CFA Institute Journal Review summarizes "Government Investment in Publicly Traded Firms," by Kateryna Holland, published in Journal of Corporate Finance, Vol. 56 (June 2019).
Although shareholder wealth increases in general when governments announce investment in publicly traded firms, stock prices react differently when the investment is made by different arms of government. Market participants react negatively when trades are made by political arms but positively when trades are initiated by industrial or financial arms.
What Is the Investment Issue?
Governments have invested a vast amount in private firms over the past few decades. Between the late 1980s and 2013, governments around the world invested USD2.9 trillion to acquire ownership stakes in privately held firms. The effects of government investment on stockholder wealth should not be overlooked.
Government investments are motivated by both economic objectives (e.g., investor wealth maximization) and noneconomic objectives (e.g., employment maximization, domestic investment, public officials’ personal financial objectives).
The author conjectures that different government entities may be motivated by different objectives. In particular, political groups (e.g., governments, the central bank, regulatory boards) may be more likely to promote political objectives, while industrial groups (e.g., state-owned enterprises that are subject to industry competition) and financial groups (e.g., government commercial and development banks, sovereign wealth funds) may focus more substantially on economic objectives.
The author investigates whether market participants react differently when investments are announced by different arms of government. Whether the target firms perform differently in the long term is also of interest to investors.
How Did the Author Conduct This Research?
The author empirically examines all announcements of government purchases from the Thomson Reuters Securities Data Company Platinum Mergers and Acquisitions database over the 1987–2013 period. The sample is restricted to publicly traded targets. Stock returns and accounting data are from Datastream and Worldscope, respectively. The final sample encompasses 2,118 transactions involving 1,670 unique target firms in 71 countries.
Government investors are categorized into three broad groups: political, industrial, and financial. All three groups exhibit a tendency to invest in similar targets; no significant variations were noted with respect to leverage, return on assets, size, liquidity, or market value. However, one notable difference is that political entities are prone to invest in firms with higher employment.
The author undertakes an event study to calculate target firms’ cumulative abnormal returns around the time government acquisitions are announced. An examination is also made of the target firms’ stock reaction for the (–2, +2) and (–5, +5) event windows around the announcements.
To further examine the effect an announcement of government investment has on a target firm’s stock price, the author uses regression analysis and includes target industry, year, and both target and acquirer nation fixed effects. In particular, the interaction effects of institutional environment strength, credit access, valuation, and government investment are investigated, and the author hypothesizes that left-wing governments, civil law systems, and weak legal environments may facilitate political intervention. As a result, shareholders’ wealth should be further negatively affected.
In addition, government investment is believed to provide preferential access to financing from government owners, which can be a benefit to the target firms. However, when the target firm already has easy access to external credit, this benefit may seem trivial. The author investigates whether these firms suffer larger wealth loss because not only must they bear the cost of political intervention but they also receive negligible benefit from preferential financing.
Finally, the author compares the target firms’ performance after three years of investments to determine whether the short-term announcement effects and longer-term performance in profitability and efficiency are related.
What Are the Findings and Implications for Investors and Investment Professionals?
The results of the event study show that target stock prices exhibit a significant positive reaction with a mean (median) of 4.38% (1.22%) for the (–2, +2) window. However, this reaction is significantly negative for government investors from the political group, at –1.81% (–0.62%), while significantly positive for those from the financial group and industrial group, at 3.05% (–0.97%) and 7.83% (2.22%), respectively. In regression analysis, after controlling for other factors, the political group still underperforms by 3.4% (2.9%) when compared with industrial (financial) arms of government. The effect is even more pronounced in regulated industries, showing that political groups exert intervention more explicitly in these industries.
Moreover, as the author predicts, shareholders in weaker institutional climates tend to react more negatively to announcements of investment from members of the political group. Left-wing governments, civil law jurisdictions, and environments with weak accounting standards facilitate political intervention, which leads to a stronger negative reaction.
Similarly, firms with better capital access and in countries with better financial development also react more negatively to investment from political arms, probably because the benefit of preferential access to government financing is limited.
After three years of announcements, firms targeted for investment by political investors demonstrate significantly lower profitability and growth; their ROE declines from an average of 12% to 4% after government investment. By comparison, the profitability and growth rates of firms in which industrial arms invest are 5% and 15% lower, respectively.
To conclude, market participants are efficient at differentiating among the investment motives of different government entities.