquely to the London Stock Exchange, the trading mechanisms for both the Main Market and AIM are the same, as is the legal regime under which both operate.

At the time of announcing the change “down” from listing on the Main Market to AIM, these companies experience a decline in price — perhaps as investors perceive that AIM’s lighter touch regulation will threaten their interests. But after beginning trading on AIM, these former Main Market-traded companies are observed to provide excess risk-adjusted returns approaching 25 percent in the first year after switching. In addition, significant improvement in operating performance is noted after the switch, implying that lower regulatory costs associated with the lighter touch regime translate into better financial performance, which is recognized eventually by investors.

Deciding to list on AIM rather than the Main Market is at the discretion of a firm’s management, and does not require shareowner approval. Investors may interpret the decision to switch to an AIM listing as detrimental to their interests, but the increased operating performance of the sample observed suggests that, for these firms at least, a lightly regulated listing may be best for the company and investors. Although not definitive, Jenkinson and Ramadorai’s perspective informs the ongoing debate over balancing regulatory compliance costs with improved corporate governance and investor protections.