Financial market implications of firm operations in countries designated as state sponsors of terrorism

Abstract

The first out of three papers assesses the short- and long term financial impact of firm announcements to withdraw from countries designated as State Sponsors of Terrorism. In an event-study framework, announcement period abnormal returns are analysed. Moreover, long-term return performance in the period subsequent to the withdrawals is investigated. Evidence indicates investors rewarded firms for withdrawing from the designated countries. During the period prior to announcement, sample firms experience a substantial, statistically significant stock price increase. The positive effect is more pronounced for US firms, for firms in the bank and financial trading industry and for firms in the oil and gas industry. In contrast, the long-term performance analysis does not reveal return differences attributable to terror-related considerations. During the long-term period after withdrawal, a portfolio of withdrawing firms does not display return differences to a portfolio of carefully chosen control firms. The second paper analyses the consequences of the U.S. Securities and Exchange Commission’s (SEC) publication of an online tool for detecting firms doing business in countries designated as State Sponsors of Terrorism. Similar to the first paper, short-term announcement period abnormal return reactions are analysed before long-term performance is measured. Evidence indicates investors punished firms for being mentioned in the tool. In the period subsequent to the tool’s publication, stock prices of mentioned firms decreased. Furthermore, faint evidence consistent with the notion that the portfolio of mentioned firms delivers abnormally positive long-term returns is obtained. The third paper is about ownership in such firms. As will become apparent, pension and endowment funds are substantially less likely to hold majority stakes in a firm if the firm has severe business ties in a country designated as a State Sponsor of Terrorism. For the reason that such investors shun firms with operations in the designated countries, stocks of these firms match the definition of neglected stocks in the sense of Merton’s (1987) model. In this way, positive short-term stock price reactions upon withdrawal and negative short-term stock price reactions upon stigmatisation can be reconciled by means of Merton’s (1987) theoretical groundwork. Upon withdrawal, firms overcome neglect and profit from increasing stock prices. By the same token, firms receiving the terror-label due to them being mentioned in the online tool are instantly neglected and suffer from a decrease in stock prices