Art Durnev

Precarious Politics and Return Volatility

We examine how local and global political risks affect industry return volatility. Our central premise is that some industries are more sensitive to political events than others. We find that industries that are more dependent on trade, contract enforcement, and labor exhibit greater return volatility when local political risks are higher. Political uncertainty in countries of trading partners of trade-dependent industries similarly results in greater volatility. Volatility decomposition results indicate that while systematic volatility is associated with domestic political uncertainty, global political risks translate into larger idiosyncratic volatility. The Author 2011. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: journals.permissions@oup.com., Oxford University Press.

The Real Effects of Political Uncertainty: Elections and Investment Sensitivity to Stock Prices

We show that political uncertainty surrounding elections can affect how corporate investment responds to stock prices. In a large panel of elections around the world, investment is 40% less sensitive to stock prices during election years compared to non-election years. The decrease in investment-to-price sensitivity appears to be due to stock prices becoming less informative during election years making them noisier signals for managers to follow. Further, the drop in investment-to-price sensitivity is larger when election results are less certain, in countries with higher corruption, large state ownership, and weak standards of disclosure by politicians. Finally, we show that election uncertainty leads to inefficient capital allocation, reducing company performance.

Expropriation Risk and Firm Growth: A Corporate Transparency Channel

We propose a new channel through which expropriation risk reduces capital allocation efficiency and decreases firm growth. We build an agency model of corporate disclosure when companies face risks of expropriation. The model predicts that in countries with insecure property rights, corporations mitigate the risk of expropriation by reducing transparency. We test this channel by employing a difference-in-difference approach. Using a panel of over 16,000 firms from 84 countries, we find that transparency of companies prone to expropriation is lower in countries with insecure property rights. The reduced transparency has an adverse effect on the efficiency of capital allocation and corporate growth.

Politics, instability, and composition of international investment flows

We analyze the role of political instability for the composition of foreign investment, whether it takes the form of a majority- or minority-owned investment. We focus on the instability generated by the change of the party in power rather than on the risk of change of political regime or expropriation risk associated with this change. In majority-owned establishments, a foreign investor retains the control and enjoys fewer agency problems, while for minority-owned investments or joint ventures domestic partners of a foreign investor can lobby the government for preferential arrangements, such as firm-specific tax breaks. Political instability decreases the payoff of political connections in the future and decreases the attractiveness of minority-owned investments. The implications of our model are supported by empirical tests.

Privatization and Natural Advantage

We investigate the role of natural advantage (substantial oil reserves or mineral deposits) in the shaping of privatization policies. We find that governments tend to retain high ownership in natural advantage based firms. In addition, our results suggest the existence of too-big-to-relinquish firms in the natural advantage based industries. Finally, we show that access to the sea plays an important role in the drafting of privatization policies in those industries.

The Spillover Effects of MD&A Disclosures for Real Investment: The Role of Product Market Competition

We explore the association between a company’s investments and the tone of its peers’ MDA we ask whether the direction and the strength of this association is affected by product market competition. We find that the direction of the association can differ according to whether investing companies and disclosing peers in a product market have positive or negative interdependencies. Moreover, we document that the strength of the association between a company’s investments and the tone of its peers’ MD&A disclosures varies with product market fundamentals: the association is stronger when entry costs are lower, the product market is larger and products are less substitutable. Finally, we show that our results regarding investments generally carry over to investment efficiency.

Foreign Risk - Domestic Problem: Trade, Capital Allocation, and PerformanceUnder Political Uncertainty

We argue that international trade is a significant conduit of foreign political uncertainty into U.S. markets. We find that industries that export considerable shares of their output to countries with high political risk or countries that hold national elections in a given year experience lower total factor productivity growth, lower valuation, and worse accounting performance. The key channel of political uncertainty transmission is disruption of investment efficiency. Our results are not driven by economic risk or the quality of institutional environment of trading-partner countries, and they remain robust when we account for potential endogeneity of export flows.

Foreign Risk - Domestic Problem: Trade, Politics, and Capital Allocation

We argue that international trade is a significant conduit of foreign political uncertainty into U.S. markets. We find that industries that export considerable shares of their output to countries with high political risk or countries that hold national elections in a given year experience suboptimal investment efficiency, slower total factor productivity growth, lower valuation, and worse accounting performance. Our results are not driven by economic risk or the quality of institutional environment of trading-partner countries, and they remain robust when we account for potential endogeneity of export flows.

Events and Price Adjustment Accuracy: Evidence from Post-IPO Market

We use the post-IPO market to examine this accuracy of price adjustment to new information. The unique setting of immediate aftermarket allows us to assess subject after the trading has just begun and investors possess little information about stock return properties. They are, therefore, likely to misinterpret firm-specific information in the immediate aftermarket. As time since the IPO elapses, investors accumulate more information, and price reaction to new events becomes more accurate. We show that the accuracy of price adjustment increases by 14% in the first year of trading for all events, and by as much as 26% for public events. We conclude that the incorporation of new information into stock prices becomes more accurate as stocks season.