Dual-listed Companies - Mispricing in DLCs

Mispricing in DLCs

The shares of the DLC parents represent claims on exactly the same underlying cash flows. In integrated and efficient financial markets, stock prices of the DLC parents should therefore move in lockstep. In practice, however, large differences from theoretical price parity can arise. For example, in the early 1980s Royal Dutch NV was trading at a discount of approximately 30% relative to Shell Transport and Trading PLC. In the academic finance literature, Rosenthal and Young (1990) and Froot and Dabora (1999) show that significant mispricing in three DLCs (Royal Dutch Shell, Unilever, and Smithkline Beecham) has existed over a long period of time. Both studies conclude that fundamental factors (such as currency risk, governance structures, legal contracts, liquidity, and taxation) are not sufficient to explain the magnitude of the price deviations. Froot and Dabora (1999) show that the relative prices of the twin stocks are correlated with the stock indices of the markets on which each of the twins has its main listing. For example, if the FTSE 100 rises relative to the AEX index (the Dutch stock market index) the stock price of Reed International PLC generally tends to rise relative to the stock price of Elsevier NV. De Jong, Rosenthal, and van Dijk (2008) report similar effects for nine other DLCs. A potential explanation is that local market sentiment affects the relative prices of the shares of the DLC parent companies.

Because of the absence of "fundamental reasons" for the mispricing, DLCs have become known as a textbook example of arbitrage opportunities, see for example Brealey, Myers, and Allen (2006, chapter 13).