From Pink Slips to Pink Sheets Liquidity and Shareholder

From Pink Slips to Pink Sheets: Liquidity and Shareholder Wealth Consequences of Nasdaq Delistings James J. Angel Georgetown University McDonough School of Business angelj@georgetown.edu Jeffrey H. Harris University of Delaware Lerner College of Business and Economics harrisj@lerner.udel.edu Venkatesh Panchapagesan* Washington University-St. Louis Olin School of Business panchapagesan@wustl.edu Ingrid M. Werner The Ohio State University Fisher College of Business werner@cob.osu.edu Abstract If liquidity is priced, as suggested by Amihud and Mendelson (1986) and Acharya and Pedersen (2004), shareholders of firms that experience drastic declines in liquidity should experience a significant decline in their wealth. We first hypothesize and confirm that an involuntary delisting is associated with a large decline in liquidity. The deterioration in liquidity is significant: share volume declines by two-thirds; quoted spreads almost triple from 12.1 to 33.6 percent; effective spreads triple from 3.3 to 9.9 percent; and volatility more than triples from 4.4 to 14.3 percent. We then hypothesize and confirm that this liquidity decline is associated with a significant loss of shareholder wealth. Shareholders in our sample experience a wealth-loss of 19 percent on average due to delisting. We further test and find that the decline in liquidity and loss in shareholder wealth are related to the severity of the listing violation and to how far down the market hierarchy the firm is pushed during delisting. Draft Date: November 02, 2004 *Corresponding author: Venkatesh Panchapagesan, Washington University-St. Louis, Olin School of Business, One Brookings Drive, St. Louis, MO 63130, panchapagesan@wustl.edu, +1 (314) 935-9196. Please quote, but get permission first. The authors wish to thank the Nasdaq Stock Market, Inc. for providing data and financial support. We are also grateful for comments from Jennifer Koski, Duane Seppi and from seminar participants at OSU, University of Michigan, Washington University, Goldman Sachs Inc., and from conference participants at the 2004 EFAs. All errors are our own. From Pink Slips to Pink Sheets: Liquidity and Shareholder Wealth Consequences of Nasdaq Delistings Abstract If liquidity is priced, as suggested by Amihud and Mendelson (1986) and Acharya and Pedersen (2004), shareholders of firms that experience drastic declines in liquidity should experience a significant decline in their wealth. We first hypothesize and confirm that an involuntary delisting is associated with a large decline in liquidity. The deterioration in liquidity is significant: share volume declines by two-thirds; quoted spreads almost triple from 12.1 to 33.6 percent; effective spreads triple from 3.3 to 9.9 percent; and volatility more than triples from 4.4 to 14.3 percent. We then hypothesize and confirm that this liquidity decline is associated with a significant loss of shareholder wealth. Shareholders in our sample experience a wealth-loss of 19 percent on average due to delisting. We further test and find that the decline in liquidity and loss in shareholder wealth are related to the severity of the listing violation and to how far down the market hierarchy the firm is pushed during delisting. Amihud and Mendelson (1986) argue that empirically observed asset prices should reflect liquidity costs, and that less liquid assets should trade at a discount. More recently, Acharya and Pedersen (2004) show that expected liquidity as well as the covariances between asset returns and liquidity both on the individual stock and the market levels should affect asset prices. There is by now a sizeable empirical literature that aims to understand the effect of market liquidity on asset prices (e.g., Pastor and Stambaugh (2003) and Chordia, Roll, and Subrahmanyam (2001)), that the level of liquidity is priced (e.g., Amihud and Mendelson (1986) and Easley, Hvidkjaer, and O’Hara (2002)), and that liquidity comoves with returns and predicts future returns (e.g., Amihud (2002)). These papers mainly test for effects of market liquidity on asset prices in the crosssection. By contrast, our experiment is designed to evaluate the effect of individual stock liquidity on asset prices in the time-series. To do so, we study a type of event that is likely to cause a significant permanent reduction in liquidity: Nasdaq delistings. By listing its securities, a firm is voluntarily taking on additional disclosure requirements (Huddart, Hughes and Brunnermeier (1999)) and is voluntarily subjecting itself to extensive monitoring by the listing-venue (Macey and O’Hara (2002)) and should therefore experience significant liquidity enhancement once listed. Consequently, we expect that involuntary delistings should be associated with significant loss of liquidity. If liquidity is priced, as suggested by Amihud and Mendelson (1986) and Acharya and Pedersen (2004), shareholders of delisted firms should experience a significant decline in their wealth following delisting. How important are delistings? In the last five years, almost 4,000 firms have been delisted by the Nasdaq Stock Market Inc. This means that roughly one in five firms listed on Nasdaq in any given year is delisted! While many of the firms leave Nasdaq voluntarily, for instance as a result of a merger or an acquisition, almost fifty percent are delisted because the firm violates one or several of Nasdaq’s listing requirements. A well-kept secret is that most delisted firms continue to trade, sometimes very actively, in the OTC Bulletin Board and in the 1 Pink Sheets.1 Provided that there is at least one market maker willing to quote after a delisting, non-bankrupt firms with current SEC filings are eligible to immediately continue trading on the OTC Bulletin Board. In fact, even delisted firms that do not satisfy these criteria may be traded on the OTC Bulletin Board after a market maker files an application with the National Association of Securities Dealers (NASD). In this paper, we first test whether liquidity deteriorates after a firm is delisted from Nasdaq based on 1,098 delistings during 1999-2002. We compute measures of liquidity such as spreads, share volume, and volatility during the three months of Nasdaq trading prior to delisting as well as the three months of OTC Bulletin Board and/or Pink Sheet trading after delisting. We find that all measures of liquidity deteriorate significantly following a delisting. Share volume declines by almost two-thirds, quoted spreads almost triple from 12.1 to 33.6 percent, effective spreads triple from 3.3 to 9.9 percent, and intraday volatility more than triples from 4.4 to 14.3 percent when stocks are delisted. Firms may be delisted for violating a number of different criteria, ranging from non-core violations that Nasdaq deems less important to bankruptcy, the most important. We test whether the liquidity decline is related to the severity of these listing violations. We find the decline in liquidity is largest for bankrupt firms, followed by delistings caused by corporate governance (e.g., SEC disclosure) violations and core listing violations (e.g., market capitalization). The erosion of liquidity is smaller, but still significant, for non-core violations (e.g., stock price below $1.00). Firms that are delisted for bankruptcy experience an 80 percent decline in share volume, an increase in quoted spreads from 11.3 to 50.0 percent, an increase in effective spreads from 3.7 to 15.4 percent, and an increase in intraday volatility from 4.2 to 22.1 percent. By comparison, the average non-core violation results in a 25 percent decline in share volume, an increase in quoted spreads from 13.4 to 29.7 percent, an increase in effective spreads from 3.3 to 10.6 percent, and an increase in intraday volatility from 4.6 to 11.2 percent. As Cromwell Coulson, the Chairman of The Pink Sheets LLC, aptly puts it, “We are the tier of stuff that can’t, won’t, or doesn’t want to be listed on the exchange.” 1 2 Nasdaq firms can be delisted from the National Market (NM) or from the SmallCap Market (SC). Delisted firms may end up trading on the OTC Bulletin Board, the Pink Sheets, or not at all. We test whether the liquidity decline is related to the number of “notches” the firm falls in the hierarchy of these dealer markets. We rank markets from top to bottom as Nasdaq NM, Nasdaq SC, OTC Bulletin Board, and Pink Sheets. Our tests examine whether the OTC Bulletin Board provides a potential “soft landing” for delisted firms. We find that the further the firm falls, the worse the erosion of liquidity. In other words, ceteris paribus, delisted firms landing on the OTC Bulletin Board experience a smaller liquidity loss than firms landing on the Pink Sheets. For example, consider delisted firms originally listed on Nasdaq’s NM. Median share volume declines by 25 percent with a move to the OTC Bulletin Board, but declines a full 60 percent with a move to the Pink Sheets. Similarly, quoted spreads increase from 10.0 to 23.7 percent with a move to the OTC Bulletin Board and from 9.4 to 49.3 percent with a move to the Pink Sheets. Volatility (based on transactions prices) increases from 4.2 to 10.6 percent with a move to the OTC Bulletin Board but from 4.3 to 25.0 with a move to the Pink Sheets. The results are qualitatively the same for delistings from Nasdaq’s SmallCap market. Based on Amihud and Mendelson (1986) and Acharya and Pedersen (2004), the decline in liquidity following delisting should translate into a loss in shareholder wealth. However, there are clearly a number of additional costs associated with delisting (such as higher regulatory costs for raising capital and higher operating costs) that are also likely to affect shareholder wealth. We therefore estimate the comprehensive loss in shareholder wealth in the narrow window around delisting (day -1 to day +1) by forming event-time portfolios of delisted firms at the end of day -1. We find that for an equally-weighted portfolio of all delisted firms, the loss in firm value is 19.1%. This number clearly underestimates the effect of delisting since most firms experience declining stock prices for several months before delisting, with at least some of the 3 decline attributable to the anticipated delisting. It is clear that the delisting imposes tremendous costs on firms’ shareholders. We also test whether the loss in shareholder wealth is related to the severity of the listing violation. As with market quality, we expect that the wealth loss is largest for bankruptcy delistings. We find that the loss in shareholder wealth is significant for all groups of delistings, suggesting that the Nasdaq listing itself inherently bestows value to a firm. The loss in shareholder wealth is highest for the most severe violations and declines monotonically with the severity of violation. For example, bankruptcy violators lose 24.2 percent, governance violators lose 23.7 percent, core violators lose 18.4 percent, and non-core violators lose 15.5% of firm value. Our main contribution is to show how large an effect a loss of liquidity may have on asset prices. We show that delisting from Nasdaq is associated with a loss in shareholder wealth ranging from 15.5 to 24.2 percent depending on which requirement was violated. Macey, O’Hara, and Pompilio (2004) also document significant liquidity losses for 55 NYSE firms that were involuntarily delisted during 2002. Due to data limitations, however, they only study Pink Sheet trading after delisting and lament the fact that there is not a market to provide a softer landing than the Pink Sheets for NYSE-delisted stocks.2 Our results show that the OTC Bulletin Board indeed does provide a softer landing for delisted firms relative to the Pink Sheets. Our second contribution is to provide the first comprehensive analysis of liquidity in the OTC Bulletin Board and Pink Sheet markets. Primarily due to data considerations, there has been almost no research on these markets in the literature. Seguin and Smoller (1997) study the survival of low-priced IPOs on Nasdaq, but they generally did not examine the off-exchange markets. Shumway (1997) and Shumway and Warther (1999) examine the price patterns of delisted stocks in order to estimate the delisting bias in CRSP stock returns. More recently, For all but eight of the involuntary delistings from the NYSE studied in Macey, O’Hara, and Pompilio (2004), there is actually subsequent trading on the OTCBB. To be able to quote a NYSE delisted stock on either the OTCBB or the PS, a market maker simply has to submit a 15c2-11 application to NASD. 2 4 Bushee and Leuz (2004) examine the impact of the SEC’s requirement that OTC Bulletin Board firms file financial statements with the SEC and Luft and Levine (2001, 2003) analyze the daily return characteristics of OTC Bulletin Board stocks. Our results are a first peek at liquidity for stocks that trade in the OTC Bulletin Board and Pink Sheet markets. Our third contribution is to extend the literature on firms that switch their listing and trading venue, e.g., from Nasdaq to the NYSE. Christie and Huang (1994), Barclay (1997) and Heidle and Huang (1999) find that Nasdaq stocks switching to the NYSE experience a significant decline in effective and quoted spreads while Bessembinder (1999) finds lower daily volatility after stocks start trading on the NYSE.3 Voluntary switches from Nasdaq to the NYSE are the flip-side of our delistings in that they constitute an “upward” move in the spectrum of market listing requirements. However, the change in liquidity documented in the exchange-switching literature is orders of magnitude smaller than for our involuntary delistings.4 Hence, it is not surprising that there is no strong evidence of changing shareholder wealth associated with voluntary listing changes. By contrast, our paper shows that the loss of liquidity associated with involuntary Nasdaq delistings is significant, and translates into a tremendous loss in shareholder wealth. Finally, our paper is related to recent work by Leuz, Triantis and Wang (2004) and Marosi and Massoud (2004) who study firms that voluntarily deregister, i.e. “go dark” in a disclosure sense, and to the literature on firms that go private (e.g., DeAngelo, DeAngelo and Rice (1984), Engel, Hayes and Wang (2004), Halpern, Kieschnick and Rotenberg (1999), Lehn and Poulsen (1989), and Weir, Laing and Wright (2003)). When a firm stops reporting to the SEC, it also has to delist its stock (a voluntary delisting). Based on data from 1998-2003, Leuz, Triantis and Wang (2004) show that going dark decisions are associated with a negative marketadjusted return of 7 to 10 percent, while going private decisions are associated with a positive Bennett and Wei (2003) study a recent sample of Nasdaq firms that voluntarily switch to the NYSE. Clyde, Schultz and Zaman (1997) study Amex firms that voluntarily move to Nasdaq. 4 For Nasdaq stocks that move to the NYSE Heidle and Huang (1999) document average percentage effective spread declines of 0.47% for 57 stocks in 1996 while Bennett and Wei (2003) document 0.18% declines for 39 stocks from October 2001 to June 2003. 3 5 market-adjusted return of 3 percent. Interestingly, they find that the voluntary deregistration and the associated delisting each accounts for a 4 percent reduction in shareholder wealth. Since the deregistering firms are delisting voluntarily, it is not surprising that the loss of shareholder wealth is much smaller than for our sample of involuntary delistings. The rest of the paper proceeds as follows. We outline our hypotheses in Section I, and describe Nasdaq’s continued listings requirements and the process of delisting in Section II. Since delisted firms continue trading in the OTC Bulletin Board and/or Pink Sheet markets, we briefly discuss these markets in Section III. We describe our data in Section IV. Section V includes our results on liquidity, and the consequences of delisting for shareholder wealth are examined in Section VI. Section VII concludes. I. Hypotheses When a firm is delisted from Nasdaq, there is no automatic transition to a new trading venue. For trading to continue, a market maker needs to apply to the NASD to get permission to start quoting the stock in either the OTC Bulletin Board or the Pink Sheets (see Section III below). In the investment community, these are labeled as “Penny Stock” or “Microcap Stock” markets,5 and are viewed as highly risky. The SEC web site warns investors to beware of the lack of information available for firms listed on the Pink Sheets and the potential for micro-cap fraud.6 In a very nice equilibrium model, Huddart, Hughes and Brunnermeier (1999) show that more extensive public disclosure requirements is associated with higher liquidity. Dealer market models, e.g., Stoll (1978) and Ho and Stoll (1981) suggest that stocks that are riskier should have higher trading costs (lower liquidity). Hence, we would expect these markets to be characterized by lower liquidity. When a stock transitions to the OTC Bulletin Board or the Pink Sheets, we therefore hypothesize that its liquidity will deteriorate. The technical definition of a Penny Stock is one with a stock price below $5.00 and not listed on the NYSE, AMEX, or Nasdaq. A Microcap stock is a stock with low market capitalization, defined to be between $50 and $300 million. Stocks with market capitalization below $50 million are often called Nanocap stocks. 6 www.sec.gov 5 6 H1: Liquidity deteriorates after delisting. Following Nasdaq’s own ranking, we consider bankruptcy and/or liquidation to be the most serious violation, followed by corporate governance violations. Nasdaq groups its other requirements into core (size, profitability, ownership, and fees) and non-core (stock price and public float) requirements. These rankings are likely correlated with the degree of uncertainty regarding future firm value, and the extent of reliable information disclosure that is available to shareholders. The payoff to shareholders after bankruptcy is highly uncertain, whereas there is relatively less uncertainty about firms that have low stock prices but continue to file financials with the SEC. The deterioration in liquidity should therefore be systematically related to this ranking. This argument forms the basis for our second hypothesis: H2: Liquidity deteriorates more after delisting for firms that violate more important listing criteria. Some firms move to the OTC Bulletin Board after delisting while others end up trading in the Pink Sheets. While a detailed description of these markets is included in Section III below, one difference between these markets is worth mentioning here. While neither market has other formal listing requirements, since 2000 the OTC Bulletin Board has required SEC disclosure. More public disclosure tends to be associated with less risk and higher liquidity, so our third hypothesis surmises that the deterioration in liquidity is less severe for firms landing on the OTC Bulletin Board than for firms landing in the Pink Sheets. H3: Liquidity deteriorates more after delisting if the firm falls down further in the hierarchy of listing standards. Whether the hypothesized liquidity decline is economically important depends on the anticipated future trading of delisted stocks. Amihud and Mendelson (1986) and Acharya and Pedersen (2004) show that a liquidity decline (increased spreads) should reduce firm value. Hence, we measure the economic effect of a liquidity decline by testing whether shareholder 7 wealth declines significantly after delisting. Shareholder wealth changes also incorporate increases in other potentially significant costs that are likely to result from delisting, e.g., increased costs for future capital raising. Thus is our fourth hypothesis is: H4: Delisting is associated with significant loss in shareholder wealth. Since we hypothesize that liquidity deteriorates more for firms that violate more important listing criteria (H2 above), it follows that shareholders of firms that violate more important listing criteria should experience a larger wealth-loss. Thus, our final hypothesis is: H5: The loss in shareholder wealth is larger for firms that violate more important listing criteria. II. A. Nasdaq’s Listing Requirements and the Delisting Process Nasdaq’s Continued Listing Requirements In order to qualify to list on Nasdaq’s National Market (NNM) or SmallCap Market, a firm has to satisfy a set of initial listing requirements, formally apply to be listed and pay an initial listing fee. Like many other markets, Nasdaq also enforces a set of continued listing requirements for each of its market segments, the so-called maintenance standards.7 These listing requirements are described in Appendix A. Nasdaq groups its continued listing requirements into bankruptcy, corporate governance, core and non-core requirements. Firms that have filed for bankruptcy protection or are in liquidation no longer qualify for listing. The corporate governance requirements include timely reporting to the SEC and a number of additional requirements on the firm’s governance process. The core requirements include size- and profitability-related variables such as a minimum level of net tangible assets, market capitalization or total assets, and a minimum total revenue or net income. Core requirements also include a minimum number of round lot shareholders, a minimum number of registered market makers, timely payment of listing fees and timely The maintenance standards are described in Marketplace 4450(a), 4450(b), 4350 and 4351 for NNM, and in Marketplace 4310(c) for SC. 7 8 response to Nasdaq information requests. The non-core requirements include a minimum bid price and a minimum market value of the firm’s public float. B. The Delisting Process Nasdaq monitors the continued listing requirements daily for all its listed stocks. When a firm is found to violate one of the continued listing requirements, Nasdaq sends a deficiency notice and the firm is given a grace period to regain compliance. If the firm continues to be in violation after the grace period is over, Nasdaq sends a determination letter informing the firm that it does not meet listing standards. The firm may appeal this determination and request a hearing before an impartial panel to present a compliance plan. The panel decides on the delisting and its decision becomes effective the day the firm is informed. Further appeals, although possible, do not stay the delisting. We provide and a time-line describing the sequence of delisting events in Figure 1 and describe further details of the delisting process in Appendix B. C. Transition to OTC Bulletin Board or the Pink Sheets What happens when a firm is delisted from the Nasdaq NM or SmallCap Market? The firm cannot list itself on the OTC Bulletin Board or the Pink Sheets. Trading may only commence on the OTC Bulletin Board or Pink Sheets if at least one market maker files an application (Form 15c2-11, commonly known as Form 211) with (and is approved by) the NASD to start quoting the stock. The market maker has to show that he has access to the latest financial statements of the firm, and that he is otherwise informed about the firm’s business etc. It takes a minimum of 3 days to get approval for an initial Form 211 application.8 In order to be eligible to be traded on the OTC Bulletin Board, the firm also has to be current in its SEC filings. However, the OTC Bulletin Board offers a 30-day grace period (60 days for banks and financial institutions) so that a filing-delinquent firm might still qualify for OTC Bulletin Board trading. If the delisted firm was quoted by a Nasdaq market maker for at least 12 of the last 30 trading days prior to delisting, the market maker may qualify for a Form 211 exemption. Under this exemption, the market maker may apply to continue quoting the firm immediately on the OTC Bulletin Board provided that the firm is current in its SEC filings and it is not in bankruptcy. 8 9 Note that even bankrupt firms can be traded on the OTC Bulletin Board as long as SEC filings are current. There is no SEC reporting requirement for quoting on the Pink Sheets. III. The OTC Bulletin Board and Pink Sheets Markets The OTC Bulletin Board and Pink Sheets markets trade stocks that either do not or choose not to qualify to trade on other markets in the United States. The OTC Bulletin Board and Pink Sheet trading data is not included in traditional databases such as CRSP and TAQ. There is also very limited analyst coverage of OTC Bulletin Board or Pink Sheet stocks. Hence, despite the fact that approximately 3,200 stocks trade concurrently on both venues and another 4,300 stocks trade exclusively in the Pink Sheets, very little is actually known about them in the academic community. The OTC Bulletin Board was established by the NASD in 1990 to serve as a quotation medium for stocks that were not traded on other markets. As noted above, companies do not list on the OTC Bulletin Board, but are traded on the OTC Bulletin Board at the market maker community’s discretion.9 In fact, companies cannot prevent the trading of their shares in the OTC Bulletin Board. The only formal requirement for trading to be permitted on the OTC Bulletin Board is that the company is current with financial statement filings to the SEC.10 The OTC Bulletin Board operates a quotation service but does not provide order delivery or execution. If a broker or market maker wants to trade with another market maker, they have to contact that other market maker via the telephone or through a private electronic linkage. Unlike Nasdaq trading, many OTC Bulletin Board trades were until very recently executed via telephone, but automated execution is now available through Electronic Communication Networks (ECNs). On June 26, 2003, Nasdaq scrapped plans to replace the OTC Bulletin Board with a new SuperMontage-based exchange (called the BBX) that included minimal listing The exact rules can be found in SEC Rule 15c2-11, NASD Rule 6740, and Securities Exchange Act Release No. 29094 (April 17, 1991). 10 Prior to 2000, companies were not required to be SEC registrants. See Bushee and Leuz (2004) for more about the consequences of the introduction of this requirement. 9 10 requirements (based mostly on corporate governance) and listing fees. ECNs (both Island/Instinet and Archipelago), however, started trading OTC Bulletin Board stocks in 2003.11 Most of the stocks that trade on the OTC Bulletin Board are penny stocks. Approximately 2,500 or 78% of the stocks that trade on the OTC Bulletin Board are priced less than $1, and almost 3,000 (or 94%) are priced less than $5, which means that they fall under the SEC’s Penny Stock Rules (Rules 15g-2 through 15g-9).12 The Penny Stock Rules were designed to combat micro-cap fraud, and generally require that the broker determine that the transaction is suitable for the customer, obtain a written agreement for a transaction from new customers before the transaction is executed, and provide a written warning document about the risks of penny stocks. These rules make it more difficult for brokers to recommend and trade low-priced stocks for their customers. The Pink Sheets grew out of the price quotations for unlisted stocks that were originally published daily on pink sheets of paper by the National Quotation Bureau. The old physical Pink Sheets served as advertising for the market makers who quoted those stocks. The Pink Sheets introduced electronic quotations in 1999. On February 14, 2003, Pink Sheets LLC started allowing issuers to sponsor (for $174.95/month) real-time quote display for their stocks on www.pinksheets.com, and on June 2, 2003, they introduced PinkLink – an electronic messaging and automated trade negotiation service. On May 10, 2002, the SEC approved ECN and alternative trading system (ATS) trading in the Over-theCounter Bulletin Board (OTCBB). The revised Rule 6540 states that ATSs and ECNs that wish to participate in the OTCBB must comply with all other OTCBB rules applicable to market makers. These rules include: The OTCBB system does not permit a market maker to post a firm quote for less than the minimum size required by NASD Rule 6750. A participating ATS or ECN is prohibited from charging access fees or post-transaction fees, unless such fees are incorporated in its posted quote. NASD Rule 6740, Submission of Rule 15c2-11 Information on Non-Nasdaq Securities, is applied to ATSs and ECNs in the same manner as it applies to market makers. GlobeNet, now part of Archipelago, was the first ECN to avail of this opportunity. On July 3, 2003, Archipelago announced its intention to trade OTCBB stocks on its ArcaEdge platform. On November 24, 2003, Instinet/Island began trading OTCBB and Pink Sheet securities. Both Instinet/Island and Archipelago permit trading in OTCBB and Pink Sheet securities that can be cleared electronically (i.e. do not require physical delivery). 12 Stocks that are listed on the NYSE, AMEX, or NASDAQ are automatically exempt from the Penny Stock Rules, no matter how low their share price. See http://www.sec.gov/answers/penny.htm for more details on the penny stock rules. 11 11 The broker-dealers who trade on the Pink Sheets are regulated by the NASD,13 but the Pink Sheets LLC itself is not required to submit to SEC regulation because it is neither a brokerdealer nor an exchange under current SEC definitions.14 Companies quoted in the Pink Sheets do not even need to be SEC registrants and, in fact, many well-known foreign stocks such as Nestlé are quoted through the Pink Sheets. Trading rules are very different between the OTC Bulletin Board and the Pink Sheets and the major exchanges during our sample. For example, the SEC’s Limit Order Display Rule (Rule 11Ac1-4), which requires market makers to display customer limit orders in their quotes, did not apply in these markets.15 Similarly, there is no equivalent of the NYSE’s uptick rule or NASDAQ’s short sale rule to inhibit short selling. It is often difficult to borrow OTC Bulletin Board and Pink Sheet shares, making short selling difficult in these markets. Furthermore, there are no tick size rules in either the OTC Bulletin Board or Pink Sheets – participants are free to use any price increment they choose. IV. Data We identify 3,631 securities that were delisted during the period January 1, 1999 to December 31, 2002 using Nasdaq’s website (www.nasdaqtrader.com).16 We eliminate all securities other than common stocks or ADRs, which reduces the sample to 2,943 delistings. Since our focus is on regulatory delistings, we eliminate securities that were delisted voluntarily (e.g., the security moved to the NYSE or AMEX or the firm went private) and securities that were delisted because of mergers and acquisitions. Also, we remove securities that did not have a Until recently, the NASD had difficulty enforcing regulations for lack of data. In April 2003, the SEC approved NASD Rule 6630 requiring NASD members to record detailed information on their quoting activity on Pink Sheets. The Pink Sheets market now provides market maker quotations to the NASD for regulatory purposes. 14 SEC Rule 3b-16 provides the formal definition of an exchange. For more information, see the 1998 SEC Release No. 34-40760 (Reg ATS), which regulates automated trading systems. See http://www.sec.gov/rules/final/34-40760.txt. 15 On December 24, 2002, the SEC approved a limit order protection rule (SR-NASD-2002-153) for all OTCBB securities. 16 There was one security (ticker=’MCITE’) that was included in the Nasdaq website whose delisting was postponed to a later date. There was another entry in the website on the correct delisting date. 13 12 unique Nasdaq identifier that allows us to track it across many ticker changes, leaving a sample of 1,260 securities that experienced an involuntary regulatory delisting.17 We obtain proprietary data on trades and quotes from the Nasdaq Stock Market Inc. and from Pink Sheets LLC. Our data includes trade-by-trade and quote data for all Nasdaq National Market (NNM), SmallCap Market, OTC Bulletin Board and Pink Sheet stocks (quotes are daily summary statistics for Pink Sheets) for the period October 1, 1998 to March 31, 2003. In addition, we obtain daily data on open, close, intraday high and low, closing bid and ask quotes, and share volume for Pink Sheet stocks. Our event window is 60 trading days prior to the day of delisting to 60 days after the day of delisting. We utilize Nasdaq trading data for the three-month period prior to delisting. We find Nasdaq trading data for 1,245 securities in the three-month period preceding delisting, with 1,098 of these trading in the OTC Bulletin Board and/or the Pink Sheets during the three-month period after delisting. Thus, our final sample consists of 1,098 securities that experienced an involuntary regulatory delisting from Nasdaq during 1999-2002. A security may be delisted for violating one or several of the continued listing requirements discussed in Section I. For example, the firm’s stock price might be below the minimum bid price requirement ($1.00) and its market capitalization might be below the minimum ($50 million) at the same time. Panel A of Table 1 breaks down our delisting sample by year and provides the specific reasons for the delisting within bankruptcy, governance, core and non-core violation categories. Almost two-thirds of our sample firms are delisted because they violate one or more of the non-core listing requirements. In fact, the most common individual reason for delisting is that the bid price is below $1.00–almost half the sample firms violate the minimum bid price rule. Roughly forty percent of delisted firms violate core listing requirements. These include a failure to meet the minimum market capitalization of $50 million, the minimum on net tangible assets (NNM) and net income requirement (SmallCap). Governance issues cause a delisting for roughly 17 It is very common for tickers to change around delisting. Nasdaq uses a fifth symbol in its ticker to identify special situations such as a bankruptcy, for instance. 13 forty percent of the sample. Recall that these include timely reporting to the SEC. The fraction of firms that are delisted for governance violations increases dramatically over the sample. Delistings due to bankruptcy are, by comparison, rare. A delisted firm often violates more than one listing requirement. In Panel B, we tabulate the frequency distribution of violations across all delisting criteria. The numbers on the diagonal report the number of firms that violate a single delisting criterion. For example, 382 firms (or roughly 35 percent) in our sample violated the non-core listing criteria, but did not violate any core listing criteria, governance requirements, and were not bankrupt. By comparison, 207 firms violated both core and non-core listing criteria. For completeness, Panel C breaks down these numbers by year of delisting, classifying delisted firms according to the most severe violation (bankruptcy, governance, core and non-core in that order), which we use to assign firms to categories. For instance, if a firm violates both governance and core requirements, we treat it as a governance violation. Our sample of firms includes those that originated in both Nasdaq’s National Market (NM) and SmallCap (SC) market prior to delisting. After delisting, the firms may trade on the OTC Bulletin Board and/or the Pink Sheets. Table 2 illustrates the reasons for delisting by market of origin (Panel A) and market of trading after delisting (Panel B). Note that after delisting, a disproportionate number of bankrupt firms and governance violators trade exclusively on the Pink Sheets. This is expected, given the higher degree of disclosure required for OTC Bulletin Board trading. Interestingly, securities that are delisted for less severe non-core infractions rarely trade on the Pink Sheets. Of the 382 securities that were delisted for non-core reasons, only 27 securities trade on the Pink Sheets. This suggests that these firms choose to maintain regular filing status with the SEC thereby not worsening the information environment for their investors. Table 3 presents summary statistics on the distribution of market capitalization, trading volume, volatility, quoted spread and stock price for our sample firms. Market capitalization is 14 based on total shares outstanding and the stock price twelve months preceding delisting as reported by CRSP. Daily trading volume is the average daily share volume, volatility is the average daily (high-low)/low, quoted spread is the average daily closing ask-closing bid divided by the closing mid-quote and the stock price is the average closing mid-quote as reported by CRSP. Average statistics are computed over the period between 18 and 12 months prior to delisting for 1,083 firms. Due to data limitations (i.e., CRSP does not cover the entire period), we use between 12 and 6 months prior to delisting for 14 firms and over the six-month period prior to delisting for one firm. The average (median) market capitalization of sample firms one year before delisting is $149.8 ($24.82) million. The market capitalization declines to $12.7 ($4.4) million at the time of delisting. Hence, the market capitalization for these firms is truly decimated before delisting occurs. The average (median) price is $5.53 ($3.13) and quoted spread 5.59 (4.31) percent for sample firms one year before delisting. These firms were already relatively low-priced stocks with relatively high spreads.18 Finally, our volatility measures suggest that the market was very uncertain about the value of these stocks already one year before delisting with the average (median) intraday price range ((high-low)/low) at 11.2 (10.3) percent. Note also that the crosssectional distribution across characteristics in our sample is significant. For example, the market capitalization one year before delisting ranges from $10,000 to $42 billion. Similarly, average daily share volume ranges from 132 shares to 32 million shares. V. Delistings and Liquidity We examine how delisting impacts liquidity by analyzing intraday trading data for the six-month period straddling the actual delisting date. Note that for the 147 securities for which no quotes or trades are reported after delisting, there is absolutely no liquidity after delisting. Hence, our estimates are lower bounds on the effect of a delisting on liquidity. Note that the spread numbers one year before delisting are higher, in part, because of decimalization effects. 18 15 A. Does Liquidity Deteriorate After Delisting? Our first hypothesis is that liquidity deteriorates after delisting from Nasdaq. We test this hypothesis by comparing liquidity measures in the three-month period preceding delisting to liquidity measures in the three months following. The results are reported in Table 4. Each cell in the table represents the equally weighted cross-sectional average (or median) of the individual security averages over the three-month period before and after their delisting. The superscript, ‘OTCBB’, indicates that the measure is computed only for securities that traded on the OTC Bulletin Board. The last column gives the difference between after delisting and before delisting in percent as well as significance tests for the difference in means (pair-wise t-tests) and medians (Wilcoxon test). Table 4 reveals that share volume declines by two-thirds from about 386,000 to 133,000 shares per day, quoted spreads almost triple from 12.1 to 33.6 percent and effective spreads triple from 3.3 to 9.9 percent when stocks are delisted from Nasdaq. In addition, average quoting activity declines significantly, from 25 quote updates to 5 updates per day. Our volatility measures also point to a deterioration in market quality. Average intraday return volatility more than triples from 4.4 to 14.3 percent and intraday volatility almost doubles from 34.4 to 61.5 percent. These differences are statistically significant, clearly highlighting an economically and statistically significant decline in liquidity for Nasdaq-delisted firms. In Figure 2, we illustrate trading activity around the delisting event. The top panel shows that share volume and the daily number of trades decline significantly after delisting. There is elevated trading activity in the two weeks preceding delisting, suggesting that traders have different views on the likelihood of an ultimate delisting of (at least some) sample stocks. The bottom panel illustrates that the decline in dollar volume is much smoother than the decline in share volume, suggesting that some stocks with very high share volume experience a significant decline in the stock price (e.g., WorldCom). The bottom panel also shows that the stock price declines steadily in the three months preceding delisting, from slightly above $1 to near $0.80 per 16 share. Although we cannot measure the effect of anticipated delisting, we can infer that the price decline partially reflects this anticipation since the average stock price stabilizes after delisting. We illustrate quoting activity around delisting in Figure 3. Due to data limitations, we are only able to capture quoting activity for the 871 stocks that traded on the OTC Bulletin Board after delisting. From the top panel, it is evident that quoting activity declines significantly just around the time of delisting from about 15 to about 5 quote updates per day with the adjustment taking place right around the delisting date. The bottom panel illustrates the change in quoted spreads around delisting. Quoted percentage spreads creep up gradually in the period leading up to delisting as the average stock price declines. On the delisting day, quoted percentage spreads jump dramatically from about 14 to about 40 percent. However, part of this increase is temporary with quoted spreads stabilizing at about 25 percent within three months of delisting. We illustrate the change in effective spreads around Nasdaq delistings in Figure 4. Note that we can only compute effective spreads for the sample of 871 stocks that trade in the OTC Bulletin Board after delisting. As expected, effective spreads are significantly lower than quoted spreads (even after controlling for the difference in samples, see Table 7 below). This means that studies that use bid-ask spreads to measure the effects of delistings (or deregistrations) on liquidity significantly overestimate the increase in transaction costs facing shareholders. Effective spreads hover around 4 percent leading up to delisting and increase dramatically to around 18 percent immediately following. As with quoted spreads, effective spreads decline gradually and stabilize near 13 percent following delisting. Figure 5 illustrates changing volatility around delistings measured as the event-time cross-sectional average of: (i) the standard deviation of intraday transactions returns; and (ii) the intraday price range (high-low/low). Clearly, the delisting event itself is associated with a tremendous increase in volatility, with volatility measures increasing six- to eight-fold on the day of delisting. The elevated volatility reverts quickly after the delisting day and stabilizes at a level of about twice the initial level of volatility after about a month. 17 B. Does Liquidity Deteriorate More for More Serious Violations? We next test whether the deterioration in liquidity is larger for more severe listing violations ranking the four major categories in descending order of severity as bankruptcy, governance, core, and non-core violations. As explained in Section IV, we assign firms into groups by their most severe violation. The fact that firms often violate more than one listing requirement is likely to work against finding any significant differences across groups. Table 5 reports liquidity changes by severity of listing violation. We find that declines in share and dollar volume are significantly higher the more severe the violation. For example, bankruptcy is associated with significant declines in median volume from about 117,000 to about 59,000 shares and from about $56,000 to about $3,000 per day. By comparison, non-core violations result in declines from about 27,000 to about 20,000 shares and from about $13,000 to about $6,000 per day. The increases in percent quoted and effective spreads are also higher the more severe the violation. Time-weighted quoted spreads increase from 11 to 50 percent for bankrupt firms but only from 13 to 30 percent for non-core violations. The pattern for effective spreads is similar, but muted since we are only able to calculate effective spreads for OTC Bulletin Board stocks. The increase in volatility is larger for bankrupt firms (4.2 to 22.1 percent) than for non-core violators (4.6 to 11.2 percent) as well.19 We explore whether the increase in transactions costs that we document above are explained by increased adverse selection costs facing dealers in the OTC Bulletin Board and Pink Sheet markets. We follow Glosten and Harris (1988) and decompose spreads into an adverse selection and a combined order processing and inventory component. Only 833 securities out of our sample of 1,098 securities had theoretically plausible estimates (i.e. adverse selection component of the spread was between 0 and 1) in both the pre- and post- periods.20 Table 6 shows that both components of the spread increase after delisting, but the adverse selection 19 We also reproduce (not reported) the event-time plots in Figures 2-6 for the different categories of delisting, and find that they are qualitatively very similar to the plots for the overall sample. 20 Spread decompositions following Huang and Stoll (1997) generate an even larger number of securities with implausible estimates. 18 component comprises a smaller proportion of the spread. When we divide the sample into the reason for delisting (columns 3 to 10), we find a significant increase in the adverse selection component only for securities that are delisted due to bankruptcy. However, even in this case, the adverse selection component only comprises 10.3 percent of the spread or 5.7 percent of price. Hence, we conclude that the spread increases that we document are primarily explained by significantly higher order processing and inventory costs after delisting, results consistent with the fact that brokers face increased requirements in penny stocks. C. Does Liquidity Deteriorate More The Further The Firm Falls? The markets covered in this analysis can be ranked from top to bottom in terms of their perceived liquidity as follows: Nasdaq’s NM, Nasdaq’s SmallCap market, OTC Bulletin Board, and the Pink Sheets. Since firms have higher disclosure requirements on the OTC Bulletin Board relative to the Pink Sheets, we expect liquidity to deteriorate significantly more when a firm lands on the Pink Sheets rather than the OTC Bulletin Board. Table 7 reports the results. We assign each security to an originating market based on whether it traded in that market anytime during the three months prior to delisting. Similarly, a security is defined to reach a market of destination if it trades in that market anytime during the three months after its delisting. Each cell in the table represents the equally weighted crosssectional average (or median) of the individual security averages over the three-month periods before and after their delisting. By and large, the data support our hypothesis that liquidity deteriorates more the when firms move to the Pink Sheets than when they move to the OTC Bulletin Board. We formally test whether the liquidity decline in relative terms is larger for firms that move to the Pink Sheets holding their original listing venue constant. The results show that the dollar volume and volatility decline significantly. But the decline in quoted spreads, while of the correct sign, is not significant (last two columns). 19 We compare these results to those reported by Macey, O’Hara and Pompilio (2004) for NYSE-delisted firms that land in the Pink Sheets. They find that daily share volume is cut in half, spreads increase from 5.9 to 8.7 percent and volatility more than doubles for NYSE to Pink Sheet delistings. Our numbers for Nasdaq NM to Pink Sheet delistings (Group 2) are very similar. We find that share volume declines by almost 60 percent, quoted spreads increase from 7.6 to 11.8 percent and volatility more than doubles as well. Interestingly, the decline in liquidity for moves from Nasdaq NM to OTC Bulletin Board delistings (Group 1) is much less dramatic, suggesting that the softer landing provided by the OTC Bulletin Board is valuable to shareholders of delisted firms. VI. Delistings and Shareholder Wealth If liquidity is priced as suggested by Amihud and Mendelson (1986) and Acharya and Pedersen (2004), we should see a significant decrease in shareholder wealth around delistings. Note that many additional costs facing shareholders when a firm is delisted are also likely to depress shareholder wealth. For example, delisted firms are likely to face significantly higher regulatory costs for raising capital in the future.21 Moreover, a delisting from Nasdaq’s NM or SmallCap markets may result in a loss of confidence by suppliers, customers and employees, the loss of analyst coverage and institutional investor interest, and fewer business development opportunities. Our estimates of the change in shareholder wealth are composite measures of all the costs associated with delisting. In almost all cases, the firms that are ultimately delisted have been publicly on Nasdaq’s watch list for delisting at least six weeks (and up to three months) in advance of the delisting date. Hence, the delisting event itself does not provide any material information about the firm’s 21 A Nasdaq-delisted firm may violate equity or debt covenants that necessitate a refinancing of the firm’s balance sheet. Moreover, firms trading on the SmallCap, OTC Bulletin Board, or Pink Sheets are not covered by federal preemption of state securities laws (“blue sky” laws) for issuer transactions, so the firm’s securities must either be registered or exempt in each applicable state following delisting from the Nasdaq NM. Further, a firm that lands on the OTC Bulletin Board or Pink Sheets with public float under $75 million is not allowed to automatically incorporate information contained in subsequent filings into most registration statements (they lose Form S-3 eligibility). Lastly, Rule 144 sales (which are exempt from registration) are also curtailed for OTC Bulletin Board and Pink Sheet firms. 20 fundamental value apart from the fact that it will no longer benefit from the liquidity provided by Nasdaq listing. We therefore interpret any changes in shareholder wealth in the narrow window around delisting as being associated with deteriorating liquidity and possibly other costs caused by the delisting. A. Is Delisting Associated with Significant Loss in Shareholder Wealth? We measure the delisting effect on shareholder wealth by following an equally-weighted buy-and-hold portfolio of delisted stocks from the day before to 60 days following delisting. As demonstrated in Figure 2, the decline in closing prices prior to delisting suggests that most of the delisting costs are incorporated into firm value prior to delisting. However, part of this loss in shareholder wealth may also reflect deteriorating fundamentals so our measure almost surely significantly underestimates the true loss of shareholder wealth. We scale to a $100 starting portfolio and follow daily changes after delisting. Table 8 shows that the losses in shareholder wealth are significant. For the overall sample, the value of the portfolio drops by 19.0 percent (to $81) by day +1. Over the next sixty days, the portfolio drops another 3.2 percent (to $77.8), for a cumulative loss of 22.2 percent by the end of the window. For a value-weighted portfolio, the losses are even more significant, with the initial loss of 21.1 percent reaching 26.7 percent by the end of three months. The losses occur almost entirely from days -1 to +1. The downward drift in the remaining event window is minor by comparison suggesting that our estimates are primarily driven by the delisting and not by deteriorating firm fundamentals. B. Is the Loss in Shareholder Wealth Larger for Firms that Violate More Important Listing Criteria? We find that the liquidity decline is larger for firms with more serious listings violations. Table 8 shows that, when broken down by listing violations, the loss in value from day -1 to day +1 based on an equally-weighted portfolio is 24.2 percent for bankruptcy, 21.5 percent for governance, 18.4 percent for core, and 15.5 percent for non-core violations. Over the entire delisting window, the loss in shareholder wealth reaches 27.6 percent for bankruptcy, 29.6 21 percent for governance, 19.7 percent for core, and 17.4 percent for non-core violations. With the exception of bankruptcy, value-weighted portfolio results are very similar. Shareholders of bankrupt firms on average lose as much as 38.0 percent in the narrow window and up to 50.3 percent over the three-month period following delisting. C. Cumulative Abnormal Returns Around Delistings As a robustness test, we compute market-adjusted mean cumulative abnormal returns (CARs) around delisting for Nasdaq securities. We use two event windows to compute CARs based on a simple buy and hold strategy (-2, +2) and (-10, +10). Day 0 indicates the date of delisting. We use the total Nasdaq index return from CRSP (with distributions) as our market return. The results for the overall sample, as well as sub-samples by market of final trading, reason for delisting, and pre- and post-decimals are in Table 9. On average, shareholders of delisted firms earn a significantly negative return of minus 17.8 percent after adjusting for the market in the narrow window, (-2,+2). The cumulative abnormal returns are slightly lower for the longer window. Hence, the market adjustment does reduce the effect of delisting on shareholder wealth, but only marginally. The loss in firm value is larger for firms delisted to the Pink Sheets than for those ending up on the OTC Bulletin Board after delisting, but the difference is not significant. The loss in firm value is significant for all reasons for delisting, but also here the difference across reasons is not significant. Finally, firms that were delisted after decimalization experience a larger loss of wealth, but again the difference is not significant. Our result that shareholders of delisted firm lose 15 to 20 percent of firm value due to the loss of liquidity is robust to adjusting for the market. D. Liquidity and Shareholder Wealth Liquidity and shareholder wealth are obviously jointly determined. To disentangle what part of the decline in shareholder wealth comes from decreased liquidity and what part can be explained by other factors, we run simultaneous regressions of percentage quoted spreads and the 22 log of market capitalization on trading-related and corporate variables, respectively. These regressions also provide robustness checks on our univariate analysis above. Previous research has shown that the log of dollar volume and the volatility of returns are important determinants of quoted spreads in the cross-section. Since our sample straddles the Nasdaq decimalization date, we also control for decimalization. Corporate variables that might affect the log of market capitalization include the log of sales, EBIT, and leverage which were pulled from Compustat. All the variables in the regressions, including the dependent variables, are averages over the three months before and after delisting. Table 10a tests whether firms that violate more important listing criteria experience a larger deterioration in liquidity and shareholder wealth after controlling for other factors. The results show that quoted spreads are significantly lower for larger firms, and significantly higher for firms with more volatile stock prices. As expected, spreads are significantly lower after the introduction of decimals. Spreads are increasing in dollar volume controlling for market capitalization, suggesting that adverse selection increases with turnover. After controlling for these other factors, there is no significant difference in quoted spreads across firms that violate different listing criteria (the intercept corresponds to non-core violations). We incorporate a set of dummy variables and interaction terms to capture the effects of delisting on quoted spreads. The results show that firms with higher dollar volume and higher volatility after delisting experience a smaller spread increase. The delisting dummy interacted with the type of violation shows that the effect on liquidity is larger the more severe the listing violation, ranging from 26.17 percent for bankruptcy to 19.17 percent for non-core violations. Liquidity deterioration is significantly greater for bankruptcy than for non-core violations (pvalue=0.0025). The second column reports the log market capitalization regression, where we include both corporate and trading characteristics. Perhaps not surprisingly, market capitalization is positively associated with dollar volume and with sales. As expected, firms with higher spreads 23 have lower market cap. Market capitalization declines slightly more for firms that are delisted for bankruptcy (-0.94) than for non-core violations (-0.61), but this loss in firm value is not significantly different (p-value=0.13). In other words, the entire effect of delistings on market capitalization is caused by the liquidity deterioration. In Table 10b, we repeat this exercise to test the hypothesis that the deteriorations in liquidity and shareholder wealth are larger for firms that end up in the Pink Sheets than for those that continue trading in the OTC Bulletin Board. The results show that firms that end up in the Pink Sheets experience a significantly larger deterioration in liquidity (28.61 percent increase in quoted spreads compared to 20.91 percent) and shareholder wealth (-0.81 decline in log of market cap compared to -0.69) following delisting even after we control for other factors. Liquidity deterioration is significantly greater for firms that land on the Pink Sheets than those that land on the OTC Bulletin Board (p-value=0.0001). VII. Conclusion We test whether liquidity and shareholder wealth deteriorate significantly for 1,098 firms whose stocks were delisted from Nasdaq during the period January 1, 1999 to December 31, 2002. We evaluate various measures of liquidity in the three-month period before to the threemonth period after delisting. With the exception of bankrupt firms, firms are publicly put on Nasdaq’s watch list for delisting at least six weeks, and sometimes more than three months before the actual delisting date, depending on the nature of the violation. Hence, the delisting event does not provide any material information about the firm except that it will no longer benefit from trading in Nasdaq’s systems. As predicted by Huddart, Hughes and Brunnermeier (1999), we find that liquidity deteriorates significantly around the delisting event itself. Share volume declines by almost twothirds, quoted spreads almost triple from 12.1 to 33.9 percent, and effective spreads triple from 3.3 to 9.9 percent when stocks are delisted. Moreover, the average stock price declines by more than fifty percent from $0.63 to $0.26, highlighting that delisting imposes tremendous costs on 24 shareholders. Not only do they suffer from falling stock prices, sometimes for many preceding months, now they face significantly higher trading costs as well. Violations of the continued listing requirements range from minor (non-core) infractions such as a bid price below $1.00 to severe problems such as bankruptcy. We hypothesize and confirm that liquidity deteriorates significantly more for firms that are delisted because of bankruptcy or because they are delinquent in their SEC filings than for firms that are delisted for non-core reasons. For example, bankrupt firms experience an 80 percent decline in share volume, an increase in quoted spreads from 11.3 to 50.0 percent and an increase in effective spreads from 3.7 to 15.4 percent. By comparison, non-core violators experience a 25 percent decline in share volume, an increase in quoted spreads from 13.4 to 29.7 percent, and an increase in effective spread from 3.3 to 10.6 percent. Firms that are delisted may continue trading in the Pink Sheet and/or the OTC Bulletin Board afterward. We hypothesize and confirm that liquidity deteriorates significantly more for firms that fall further in the hierarchy of markets after delisting. For example, firms that were trading on Nasdaq’s NM before delisting and end up in the Pink Sheets (a three notch move) experience nearly a fivefold increase in quoted spreads from 9.4 to 49.3 percent. By comparison, firms that were trading on Nasdaq’s SC before delisting and end up on the OTC Bulletin board see their quoted spreads double from 14.2 to 31.7 percent. Amihud and Mendelson (1986) and Acharya and Pedersen (2004) predict that a decline in liquidity should translate into a loss in shareholder wealth. To gauge the impact of delisting on shareholder wealth, we form equally-weighted portfolios of delisted firms the day before delisting. It is important to bear in mind that the delisting itself is anticipated, so these measures of the delisting effect are likely to underestimate the value-loss due to delisting. Our results show that shareholders on average lose 19 percent of firm value from the day before delisting to the day after delisting! The loss is higher for more severe violations (bankrupt firms lose 24 percent) than for less severe violations (firms experiencing non-core delistings lose 16 percent) in the two- 25 day window. We conclude that the liquidity decline is indeed priced, and shareholders experience a significant loss of wealth due to delisting. We check the robustness of our univariate results by running multivariate regressions simultaneously estimating the effect of delisting on liquidity (quoted spreads) and shareholder wealth (market capitalization). The results confirm that liquidity and shareholder wealth deteriorate significantly more for more severe violations and for those firms that trade in the Pink Sheets after delisting. Given these significant losses of shareholder value associated with delisting, we would expect that firms will do everything in their power to remain listed. In the case of bankruptcy, there is very little that the firm can do to prevent a delisting. Similarly, if the firm is violating a governance requirement or a core listing requirement, the firm may be in such significant trouble that remaining listed is a secondary concern, at least in the short run. By contrast, if the firm is simply violating one of the non-core requirements, say that the stock price falls below $1.00, there are strategies readily available to the firm to prevent delisting. For example, the firm could conduct a reverse split (reduce the number of shares outstanding) to effectively raise its price per share above the $1.00 level. In a recent paper, Rosenthal, Gleason and Lee (2004) find that firms conducting reverse splits on average lose 5 percent of firm value as a result. However, if the reason for the reverse split is that the firm risks being delisted the loss is as high as 7 percent of firm value. Harris, Panchapagesan and Werner (2004), analyze the tradeoff between reverse splits, other corporate actions, and delistings more extensively. 26 References Acharya, Viral V., and Lasse Heje Pedersen, 2004, Asset pricing and liquidity risk, Journal of Financial Economics, forthcoming. Amihud, Yakov, 2002, Illiquidity and stock returns: Cross-section and time-series effects, Journal of Financial Markets 5, 31-56. Amihud, Yakov, and Haim Mendelson, 1986, Asset pricing and the bid-ask spread, Journal of Financial Economics 17, 223-250. Barclay, Michael J., 1997, Bid-Ask spreads and the avoidance of odd-eighth quotes on Nasdaq: An examination of exchange listings, Journal of Financial Economics 45, 35-60. Bennett, Paul, and Li Wei, 2003, Market structure, fragmentation and market quality – Evidence from recent listing switches, NYSE Working Paper, November 2003. Bessembinder, Hendrik, 1999, Trade execution costs on Nasdaq and the NYSE: A post-reform comparison, Journal of Financial and Quantitative Analysis 34, 387-407. Bushee, Brian J., and Christian Leuz, 2004, Economic consequences of SEC disclosure regulation, Journal of Accounting and Economics, forthcoming. Brown, Stephen J., and Jerold B. Warner, 1980, Measuring security price performance, Journal of Financial Economics 8, 205-258. Brown, Stephen J., and Jerold B. Warner, 1985, Using daily stock returns: The case of event studies, Journal of Financial Economics 14, 3-31. DeAngelo, Harry, Linda DeAngelo, and E. Rice, 1984, Going private: Minority freezouts and stockholder wealth, Journal of Law and Economics 27, 367-401. 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Kieschnick and Wendy Rotenberg, 1999, On the heterogeneity of levered going private transactions, Review of Financial Studies 12, 281-309. Harris, Jeffrey H., Venkatesh Panchapagesan and Ingrid M. Werner, 2004, Dealing with stock price declines, Ohio State working paper. Heidle, Hans, and Roger D. Huang, 2002, Information-based trading in dealer and auction markets: An analysis of exchange listing, Journal of Financial and Quantitative Analysis 37, 391-424. Ho, Thomas, and Hans R. Stoll, 1981, Optimal dealer pricing under transactions and return uncertainty, Journal of Financial Economics 9, 47-73. Huang, Roger D. and Hans R. Stoll, 1997, The components of the bid-ask spread : A general approach, Review of Financial Studies 10, 995-1034. Huddart, Steven, John S. Hughes, and Markus Brunnermeier, 1999, Disclosure requirements and stock exchange listing choice in an international context, Journal of Accounting and Economics 26, 237-269. Lehn, Kenneth, and Annette B. Poulsen, 1989, Free cash flows and stockholder gains in going private transactions, Journal of Finance 64, 771-787. Leuz, Christian, Alexander J. Triantis and Tracy Yue Wang, 2004, Why do firms go dark? Causes and economic consequences of voluntary SEC deregistrations, University of Pennsylvania working paper. Luft, Carl, and Lawrence M. Levine, 2001, Over the counter Bulletin Board Exchange: market structure, risk and return, Journal of Alternative Investments, Fall. Luft, Carl, and Lawrence M. Levine, 2003, Over the counter Bulletin Board Exchange: The impact of liquidity and size to return, volatility, and bid/ask spread, DePaul University working paper. Macey, Jonathan R., and Maureen O’Hara, 2002, The economics of stock exchange listing fees and listing requirements, Journal of Financial Intermediation 111, 297-313. Macey, Jonathan R., Maureen O’Hara, and David Pompilio, 2004, Down and out in the stock market: The law and finance of the delisting process, Cornell University working paper. Marosi, András, and Nadia Massoud, 2004, Why do firms go dark?, University of Alberta working paper. Pastor, Luis, and Robert F. Stambaugh, 2003, Liquidity risk and expected stock returns, Journal of Political Economy 111, 642-685. Rosenthal, Leonard, Kimberly C. Gleason and Chun I. Lee, 2004, Can a reverse split be good news? Wealth effects and performance implications of reverse splits, Bentley College working paper. Seguin, Paul M., and Margaret M. Smoller, 1997, Share price and mortality: An analysis of newly listed Nasdaq stocks, Journal of Financial Economics 45, 333-363. 28 Shumway, Tyler, 1997, The delisting bias in CRSP data, Journal of Finance52, 327-340. Shumway, Tyler and Vincent A. Warther, 1999, The delisting bias in CRSP's Nasdaq data and its implications for the size effect, Journal of Finance 54, 2361-2379. Stoll, Hans R., 1978, The supply of dealer services in securities markets, Journal of Finance 33, 1133-1151. Weir, Charlie, David Laing and Mike Wright, 2003, Going private transactions and the market for corporate control, Aberdeen Business School working paper. 29 Table 1 Regulatory Reasons for Delisting Nasdaq Firms Between 1999-2002 This table presents distribution of the regulatory reason for the delisting of all common stock and ADRs in Nasdaq between January 1, 1999 to December 31, 2002. All delistings data were obtained from Nasdaq’s website (www.nasdaqtrader.com). Regulatory reasons for delistings are classified into four major categories in the descending order of the severity of the violation of Nasdaq’s listing criteria: (1) Reasons triggered by bankruptcy filing or liquidation, (2) Reasons triggered by corporate governance issues such as SEC filing violation and public interest, (3) Reasons triggered by violation of core objective listing criteria as defined by Nasdaq, and (4) Reasons triggered by violation of non-core listing criteria. Since a security may be delisted for multiple reasons, we define the dominant reason as the reason triggered by the most severe violation. For example, if a security was delisted for public interest (corporate governance) as well as for having market capitalization below minimum (core listing), we will define its dominant reason for delisting as corporate governance. Panel A: Breakdown by all the reasons mentioned for delisting Nasdaq firms between 1999-2002 1999 2000 2001 2002 Total All Regulatory Delistings Bankruptcy/Liquidation reasons Governance-related reasons Filing Public Interest Shareholder Meeting Proxy-related Independent Directors Disclosure Core listing reasons Market capitalization below minimum Net tangible assets below minimum Revenue below minimum Net income below minimum Round lot shareholders below minimum Insufficient market makers Non-core listing reasons Bid price below $1 Market float below minimum Nasdaq-related reasons (fees, qualifications exception etc.) 272 11 47 25 15 12 0 2 0 186 25 40 20 11 18 4 0 0 371 71 148 51 61 62 10 3 2 269 46 172 30 17 141 12 8 1 1,098 153 407 126 104 233 26 13 3 109 75 106 34 54 1 1 76 53 73 34 25 2 1 126 114 120 59 61 1 4 121 107 107 43 78 0 0 432 349 406 170 218 4 6 207 165 61 32 102 75 27 18 221 189 54 23 140 91 40 50 670 520 182 123 30 Table 1 (Continued) Panel B: Frequency distribution of the overlap among reasons for delisting (numbers in the diagonal represent delistings for that reason alone) Bankruptcy Governance Core listing Non-core listing Bankruptcy Governance Core listing Non-core listing 50 71 102 16 199 104 42 138 207 382 Panel C: Breakdown of final sample by the dominant reason for delisting Dominant Reason 1999 2000 2001 2002 Total Bankruptcy/Liquidation reasons Governance-related reasons Core listing reasons Non-core listing reasons 11 44 98 119 25 35 63 63 71 99 66 135 46 158 0 65 153 336 227 382 31 Table 2 Regulatory Reasons for Delisting Nasdaq Firms By Markets of Origin and Destination This table presents distribution of the regulatory reason for the delisting of all common stock and ADRs in Nasdaq between January 1, 1999 to December 31, 2002 by the markets of origin and destination. All delistings data were obtained from Nasdaq’s website (www.nasdaqtrader.com). A security is defined to originate from a market if it traded in that market anytime during the three months prior to its delisting. Similarly, a security is defined to reach a market of destination if it trades in that market anytime during the three months after its delisting. We do not consider delistings that did not trade in any market after their delisting. NNM refers to the Nasdaq National Market, SC refers to the SmallCap Market, OTCBB refers to the OTC Bulletin Board Market operated by Nasdaq and PS refers to the Pink Sheets Markets operated by Pink Sheets LLC. Regulatory reasons for delistings are classified into four major categories in the descending order of the severity of the violation of Nasdaq’s listing criteria: (1) Reasons triggered by bankruptcy filing or liquidation, (2) Reasons triggered by corporate governance issues such as SEC filing violation and public interest, (3) Reasons triggered by violation of core objective listing criteria as defined by Nasdaq, and (4) Reasons triggered by violation of non-core listing criteria. Since a security may be delisted for multiple reasons, we define the dominant reason as the reason triggered by the most severe violation. For example, if a security was delisted for public interest (corporate governance) as well as for having market capitalization below minimum (core listing), we will define its dominant reason for delisting as corporate governance. Panel A: Breakdown by the dominant (all) reason for delisting by market of origin NNM only SC only NNM and SC Total All Regulatory Delistings 544 121 (121) 145 (203) 99 (181) 179 (311) 520 24 (24) 187 (200) 121 (240) 188 (336) 34 8 (8) 4 (4) 7 (11) 15 (23) 1,098 153 (153) 336 (407) 227 (432) 382 (670) Bankruptcy/Liquidation reasons Governance-related reasons Core listing reasons Non-core listing reasons 32 Table 2 (Continued) Panel B: Breakdown by the dominant (all) reason for delisting by market of destination OTCBB OTCBB PS only Total only and PS 756 227 115 1,098 All Regulatory Delistings 6 (6) 185 (187) 210 (365) 355 (552) 99 (99) 120 (173) 1 (37) 7 (66) 48 (48) 31 (47) 16 (30) 20 (52) 153 (153) 336 (407) 227 (432) 382 (670) Bankruptcy/Liquidation reasons Governance-related reasons Core listing reasons Non-core listing reasons 33 Table 3 Descriptive Statistics for Delisted Firms One Year Before Delisting This table presents descriptive statistics for 1,098 securities that were delisted in Nasdaq between January 1, 1999 to December 31, 2002. All statistics are computed using data from CRSP. Average statistics are computed over the period between 18 months and 12 months prior to delisting for 1,083 securities, between 12 months and 6 months prior to delisting for 14 securities and over the six-month period prior to delisting for 1 security. Mean Market Capitalization one year before delisting in $millions Market Capitalization at the time of delisting in $millions Average closing price Average daily share volume (in shares) Average daily dollar volume (in $000) Average quoted spread at close ($) Average percentage quoted spread at close Average standard deviation of close-to-close return in % Average intra-day transaction price range ((High-Low)/Low in %) 149.78 12.68 5.53 200,357 2,560.35 0.1669 5.59 8.31 11.15 Median 24.82 4.42 3.13 47,366 139.24 0.1243 4.31 7.62 10.30 Minimum 0.01 0.01 0.17 Maximum 42,196.82 890.25 80.51 132 32,221,055 0.02 547,583.01 0.0134 0.16 0.88 1.22 2.4567 115.73 61.00 276.53 34 Table 4 Changes in Liquidity around Delisting This table presents changes in market liquidity for 1,098 securities in the six months around their delisting from Nasdaq. Securities that were delisted from the Nasdaq market (from the National Market or SmallCap Market) traded in the Bulletin Board or in the Pink Sheets or in both. All trading and quoting data were obtained from The Nasdaq Stock Market and Pink Sheets LLC. Quoting data in the Pink Sheets market is limited to the end of the day quotes. Each cell in the table represents the equally weighted crosssectional average [median] of the individual security averages over the three-month period before and after their delisting. The superscript, ‘OTCBB’, indicates that the measure was computed only for securities that traded in the OTC Bulletin Board. The superscript, ‘*’ indicates statistical significance (at the 5% level) using a paired t-test under the null that the average before delisting is the same as the average after delisting. The superscript ** indicates statistical significance for the medians using a paired signed-rank test (Wilcoxon test). 3 months before delisting (trading in NNM/SC) Daily share volume (in shares) 385,788 [33,233] 353.13 [20.28] 1.077 [0.629] 25 0.0847 12.09 0.0218 3.29 4.44 [3.74] 34.41 [27.00] 3 months after delisting (trading in OTCBB/PS) 133,457 [24,845] 45.03 [6.50] 0.674 [0.260] 5 0.1286 33.56 0.0399 9.93 14.34 [9.05] 61.49 [34.50] Difference after – before divided by before (in %) -65.4 [-25.2**] -87.3* [-67.9**] -37.4* [-58.7**] -80.0* 51.8* 177.6* 83.0* 201.8* 223.0* [142.0**] 78.7* [27.8**] Daily dollar volume (in $000) Transaction price (in $) Number of quotes per day OTCBB Time-weighted quoted spread (in $) Time-weighted percentage quoted spread Value-weighted effective spread (in $)OTCBB Value-weighted percentage effective spread OTCBB Standard deviation of intra-day transaction price return in % Intra-day transaction price range ((High-Low)/Low in %) 35 Table 5 Changes in Liquidity around Delisting by the Dominant Regulatory Reason for Delisting This table presents changes in market liquidity for 1,098 delisted Nasdaq securities by the dominant regulatory reason for their delisting. Regulatory reasons for delistings are classified into four major categories in the descending order of the severity of the violation of Nasdaq’s listing criteria: (1) Reasons triggered by bankruptcy filing or liquidation, (2) Reasons triggered by corporate governance issues such as SEC filing violation and public interest, (3) Reasons triggered by violation of ‘core’ objective listing criteria as defined by Nasdaq, and (4) Reasons triggered by violation of ‘non-core’ listing criteria. Since a security may be delisted for multiple reasons, we define the dominant reason as the reason triggered by the most severe violation. For example, if a security was delisted for public interest (corporate governance) as well as for having market capitalization below minimum (core listing), we will define its dominant reason for delisting as corporate governance. Securities that were delisted from the Nasdaq market (from the National Market or SmallCap Market) traded in the Bulletin Board or in the Pink Sheets or in both. NNM refers to the Nasdaq National Market, SC refers to the SmallCap Market, OTCBB refers to the OTC Bulletin Board Market operated by Nasdaq and PS refers to the Pink Sheets Markets operated by Pink Sheets LLC. All trading and quoting data were obtained from The Nasdaq Stock Market and Pink Sheets LLC. Quoting data in the Pink Sheets market is limited to the end of the day quotes. Each cell in the table represents the equally weighted cross-sectional average [median] of the individual security averages over the three-month period before and after their delisting. The superscript, ‘OTCBB’, indicates that the measure was computed only for securities that traded in the OTC Bulletin Board. The superscript, ‘*’ indicates statistical significance (at the 5% level) using a paired t-test under the null that the average before delisting is the same as the average after delisting. The superscript ** indicates statistical significance for the medians using a paired signed-rank test (Wilcoxon test). The last column reports a t-test for differences in relative changes (after-before)/before for the group of bankrupt compared to the group of non-core delistings, H0: reldiffbankruptcy-reldiffnoncore=0. reldiffbankruptcy Bankruptcy/Liquidation Governance Issues Core Listing Issues Non-Core Listing Issues -reldiffnoncore Number of observations 153 NNM/SC Daily share volume (in shares) Daily dollar volume (in $000) Transaction price (in $) Number of quotes per day OTCBB Time-weighted quoted spread (in $) Time-weighted percentage quoted spread Value-weighted effective spread (in $) OTCBB OTCBB 336 NNM/SC 225,788 [23,741] 282.63 [15.69] 1.275 [0.639] 31 0.0831 11.23 0.0256 3.52 4.22 [3.46] 35.19 [26.78] OTCBB/PS 103,226* [20,441**] 38.42* [4.95**] 0.622* [0.269**] 5* 0.1540* 35.92* 0.0352* 9.13* 15.02* [9.89**] 63.07* [35.75**] 227 NNM/SC 148,963 [34,735] 113.38 [28.00] 1.107 [0.784] 16 0.1064 11.60 0.0211 2.61 4.69 [4.21] 30.95 [26.37] OTCBB/PS 112,739 [28,844**] 76.37 [12.20**] 1.210 [0.433**] 6* 0.1279* 24.74* 0.0445* 8.18* 12.25* [8.90**] 42.05* [32.01**] 382 NNM/SC 104,310 [26,829] 51.64 [13.45] 0.827 [0.517] 12 0.0809 13.43 0.0191 3.33 4.55 [3.93] 32.04 [25.15] OTCBB/PS 73,670* [19,886**] 22.63* [6.25**] 0.629* [0.300**] 4* 0.1349* 29.73* 0.0430* 10.65* 11.22* [8.33**] 40.06* [28.50**] t-statistic -3.178 -4.10* -16.96* -9.28* -7.34* 1.08 -0.14 6.34* 1.47 10.67* OTCBB/PS 333,274 [58,831**] 64.04 [2.84**] 0.209* [0.062**] 4* 0.0655 49.98* 0.0185 15.35* 22.13* [12.46**] 132.63* [91.04**] 1,761,962 [117,329] 1593.91 [55.76] 1.235 [0.755] 56 0.0658 11.34 0.0216 3.67 4.23 [3.44] 43.62 [35.35] Value-weighted percentage effective spread Standard deviation of intra-day transaction price return in % Intra-day transaction price range ((HighLow)/Low in %) 36 Table 6 Decomposition of Spreads around Delisting This table presents changes in the adverse selection, order processing and inventory control components of quoted spreads before and after delisting for 833 delisted Nasdaq securities. The decomposition of spreads is made using the trade indicator model suggested by Glosten and Harris (1988). Only 833 securities out of our sample of 1,098 securities had theoretically plausible estimates (i.e. adverse selection component of the spread was between 0 and 1) in both the before and after periods. NNM refers to the Nasdaq National Market, SC refers to the SmallCap Market, OTCBB refers to the OTC Bulletin Board Market operated by Nasdaq and PS refers to the Pink Sheets Markets operated by Pink Sheets LLC. All trading and quoting data were obtained from The Nasdaq Stock Market and Pink Sheets LLC. Quoting data in the Pink Sheets market is limited to the end of the day quotes. The superscript, ‘*’ indicates statistical significance (at the 5% level) using a paired t-test under the null that the measure before delisting is the same as the measure after delisting. All stocks 833 NNM/SC OTCBB/PS Bankruptcy/Liquidation 89 NNM/SC OTCBB/PS Governance Issues 255 NNM/SC OTCBB/PS Core Listing Issues 189 NNM/SC OTCBB/PS Non-core Listing Issues 300 NNM/SC OTCBB/PS Number of observations Adverse selection in dollars as proportion of spread as proportion of price Inventory and order processing in dollars as proportion of spread as proportion of price 0.009 0.103 0.012 0.013* 0.088* 0.033* 0.005 0.068 0.006 0.009 0.103* 0.057* 0.009 0.120 0.013 0.018* 0.104 0.039* 0.011 0.099 0.012 0.009 0.071* 0.017* 0.009 0.101 0.012 0.013 0.080* 0.031* 0.063 0.897 0.087 0.088* 0.912* 0.247* 0.048 0.932 0.070 0.034* 0.897* 0.376* 0.060 0.880 0.083 0.094* 0.896 0.284* 0.077 0.901 0.083 0.097* 0.929* 0.172* 0.062 0.899 0.097 0.092* 0.920* 0.229* 37 Table 7 Changes in Liquidity around Delisting by Market of Origin and Market of Destination This table presents changes in market liquidity for 1,098 delisted Nasdaq securities by the market of their origin and by the market of their destination. A security is defined to originate from a market if it traded in that market anytime during the three months prior to its delisting. Similarly, a security is defined to reach a market of destination if it trades in that market anytime during the three months after its delisting. We do not consider delistings that did not trade in any market after their delisting. NNM refers to the Nasdaq National Market, SC refers to the SmallCap Market, OTCBB refers to the OTC Bulletin Board Market operated by Nasdaq and PS refers to the Pink Sheets Markets operated by Pink Sheets LLC. All trading and quoting data were obtained from The Nasdaq Stock Market and Pink Sheets LLC. Quoting data in the Pink Sheets market is limited to the end of the day quotes. Each cell in the table represents the equally weighted cross-sectional average [median] of the individual security averages over the three-month period before and after their delisting. The superscript, ‘*’ indicates statistical significance (at the 5% level) using a paired t-test under the null that the average before delisting is the same as the average after delisting. The superscript ** indicates statistical significance for the medians using a paired signed-rank test (Wilcoxon test). The last column reports a t-test for differences in relative changes (after-before)/before between groups i and j, where i=1 or 2 and j=3 or 4, H0: reldiffgroupi-reldiffgroupj=0. The cell entry ‘NA’ represents ‘not applicable.’ reldiffGroup1 reldiffGroup3 Group 1 Group 2 Group 3 Group 4 reldiffGroup2 reldiffGroup4 Number of observations 423 225 475 129 NNM Daily share volume (in shares) 192,760 [53,110] 143.27 [32.14] 1.062 [0.647] 24 0.0717 10.00 0.0201 3.17 4.21 [3.61] 32.32 [27.03] OTCBB 117,548* [39,807**] 41.67* [11.59**] 0.689* [0.298**] 6* 0.1071* 23.70* 0.0326* 8.65* 10.57* [8.01**] 44.45* [32.02**] NNM 1,460,762 [115,773] 1437.67 [68.27] 1.606 [0.918] 61 0.0773 9.37 0.0269 3.10 4.28 [3.39] 37.58 [30.52] PS 333,578 [46,702**] 81.13* [3.96**] 0.942 [0.102**] 0.1183* 49.29* 25.01* [16.04**] 137.69* [100.12**] SC 90,221 [20,098] 73.45 [11.80] 0.865 [0.575] 12 0.0959 14.24 0.0220 3.39 4.63 [3.97] 33.97 [25.69] OTCBB 69,665 [16,940**] 41.48 [5.51**] 0.606* [0.338**] 4* 0.1444* 31.74* 0.0458* 10.88* 11.07* [8.42**] 38.84* [28.66] SC 168,367 [22,432] 134.89 [14.06] 0.858 [0.555] 17 0.0861 15.86 0.0168 3.38 4.74 [4.09] 43.81 [31.56] PS 55,543* [11,187**] 22.11 [1.22**] 0.345* [0.114**] 0.1509* 61.95* 24.24* [17.26**] 86.67* [62.78**] t-statistic 1.46 t-statistic 4.19* Daily dollar volume (in $000) 2.34* 3.77* Transaction price (in $) Number of quotes per day Time-weighted quoted spread (in $) Time-weighted percentage quoted spread Value-weighted effective spread (in $) Value-weighted percentage effective spread Standard deviation of intra-day transaction price return in % Intra-day transaction price range ((HighLow)/Low in %) 2.32* -0.15 NA 7.27* -1.07 NA NA -2.95* -11.80* NA -0.47 -1.29 NA NA -23.80* -23.74* 38 Table 8 Value of the Portfolio of All Nasdaq Delistings Between 1999-2002 The table depicts the value of a $100 investment made at the end of day -1 in an equally-weighted (valueweighted) portfolio of Nasdaq delistings. The superscript, ‘*’ indicates statistical significance (at the 5% level) using a t-test under the null that the average portfolio value in day ‘t’ is the same as the value in day –1. Equally-Weighted Portfolio Day All -1 0 1 10 20 30 40 50 60 100 82.25* 80.95* 79.53* 76.74* 74.85* 72.76* 73.74* 77.76* Bankruptcy 100 76.12* 75.85* 83.46* 70.99* 64.53* 74.10* 75.63* 72.38* Governance 100 78.46* 76.30* 71.86* 70.37* 68.26* 67.87* 66.01* 70.41* Core 100 84.61* 81.58* 79.50* 75.67* 75.36* 71.55* 76.55* 80.26* Non-Core 100 84.23* 84.50* 84.69* 82.73* 80.68* 77.10* 77.40* 82.57* Value-Weighted Portfolio Day All -1 0 1 10 20 30 40 50 60 100 80.37* 78.87* 75.59* 71.65* 70.51* 68.10* 70.14* 73.35* Bankruptcy 100 65.73* 61.95* 64.85* 54.55* 60.63* 53.48* 48.23* 49.71* Governance 100 80.13* 79.35* 75.15* 73.90* 70.52* 71.86* 69.52* 71.75* Core 100 82.87* 81.56* 77.51* 73.84* 74.00* 68.44* 76.10* 81.91* Non-Core 100 85.75* 84.21* 79.87* 75.28* 72.65* 69.95* 77.61* 82.53* 39 Table 9 Cumulative Abnormal Returns Around Delisting This table presents the market-adjusted mean cumulative abnormal returns (CAR) around delisting for Nasdaq securities. We use two event windows to compute CARs using a simple buy and hold strategy. Day 0 indicates the date of delisting. We use the total Nasdaq index return from CRSP (with distributions) as our market return. T-statistics for CARs based on BrownWarner (1980, 1985) as well as t-statistics for simple difference in CARs between sub-samples are provided. For the “By reason” sub-samples, t-statistics are for the difference between bankruptcy and non-core reasons only. Significance at the 5% level under a two-sided test is denoted by *. Event window (-2,+2) (-10,+10) -17.79%* -16.05%* (-21.57) (-9.49) 810 818 -17.33%* (-16.51) 679 -20.19%* (-13.27) 131 2.85 (0.48) -19.65* (-15.12) 76 -19.54%* (-24.20) 239 -20.21%* (-28.72) 195 -14.36%* (-6.70) 300 -5.29 (-0.68) -16.34%* (-12.98) 420 -18.99%* (-27.66) 378 2.65 (0.81) -16.64%* (-7.74) 683 -13.05%* (-4.19) 135 -3.59 (-0.38) -4.85 (-1.82) 78 -22.10%* (-13.35) 243 -17.96%* (-12.45) 196 -12.83%* (-2.92) 301 7.99 (0.57) -14.27%* (-5.53) 424 -17.48%* (-12.43) 382 3.22 (0.64) Sample All firms CAR T-stat N CAR T-stat N CAR T-stat N Mean T-stat CAR T-stat N CAR T-stat N CAR T-stat N CAR T-stat N Mean T-stat CAR T-stat N CAR T-stat N Mean T-stat By market OTCBB PS Difference By reason Bankruptcy Governance Core Non-core Difference By decimalization Pre-decimals Post-decimals Difference 40 Table 10a Regression Results (only reason dummies included) This table presents regression results of the simultaneous estimation using two-stage least squares of percentage quoted spreads and log market capitalization around delisting from Nasdaq. All our variables, including the dependent variables, are averages over the three months before and after delisting. All trading and quoting data were obtained from The Nasdaq Stock Market and Pink Sheets LLC. Quoting data in the Pink Sheets market is limited to the end of the day quotes. Financial data are obtained from Compustat. Delist dummy is one if the average is over the three months after delisting. Decimal dummy is one if the average is over a period that includes April 9, 2001. The superscript, ‘*’ indicates statistical significance at the 5% level. Intercept Core dummy Governance dummy Bankruptcy dummy Delist dummy x Noncore dummy Delist dummy x Core dummy Delist dummy x Governance dummy Delist dummy x Bankruptcy dummy Decimal dummy Log dollar volume Price volatility Delist dummy x Log dollar volume Delist dummy x Price volatility Log Sales EBIT Leverage Delist dummy x Log sales Delist dummy x EBIT Delist dummy x Leverage Log market capitalization Percentage quoted spreads R-square N Percentage quoted Log market capitalization spreads Std. Std. Coefficient Coefficient Error Error 64.16* 8.28 9.08* 0.23 -1.34 1.31 0.13 0.12 -0.25 1.26 0.17 0.11 1.11 1.67 0.20 0.15 19.17* 2.22 -0.61* 0.20 20.66* 2.60 -0.71* 0.24 23.29* 2.32 -0.76* 0.21 26.17* -2.25* 1.48* 2.63* -6.58* -0.81* 2.92 0.84 0.61 0.37 0.44 0.38 -0.94* 0.10* 0.01 0.04 0.14* 0.09* 0.00 -0.01 -0.03 0.00 0.01 -0.07* 0.65 1,523 0.43 1,523 0.27 0.05 0.04 0.04 0.03 0.02 0.00 0.01 0.03 0.00 0.01 0.01 -7.35* 1.09 41 Table 10b Regression Results (only market dummies included) This table presents regression results of the simultaneous estimation using two-stage least squares of percentage quoted spreads and log market capitalization around delisting from Nasdaq. All our variables, including the dependent variables, are averages over the three months before and after delisting. All trading and quoting data were obtained from The Nasdaq Stock Market and Pink Sheets LLC. Quoting data in the Pink Sheets market is limited to the end of the day quotes. Financial data are obtained from Compustat. Delist dummy is one if the average is over the three months after delisting. Decimal dummy is one if the average is over a period that includes April 9, 2001. The superscript, ‘*’ indicates statistical significance at the 5% level. Intercept PS dummy Delist dummy x OTCBB dummy Delist dummy x PS dummy Decimal dummy Log dollar volume Price volatility Delist dummy x Log dollar volume Delist dummy x Price volatility Log Sales EBIT Leverage Delist dummy x Log sales Delist dummy x EBIT Delist dummy x Leverage Log market capitalization Percentage quoted spreads R-square N Percentage quoted Log market capitalization spreads Std. Std. Coefficient Coefficient Error Error 63.40* 8.18 9.18* 0.22 1.20 1.40 0.03 0.13 20.91* 2.07 -0.69* 0.19 28.61* 2.85 -0.81* 0.27 -1.58* 0.78 1.50* 0.60 0.11* 0.05 2.69* 0.37 0.01 0.04 -6.57* 0.43 0.03 0.04 -0.93* 0.37 0.15* 0.03 0.08* 0.02 0.00 0.00 -0.01 0.01 -0.04 0.03 0.00 0.00 0.01 0.01 -7.39* 1.08 -0.07* 0.01 0.66 1,523 0.43 1,523 42 Figure 1: Timeline of Delisting Process Panel A. Bid Price Limit or Market Value of Public Float Deficiency Notice Below limit on bid price Determination Letter Appeal Filing, Plan of Compliance Hearing Decision Further Appeals Not above limit for 10 consecutive trading dates 30 consecutive trading days 90 NNM (180 SC) calendar day grace period 45 calendar days 2-4 weeks Panel B. Market Value Deficiency Notice Below limit on market value Determination Letter Appeal Filing, Plan of Compliance Hearing Decision Further Appeals Not above limit for 10 consecutive trading dates 10 consecutive trading days 30 NNM (90 SC) calendar day grace period 45 calendar days 2-4 weeks 43 Figure 2 Daily Trading Activity of Nasdaq Delisted Securities Around Delisting These charts show changes in the daily cross-sectional averages of measures of trading activity of 1,098 Nasdaq delisted securities in the six months around their delisting. Securities that were delisted from the Nasdaq market (from the National Market or SmallCap Market) traded in the Bulletin Board or in the Pink Sheets or in both. Daily Share Volume and Number of Trades Around Delisting 1600000 1400000 250 Daily share volume 1200000 1000000 800000 600000 400000 50 200000 0 -63 -54 -45 -36 -27 -18 -9 0 9 18 27 36 45 54 63 0 100 150 Days around delisting Share Volume Ntrades Daily Dollar Volume and Price Around Delisting 1000 900 800 700 600 500 400 300 200 0.2 100 0 -63 -54 -45 -36 -27 -18 -9 0 9 18 27 36 45 54 63 0 0.6 0.4 1 0.8 1.4 1.2 Days around delisting Dollar Volume Closing Price Closing share price in $ Dollar Volume in $000 Number of trades 200 44 Figure 3 Daily Quoting Activity of Nasdaq Delisted Securities around Delisting These charts show changes in the daily cross-sectional averages of measures of quoting activity of 1,098 Nasdaq delisted securities in the six months around their delisting. Securities that were delisted from the Nasdaq market (from the National Market or SmallCap Market) traded in the Bulletin Board or in the Pink Sheets or in both. Change in the average number of quotes is presented only for 871 securities that traded in the OTC Bulletin Board. Change in the dollar and percentage quoted spread is based on the closing quote of the day. Average Daily Number of Quotes Around Delisting (For stocks that moved to Bulletin Board only) 25 20 Average daily number of quotes 15 10 5 0 -63 -54 -45 -36 -27 -18 -9 0 9 18 27 36 45 54 63 Days around delisting Average Dollar and Percentage Quoted Spreads At Close Around Delisting 0.25 45 0.2 Dollar quoted spread 35 30 0.15 25 20 15 0.1 0.05 10 5 0 -63 -54 -45 -36 -27 -18 -9 0 9 18 27 36 45 54 63 0 Days around delisting Quoted $ Spread Quoted % Spread Percentage quoted spread 40 45 Figure 4 Change in Daily Effective Spreads around Delisting This chart shows the change in the daily cross-sectional average effective spread of 871 Nasdaq delisted securities in the six months around their delisting. These securities were delisted from the Nasdaq market (from either the National Market or the SmallCap Market) and traded in the OTC Bulletin Board after delisting. Intra-day quoting data were not available for securities that were delisted from the Nasdaq market but traded in the Pink Sheets after delisting. Average Dollar and Percentage Effective Spreads Around Delisting (For stocks that moved to the Bulletin Board only) 0.1 0.09 0.08 20 18 0.07 0.06 0.05 0.04 0.03 0.02 0.01 0 -63 -54 -45 -36 -27 -18 -9 0 9 18 27 36 45 54 63 14 12 10 8 6 4 2 0 Days around delisting Effective $ Spread Effective % Spread Average Percentage Effective Spreads 16 Average Dollar Effective Spreads 46 Figure 5 Volatility around Delisting These charts show changes in the volatility measures of 1,098 Nasdaq delisted securities in the six months around their delisting. Securities that were delisted from the Nasdaq market (from the National Market or SmallCap Market) traded in the Bulletin Board or in the Pink Sheets or in both. Intra-day price volatility for day ‘t’ is the cross-sectional average of the standard deviation of intra-day transaction return in day ‘t’. Intra-day price range for day ‘t’ is the cross-sectional average of the intra-day price change of each security in day ‘t’. Price range is computed as the ratio of the difference between the highest price and the lowest price over the lowest price. Average Intra-Day Price Volatility and Range Around Delisting 20 18 90 80 70 60 50 10 40 8 6 4 2 0 -63 -54 -45 -36 -27 -18 -9 0 9 18 27 36 45 54 63 30 20 10 0 16 14 12 Days around delisting Intraday Volatility Intraday Price Range Average Intra-day Price Range in % Standard deviation of intra-day transaction return in % 47 Appendix A: Nasdaq Maintenance Standards The Appendix Table outlines the current Nasdaq maintenance standards. It is important to note that there have been a couple of changes to the listing requirements during our sample period. Effective June 29, 2001, the minimum net tangible assets for NNM-listed stocks was increased to $10 million from $4 million, and the minimum bid price was reduced from $5 to $3. At the same time, the minimum net tangible assets for SmallCap listed stocks were increased from $2 million to $2.5 million. Until November 1, 2002, companies could qualify under either the new or the old standards. Most importantly for our study, there was a temporary moratorium of the minimum bid price and market value of public float requirements in effect between September 27, 2001, and January 2, 2002. This moratorium was declared after many Nasdaq-listed firms had seen their stock prices decimated in the spring of 2001, and then were further depressed in the wake of the terrorist attacks on September 11, 2001. Nasdaq reinstated (a somewhat amended – see Appendix B) bid price rule on January 2, 2002. 48 Appendix Table 1 Nasdaq Maintenance Standards Until November 1, 2002, companies may qualify for continued listing under either the new or former standards (in parentheses). After that date, the new rules apply. For NNM stocks, either Marketplace Rule 4450(a) or Marketplace Rule 4450(b) has to be satisfied. Nasdaq National Market Standards Core Net Tangible Assets22 requirements Market Capitalization Total Assets Total Revenue Round Lot Shareholders Market Makers Non-core Public Float (shares)23 requirements Market Value of Public Float Minimum Bid Price Marketplace Rule 4450(a) $10 million ($4 million) Marketplace Rule 4450(b) N/A $50 million OR ($50 million AND $50 million) 400 4 1.1 million $15 million $3.00 ($5.00) N/A 400 2 750,000 $5 million $1.00 Nasdaq SmallCap Market Standard Shareholders’ Equity (Net Tangible Assets) Market Capitalization Net Income (most recently completed fiscal year or 2 of the last 3 years) Market Makers Round Lot Shareholders Non-core Public Float (shares) requirements Market Value of Public Float Minimum Bid Price Marketplace Rule 4310(c) $2.5 million ($2 million) OR $35 million OR $500,000 2 300 500,000 $1 million $1.00 Core requirements Corporate Governance Requirements (Marketplace Rules 4350 and 4351) Distribution of Annual and Interim Reports Independent Directors Audit Committees Shareholder Meetings Quorum Solicitation of Proxies Conflicts of Interest Shareholder Approval Stockholder Voting Rights Auditor Peer Review 22 Net Tangible Assets equals Total Assets minus Total Liabilities minus Goodwill minus Redeemable Securities. 23 Public Float is defined as total shares outstanding less any shares held by officers, directors or beneficial owners of 10% or more. 49