How invisible hand adjusts stock prices if company is listed on multiple exchanges, under multiple currencies, and one of the currencies plunges?

Question

I'm an absolute beginner in economics and in the stock exchange and just encountered my first company that was listed in multiple stock exchanges and in multiple currencies. I'm aware of the invisible hand that keeps the prices of one company shares in all of these stock exchanges rationally equal, but I have no idea what is rational f.e. in case when the company is listed in two exchanges and in two currencies like EUR, and DOLLAR and then EUR would suddenly plunge 50%?

I came up with 3 scenarios:

• A: Company stock price in EUR suddenly rises 50% to make it equal with the dollar price that is not changed.
• B: Company stock price in dollars suddenly drops 50% to make it equal with the EUR prices that are not changed.
• C: The truth is probably somewhere in between dollar stock price gets down and EUR price gets up even though I have no idea what would be the ratios here.

I guess the main reason for writing this is that I don't quite understand the currency risk in the above example. If the company would have been listed only in one currency, the situation would be perfectly clear for me, but when it's in multiple currencies and invisible hand forces prices to be equal between various stock exchanges and currencies, then I don't understand what kind of risk I would be taking anymore.

Answer 1

It doesn’t

Dual-listed companies are more complex than you think. They are not a single company listed on two exchanges, they are two separate companies that have claims of the cash flow of the same business under the terms of their equalization agreement. So you can’t buy a share on one exchange and sell that same share on the other.

In theory, because they have equivalent claims on the same cash flow, they should have the same price. However, they are not subject to the same risks (such as currency risk, governance structures, legal contracts, liquidity, and taxation) or market forces (such as investor demand - BHP-Billiton is listed on the London Stock Exchange and the Australian Securities Exchange, the former has approximately three times the market cap of the latter). Different risk profiles will translate into different prices.

Notwithstanding, even allowing for this, dual listed companies can have unaccountable price disparities and these can persist for a very long time - we’re talking months and years here. This would seem to present a golden arbitrage opportunity. However, because the shares are not fungible the arbitrage position must be maintained until the prices converge, they can’t be forced by the arbitrager. This is risky given that this can take months or years and the shares could continue to diverge in value in the meantime.

Answer 2

If the shares are fungible between the exchanges, you are correct that the prices will be kept nearly equivalent by arbitrage. The missing piece to understand how the price reacts to currency fluctuations is the fundamentals of the company. This applies regardless of whether the shares are traded in a single currency or multiple currencies. It's a matter of what currencies the company's revenues and costs are denominated in, whether the company uses (or competes with) imported products, how the currency move will affect economic conditions, etc.

Once an estimate of the fundamental effect on company value is made in one currency, the effect on value in any other currency follows from a risk-free arbitrage condition. But that underlying fundamental effect can't be determined by arbitrage alone, only by the judgment of investors.

A limiting case in which we can pin things down is a company doing business in major currencies in major economies, whose shares also happen to be traded in a minor currency that has no strong relevance to its business (picture US stocks being traded in grubnick on the Elbonian exchange). If the minor currency surges or crashes but this doesn't significantly affect major economies, then the local share price will move inversely because its value in the major currencies should stay the same. This is a trivial case of the fundamental analysis.

Answer 3

The key question is what the currency change does to the fundamental value of the company.

If the company is an American widget company AmCo with a primarily American customer base and a primarily American supply chain, then it should be broadly insulated against the price of Euros. (At least, until you consider irritating things like competitors. There's always room for more variables.) This should broadly hold steady with the dollar price, and the Euro price be doubled to catch up.

Meanwhile if the company is an international widget company with an American supply chain but a primarily European customer base, it's going to have a hard time. It'll be taking payment in Euros, converting them to half as many dollars, and scratching its head about how to stretch across the gap. That's the sort of shock which is hard for any company to recover from, and the stock price may fall by far more than 50% as investors realise the company may have to fold completely.

Answer 4

"How" the hand does anything is easily answered by considering what the hand "really is".
"The invisible hand" is a metaphor for the concept that

• Where there is a way that can be found to make money by undercutting what someone else is doing then someone (or entity) will do it.

• or - When an opportunity exists to make a profit by reducing ones costs compared to another's then 'No stone will be left unturned'.

In the case of share trading much of the next paragraph is not directly relevant, but the principles form the fundamentals of the "engine" that drives the hand. Note that the various mentions of illegality or impropriety do not imply the hand is itself immoral - it doesn't know or care about ANYTHING that is not assigned a cost or return to it.

Reducing costs or maximising profit competitively may involve lowering prices (more volume, competitors lose volume, ...), and/or lowering cost of implementation (materials or labour)(greater profit per volume).
It can also involve increasing prices if this can achieve an increase in overall return for effort - this may involve illegal or non-regulatory-compliant actions to ensure the prices are accepted (bribes, lobbying, protection, ...).
Lowering cost may involve greater skill, special knowledge , or illegal actions or outright theft. The hand is amoral (nb: not immoral) and without conscience or regard for any factor which is not assigned a real value when it acts.

In the specific case you cite this translates to "any way that works". Dale_M explains that it cannot be done 'in some cases', and others explain why this is incorrect 'in some cases'. The hand 'examines the cases' and implements the doable ones. It also tries to implement various apparent but undoable ones. This may destroy the would be implementer - the hand and the end result are agnostic to failures. Some individuals may be put off by the difficulties and consequences experienced by some or many or most. The hand "does not care" - if some succeed then that's what the hand does. If all fail in a given case the result is simply the best that can be achieved by some mix of the most adventuresome, ingenious, unscrupulous, lucky or persistent.