We lose if merger goes ahead

By Peter Swan  Wednesday, 2 November 2011  Opinion Pieces

The Singapore stock exchange is of lesser quality than the ASX, writes Peter Swan.

The reason why the $8.4 billion bid by the Singapore Exchange for ASX Ltd was not announced as a hostile takeover is that ASX Ltd is in a weak, if not desperate position. It will face competition in the near future and, as the likelihood of competition increased, ASX Ltd shopped itself around in merger talks but with no success. The much higher price to earnings multiple of SGX shares at 27 times compared with ASX Ltd's 17 reflects the lack of prospective competition. Thus, it is far from a merger of equals. ASX Ltd, which will get only four of the 15 board seats, has abrogated nearly all power to the SGX, whose directors are people with strong connections to the Singapore government.

There are a large number of regulatory hurdles to overcome before the deal can go though. These include the Foreign Investment Review Board and a 15 per cent shareholder cap limit on the equity position of anyone investor that requires Australian government approval for the takeover. Currently, this would require approval by the
Coalition in the Senate, as the Greens is taking an opposing stance. Hence, the decision is very much in the hands of Australian politicians as the markets are less and less convinced that the bid will meet the huge regulatory hurdles.

Although it represents a considerable premium over the ASX Ltd price that ruled prior to the bid, the issue is not really the future of the Australian stock exchange but rather the success or otherwise of Australia's capital markets and our role as a regional or global player. A few years ago, co-researcher Joakim Westerholm and I investigated the design of every stockmarket in the world from a user's efficiency perspective. On transaction costs, we found that Singapore was listed with the alsorans, at 23rd in the world while Australia's costs were ranked sixth. On other measures such as volatility, the ASX was ranked 10th while Singapore was 21st.

Since this study, the ASX has had a sorry history of less transparency (in 2005 it removed the display of broker IDs on trades), so its relative position will have worsened. But we would not expect to find an increase in the ranking of Singapore.

Apart from more efficient trading, well-managed exchanges play an important role in corporate governance through their listing requirements. While many exchanges requirements are simply ineffectual motherhood statements, some of their rules are harmful and counter -intuitive, destroying huge amounts of wealth in the process.

For example, it is well known that executive or outside directors are likely to perform better if they have skin in the game, that is, have their interests aligned with those of shareholders via share ownership.

I tested this with UNSW student Serkan Honeine. Our sample consists of the top 200 companies in Australia by market capitalisation at June 30, 2009. For each company we collect data from annual reports 2005 to 2009 on board composition, executive status, remuneration and share ownership of directors. We find sizeable effects of non-executive director ownership (NEDO) on performance. This amounts to a substantial increase of 28.2 per cent of performance over the mean. We tested the same relationship over the global financial crisis period, January 2009 to June 2009, in which the S&PI ASX 200 Index fell 39 per cent. Stocks with high NEDO fell far less than other stocks, consistent with a strong relationship between NED ownership and performance.

What is strange is that the ASX finds share ownership in excess of 5 per cent is a strong barrier to NED independence. Other exchanges such as NYSE and Nasdaq do not seem to have rules that act in such a draconian manner. Probably for this reason, few NEDS on the ASX are granted shares as part of their board pay and ownership levels seem to be much lower than for other jurisdictions. Similarly, the ASX requires that independent directors make up a majority of board membership. Most studies find that company performance is not affected by board composition.

The way the ASX has run the Australian market leaves a lot to be desired. But the Singapore stock exchange's design features have placed it as one of the world's worst performers from the perspective of traders and users. If the merger is approved, we look like getting the worst of all possible worlds. Lack of competition in the Australian market has led to deteriorating performance. If the regulators refuse approval then the ASX will be forced to get its own house in order in a competitive regime. This can only benefit Australian investors, and the global competitiveness of the Australian financial services sector.

A version of this opinion piece appeared in the Australian Financial Review 2nd November 2010.