The impact of forced divestments on parent company stock prices: Buy on the rumor, sell on the news?

Abstract

We measure how warnings of expropriation and forced divestments of private property affect the stock prices of parent companies. We use a unique database of 116 events in 12 countries from 2005 to 2013. Our results show that different types of warnings have significant negative effects on stock prices, and the largest effect is from a warning that takes the form of a transitory permit revocation. In the case of forced divestments, we find a significant negative impact when a permit is permanently revoked. However, nationalizations are associated with a positive market reaction.

Introduction

We investigate the short-term impact of events related to government seizures of private property on the stock prices of the publicly listed parent company. Governments can seize assets through several methods, which Kobrin (1980) groups using the term “forced divestments.” Among these, the most popular are probably expropriations, defined by Truitt (1970) as the seizing by the sovereign of privately-owned tangible property with a view toward its continued operation. In that sense, an expropriation is a firm's involuntary divestment forced by a government. In spite of being a forceful action, expropriations are not illegal per se: a consensus seems to exist in tribunals that governmental conduct is decisive in determining state responsibility through an expropriatory action (Sloane et al., 2004).

Moreover, many countries have laws granting the government the right to expropriate private property to address public issues, such as developmental or environmental matters. Therefore, it is unlikely that the “practice of eminent domain” disappears. In fact, increased resource nationalism during the 2000s raised the number of expropriations occurring throughout the world,¹ which is consistent with the nationalization cycles described by Chang et al. (2018), and with opportunistic governments trying to take advantage of high commodity prices (Guriev et al., 2011; Stroebel and van Benthem, 2013). Although we focus on expropriation actions due to political motives, it is worth pointing out that governments appear to be acting differently in recent years² : government ownership has increased since 2003 (Borisova et al., 2015), being less driven by political motives and more strategic in pursuing economic objectives through financial and industrial investment arms (Holland, 2019). Besides, the increased economic uncertainty caused by the global financial crisis of 2008–2009 may have been a catalysis factor in this global revival of government ownership (Megginson, 2017).

Expropriations are not necessarily illegal. However, they may be considered catastrophic events for firms’ stakeholders, such that news on such events is likely to generate movements in the stock prices of both parent and subsidiary companies. The literature on the effect of forced divestment on firms’ values is relatively scarce. Most times, these actions can lead to losses for the firms’ stakeholders. For subsidiaries, they relate the loss to the lower efficiency and profitability observed in state-owned enterprises (SOEs) relative to private firms. Although the evidence is mixed, some authors found that privatized firms show higher productivity levels after the change in ownership (see Ghulam and Yaseen, 2017) and are better performers than SOEs (see Chen et al., 2006, Mathur and Banchuenvijit, 2007, Estrin et al., 2009, Brown et al., 2016). This is consistent with privatized firms bearing a lower cost of debt (Borisova and Megginson, 2011), a positive (negative) market reaction when the firm is privatized (nationalized) (Gao and Kling, 2008), and a larger Tobin's Q when the market perceives a firm's lower expropriation risk (Liao and Young, 2012). For parent firms, expropriation-related events are associated with a loss of assets and the stream of future cash flows. Shcherbakova (2010) found a negative effect of a few decrees of nationalization on the stock prices of oil firms in three developing countries.

This paper's contribution to the literature is twofold. First, we offer evidence on the market reaction to forced divestment around the world. To do this, we make a unique database of 116 events related to forced divestment that occurred between 2005 and 2013 in 12 countries and that affected firms operating in several economic sectors. Second, we find several types of events related to forced divestment and classify them into two main categories. Pre-expropriation warnings relate to references to expropriation or nationalization publicly made by the government and, thus, to the danger of an asset loss. Still, they do not imply the loss of property or control rights over the production unit. These references can be: (i) announcements of nationalization, (ii) announcements of expropriation, (iii) occupations, (iv) threats, and (v) transitory permit revocations. Thereupon, warnings may – or may not – be followed by forced divestment: the actions leading to the loss of rights over the business. For example, the firm's assets could be expropriated after an expropriation threat. This paper considers three types of government actions as forced divestment: (i) the outright expropriation, (ii) the forced sale, and (iii) the permanent rescission of permit or concession. Therefore, our analysis allows us to document whether the market considers pre-expropriation warnings as credible threats. If it does, stock market prices integrate this information before the forced divestment occurs.

To the extent that expropriation-related announcements are unexpected, one should observe an abnormal market reaction regarding targeted firms’ stock prices. Whether this movement anticipates, occurs during, or occurs after the event depends on the level of markets’ information efficiency, which we test by implementing an event study with the traditional methodology proposed by Brown and Warner, 1980, Brown and Warner, 1985 using several windows to assess the market's reaction. Our basic hypothesis is that expropriation-related events are bad news for the future performance of parent companies; therefore, their market value will decrease when these events are known. However, we document a situation in which nationalizations are correlated with positive reactions in the stock market, the reason being a rebound effect on parent firms’ valuations. We find significant negative effects associated with several types of warnings; a larger effect occurs when the warning takes the form of a transitory revocation of a permit. For forced divestments, we find a significant negative impact when a permit is permanently revocated. However, stock prices react positively to forced sales. Thus, empirical evidence supports our basic hypotheses. Although our results should be read with caution given the relatively small sample sizes for some individual event types, they remain significant after undergoing several robustness tests.

The remainder of this article is organized as follows. In Section 2, we define the type of events that we study and hypothesize about their effect on the parent firm's stock price. We describe the event study methodology in Section 3 and, in Section 4, set up the framework for the selection of events and data. Empirical results and robustness tests are presented in Section 5. Section 6 describes the possible variables that explain the cumulative abnormal returns. Section 7 concludes the paper.