Tag: stock market

Navigating Market Exits: Companies’ Responses to the Russian Invasion of Ukraine

Posted on May 20, 2024 | Policy Brief

20240519 Navigating Market Exits Image 02

Russia’s invasion of Ukraine on 24 February 2022 led to widespread international condemnation. As governments imposed sanctions on Russian businesses and individuals tied to the war, international companies doing business in Russia came under increasing pressure to withdraw from Russia voluntarily. In the first part of this policy brief, we show what kind of companies decided to leave the Russian market using data collected by the LeaveRussia project. In the second part, we focus on prominent Swedish businesses which announced a withdrawal from Russia, but whose products were later found available in the country by investigative journalists from Dagens Nyheter (DN). We collect the stock prices for these companies when available and show how investors respond to these news.

Business Withdrawal from Russia

The global economy is highly interconnected, and Russia forms an important part. Prior to the invasion, Russia ranked 13th in the world in terms of global goods exports value and 22^nd in terms of imports (Schwarzenberg, 2023). In the months following the full-scale invasion of Ukraine, Russia’s imports dropped sharply (about 50 percent according to Sonnenfeld et al., 2022). Before February 24^th, Russia’s main trading partners were China, the European Union (in particular, Germany and the Netherlands) and Belarus (as illustrated in Figure 1). While there is some evidence of Russia shifting away from Western countries and towards China following the annexation of Crimea in 2014 and the resulting sanctions, Western democracies still made up about 60 percent of Russia’s trade in 2020 (Schwarzenberg, 2023). In the same year, Sweden’s exports to Russia accounted for 1.4 percent of Sweden’s total goods exports, of which 59 percent were in the machinery, transportation and telecommunications sectors. 1.3 percent of Swedish imports were from Russia (Stockholms Handelskammare, 2022).

Figure 1. Changes in trade with Russia, 2013-2020.

Source: IMF Direction of Trade Statistics, data until 2020. From Lehne (2022).

In response to Russia’s invasion of Ukraine in February 2024, Western governments imposed strict trade and financial sanctions on Russian businesses and individuals involved in the war (see S&P Global, 2024). These sanctions are designed to hamper Russia’s war effort by reducing its ability to fight and finance the war. The sanctions make it illegal for, e.g., European companies to sell certain products to Russia as well as to import select Russian goods (Council of the European Union, 2024). Even though sanctions do not cover all trade with Russia, many foreign businesses have been pressured to pull out of Russia in an act of solidarity. The decision by these businesses to leave is voluntary and could reflect their concerns over possible consumer backlash. It is not uncommon for consumers to put pressure on businesses in times of geopolitical conflict. For instance, Pandya and Venkatesan (2016) find that U.S. consumers were less likely to buy French-sounding products when the relationship between both countries deteriorated.

The LeaveRussia Project

The LeaveRussia project, from the Kyiv School of Economics Institute (KSE Institute), systematically tracks foreign companies’ responses to the Russian invasion. The database covers a selection of companies that have either made statements regarding their operations in Russia, and/or are a large global player (“major companies and world-famous brands”), and/or have been mentioned in relation to leaving/waiting/withdrawing from Russia in major media outlets such as Reuters, Bloomberg, Financial times etc. (LeaveRussia, 2024). As of April 5^th, 2024, the list contains 3342 firms, the companies’ decision to leave, exit or remain in the Russian market, the date of their announced action, and company details such as revenue, industry etc. The following chart uses publicly available data from the LeaveRussia project to illustrate patterns in business withdrawals from Russia following the invasion of Ukraine.

Figure 2a shows the number of foreign companies in Russia in the LeaveRussia dataset by their country of headquarters. Figure 2b shows the share of these companies that have announced a withdrawal from Russia by April 2024, by their country of headquarters.

Figure 2a. Total number of companies by country.

Figure 2b. Share of withdrawals, by country.

Source: Authors’ compilation based on data from the LeaveRussia project and global administrative zone boundaries from Runfola et al. (2020).

Some countries (e.g. Canada, the US and the UK) that had a large presence in Russia prior to the war have also seen a large number of withdrawals following the invasion. Other European countries, however, have seen only a modest share of withdrawals (for instance, Italy, Austria, the Netherlands and Slovakia). Companies headquartered in countries that have not imposed any sanctions on Russia following the invasion, such as Belarus, China, India, Iran etc., show no signs of withdrawing from the Russian market. In fact, the share of companies considered by the KSE to be “digging in” (i.e., companies that either declared they’d remain in Russia or who did not announce a withdrawal or downscaling as of 31st of March 2024) is 75 percent for more than 25 countries, including not only the aforementioned, but also countries such as Argentina, Moldova, Serbia and Turkey.

Withdrawal Determinants

The decision for companies to exit the market may range from consumer pressure to act in solidarity with Ukraine, to companies’ perceived risk from operating on the Russian market (Kiesel and Kolaric, 2023). Out of the 3342 companies in the LeaveRussia project’s database, about 42 percent have, as of April 5^th, 2024, exited or stated an intention to exit the Russian market. This number increases only slightly to 49 percent when considering only companies headquartered in democratic (an Economist Intelligence Unit Democracy Index score of 7 or higher) countries within the EU. Figure 3 shows the number of companies that announced their exit from the Russian market, by month. A clear majority of companies announce their withdrawal in the first 6 months following the invasion.

Figure 3. Number of foreign companies announcing an exit from the Russian market, 2022-2024.

Source: Authors’ compilation based on data from the LeaveRussia project.

Similarly to the location of companies’ headquarters, the decision to exit the Russian market varies by industry. Figure 4 a depicts the top 15 industries with the highest share of announced withdrawals from the Russian market among industries with at least 10 companies. Most companies with high levels of withdrawals are found in consumer-sensitive industries such as the entertainment sector, tourism and hospitality, advertising etc.

Figure 4a. Top 15 industries in terms of withdrawal shares.

Figure 4b. Bottom 15 industries in terms of withdrawal shares.

Source: Authors’ compilation based on data from the LeaveRussia project.

In contrast, Figure 4b details the industries with the lowest share of companies opting to withdraw from the Russian market. Only around 10 percent of firms in the “Defense” and “Marine Transportation” industries chose to withdraw. Two-thirds of firms within the “Energy, oil and gas” and “Metals and Mining” sectors have chosen to remain in business in Russia following the war in Ukraine.

Several sectors have been identified as crucial in supplying the Russian military with necessary components to sustain their military aggression against Ukraine, mainly electronics, communications, automotives and related categories. We find that many of these sectors are among those with the lowest share of companies withdrawing from Russia. Companies for which Russia constitute a large market share have more to lose from exiting than others. Another reason for not exiting the market relates to the current legal hurdles of corporate withdrawal from Russia (Doherty, 2023). Others may simply not have made public announcements or operate within an industry dominated by smaller companies that are not on the radar of the LeaveRussia project. Nonetheless, Bilousova et al. (2024) detail that products from companies within the sanction’s coalition continue to be found in Russian military equipment destroyed in Ukraine. This is due to insufficient due diligence by companies as well as loopholes in the sanctions regime such as re-exporting via neighboring countries, tampering with declaration forms or challenges in jurisdictional enforcement due to lengthy supply chains, among others. (Olofsgård and Smitt Meyer, 2023).

And Those Who Didn’t Leave After All

The data from the LeaveRussia project details if and when foreign businesses announce that they will leave Russia. However, products from companies that have announced a departure from the Russian market continue to be found in the country, including in military components (Bilousova, 2024). In autumn 2023, investigative journalists from the Swedish newspaper Dagens Nyheter exposed 14 Swedish companies whose goods were found entering Russia, in most cases contrary to the companies’ public claims (Dagens Nyheter, 2023; Tidningen Näringslivet, 2023). For this series of articles, the journalists used data from Russian customs and verified it with information from numerous Swedish companies, covering the time period up until December 2022. This entailed reviewing thousands of export records from Swedish companies either directly to Russia or via neighboring countries such as Armenia, Kazakhstan, and Uzbekistan. All transactions mentioned in the article series have been confirmed with the respective companies, who were also contacted by DN prior to publication (Dagens Nyheter, 2023b). DNs journalists also acted as businessmen, interacting with intermediaries in Kazakhstan and Uzbekistan, exposing re-routing of Swedish goods from a company stated to have cut all exports to Russia in the wake of the invasion (Dagens Nyheter, 2023d).

For Sweden headquartered companies exposed in DN and that are traded on the Swedish Stock Exchange, we collect their stock prices and trading volume. Our data includes information on each stock’s average price, turnover, number of trades by date from around the date of the DN publications as well as the date of each company’s prior public announcement of exiting Russia. Table 1 details the companies who were exposed of doing direct or indirect business with Russia by DN and who had announced an exit from the Russian market previously. In their article series, DN also shows that goods from the following companies entered Russia; AriVislanda, Assa Abloy, Atlas Copco, Getinge, Scania, Securitas Tetra Pak, and Väderstad. Most of the companies exposed by DN operate within industries displaying low withdrawal shares.

Table 1. Select Swedish companies’, time of exit announcement and exposure in Dagens Nyheter and stock names.

Source: The LeaveRussia project, 2023; Dagens Nyheter, 2023b, 2023c, 2023d. Note: The exit statements have been verified through companies’ press statements and/or reports when available. For Epiroc, the claim has been verified via a previous Dagens Nyheter article (Dagens Nyheter, 2023a).

In Figure 5, we show the average stock price and trades-weighted average stock price of the Swedish companies in Table 1 around the time when the companies announced that they are leaving Russia.

Figure 5. Average stock price of companies in Table 1 around Russian exit announcements.

Source: Author’s compilation based on data from Nasdaq Nordic.

There appears to be an immediate increase in stock prices after firms announced their exit from the Russian market. Stock prices, however, reverse their gains over the next couple of days. In general, stock prices are volatile, and we also see similar-sized movements immediately before the announcement. Due to this volatility and the fact that we cannot rule out other shocks impacting these stock prices at the same time, it is difficult to attribute any movements in the stock prices to the firms’ decisions to leave Russia.

The academic evidence on investors’ reactions to firms divesting from Russia is mixed. Using a sample of less than 300 high-profile firms with operations in Russia compiled by researchers at the Yale Chief Executive Leadership Institute, Glambosky and Peterburgsky (2022) find that firms that divest within 10 days after the invasion experience negative returns, but then recover within a two-week period. Companies announcing divesting at a later stage do not experience initial stock price declines. In contrast, Kiesel and Kolaric (2023) use data from the LeaveRussia project to find positive stock price returns to firms’ announcements of leaving Russia, while there appears to be no significant investor reaction to firms’ decisions to stay in Russia.

When considering the effect from DN’s publications, the picture is almost mirrored, with the simple and trades-weighted average stock prices dipping in the days following the negative media exposure before not only recovering, but actually increasing. Similar caveats apply to the interpretation of this chart. In addition, the DN publication occurred shortly after the Hamas attacks on Israel on October 7 and Israel’s subsequent war on Gaza. While conflict and uncertainty typically dampen the stock market, the events in the Middle East initially caused little reaction on the stock market (Sharma, 2023).

Figure 6. Average stock price for companies listed in Table 1 around the time of DN exposure.

Source: Author’s compilation based on data from Nasdaq Nordic.

Discussion

As discussed in Becker et al. (2024), creating incentives and ensuring companies follow suit with the current sanctions’ regime should be a priority if we want to end Russia’s war on Ukraine and undermine its wider geopolitical ambitions. Nevertheless, Bilousova et al. (2024), and Olofsgård and Smitt Meyer (2023), highlight that there is ample evidence of sanctions evasions, including for products that are directly contributing to Russia’s military capacity. Even in countries that have a strong political commitment to the sanctions’ regime, enforcement is weak. For instance, in Sweden, it is not illegal to try and evade sanctions according to the Swedish Chamber of Commerce (2024). There is little coordination between the numerous law enforcement agencies that are responsible for sanction enforcement and there have been very few investigations into sanctions violations.

Absent effective sanctions enforcement and for the many industries not covered by sanctions, can we rely on businesses to put profits second and voluntarily withdraw from Russia? Immediately after the start of Russia’s invasion of Ukraine, as news stories about the brutality of the war proliferated, many international companies did announce that they will be leaving Russia. However, a more systematic look at data collected by the LeaveRussia project and KSE Institute reveals that more than two years into the war, less than half of companies based in Western democracies intend to distance themselves from the Russian market. A closer look at companies who are continuing operations in Russia reveals that they tend to be in sectors that are crucial for the Russian economy and war effort, such as energy, mining, electronics and industrial equipment. Many of these companies are probably seeing the war as a business opportunity and are reluctant to put human lives before their bottom line (Sonnenfeld and Tian, 2022).

Whether companies who announce that they are leaving Russia actually do leave is difficult to independently verify. A series of articles published in a prominent Swedish newspaper (Dagens Nyheter) last autumn revealed that goods from 14 major Swedish firms continue to be available in Russia, despite most of these firms publicly announcing their withdrawal from the country. The companies’ reactions to the exposé were mixed. A few companies, such as Scania and SSAB, have decided to cut all exports to the intermediaries exposed by the undercover journalists (for instance, in Kazakhstan, Uzbekistan and Kyrgyzstan). Other companies stated that they are currently investigating DN’s claims or that the exports exposed in the DN articles were final or delayed orders that were accepted before the company decided to withdraw from Russia. Another company, Trelleborg – a leading company within polymer solutions for a variety of industry purposes – reacted to the DN exposure by backtracking from its earlier commitment to exit the Russian market (Dagens Nyheter 2023b, 2023d). Wider reaction to these revelations was muted. Looking at changes in stock prices for the exposed companies, we find little evidence that investors are punishing companies for not honoring their public commitment to withdraw from Russia.

In an environment, where businesses themselves withdraw at low rates and investors do not shy away from companies contradicting their own claims, the need for stronger enforcement of sanctions seems more pressing than ever.

References

Becker, T., Fredheim, K., Gars, J., Hilgenstock, B., Katinas, P., Le Coq, C., Mylovanov, T., Olofsgård, A., Perrotta Berlin, M., Pavytska, Y., Ribakova, E., Shapoval, N., Spiro, D. and Wachtmeister, H. (2024). Sanctions on Russia: Getting the Facts Right. FREE Policy Brief. https://freepolicybriefs.org/2024/03/14/sanctions-russia-war-ukraine/
Bilousova, O., Hilgenstock, B., Ribakova, E., Shapoval, N., Vlasyuk, A. and Vlasiuk, V. (2024). CHALLENGES OF EXPORT CONTROLS ENFORCEMENT HOW RUSSIA CONTINUES TO IMPORT COMPONENTS FOR ITS MILITARY PRODUCTION. Yermak-McFaul International Working Group on Russian Sanctions & KSE Institute. https://kse.ua/wp-content/uploads/2024/01/Challenges-of-Export-Controls-Enforcement.pdf
Council of the European Union. (2023). Sanctions against Russia explained. European Council. https://www.consilium.europa.eu/en/policies/sanctions-against-russia/sanctions-against-russia-explained/#services
Dagens Nyheter. (2023a). DN avslöjar: Wallenbergs gruvjätte gjorde affärer med ryskgrundat bolag – efter krigsutbrottet.
Dagens Nyheter. (2023b). DN avslöjar: Svenska storbolagen i affärer med Rvssland – trots löftena.
Dagens Nyheter. (2023c). Svenska miljardbolaget svek löftet – sålde till ryska hamnprojekt.
Dagens Nyheter (2023d). Mellanhanden avslöjar: Så levereras stålet från SSAB till Ryssland.
Doherty, B. (2023). Business in Russia: Why some firms haven’t left. BBC. https://www.bbc.com/worklife/article/20230918-business-in-russia-why-some-firms-havent-left
Glambosky, M. and Peterburgsky, S. (2022). Corporate activism during the 2022 Russian invasion of Ukraine, Economics Letters, 217, 110650. https://doi.org/10.1016/j.econlet.2022.110650
Kiesel, F. and Kolaric, S. (2023) Should I stay or should I go? Stock market reactions to companies’ decisions in the wake of the Russia-Ukraine conflict. Journal of International Financial Markets, Institutions and Money, Forthcoming. http://dx.doi.org/10.2139/ssrn.4088159
LeaveRussia Project. (2024). https://leave-russia.org/our-methodology
Lehne, J. (2022). https://www.youtube.com/watch?v=I1EFcZdj2Gw
Olofsgård, A. and Smitt Meyer, C. (2024) How to Undermine Russia’s War Capacity: Insights from Development Day 2023. FREE Policy Brief. https://freepolicybriefs.org/2024/01/15/undermine-russias-war-capacity/
Pandya, S. S., and Venkatesan, R. (2016) French roast: consumer response to international conflict—evidence from supermarket scanner data. Review of Economics and Statistics, 98(1), 42-56.
Runfola, D., Rogers, L., Habib, J., Horn, S., Murphy, S., Miller, D., Day, H., Troup, L., Fornatora, D., Spage, N., Pupkiewicz, K., Roth, M., Rivera, C., Altman, C., Schruer, I., McLaughlin, T., Biddle, R., Ritchey, R., Topness, E., Turner, J., Updike, S., Buckman, H., Simpson, N., Lin, J., Anderson, A., Baier, H., Crittenden, M., Dowker, E., Fuhrig, S., Goodman, S., Grimsley, G., Layko, R., Melville, G., Mulder, M., Oberman, R., Panganiban, J., Peck, A., Seitz, L., Shea, S., Slevin, H., Yougerman, R. and Hobbs, L. (2020). geoBoundaries: A global database of political administrative boundaries. Plos One, 15(4), e0231866.
Schwarzenberg. A. (2023). Russia’s Trade and Investment Role in the Global Economy. Congressional Research Services, Report IF12066. https://crsreports.congress.gov/product/pdf/IF/IF12066
Sharma, R. (2023). Why markets are relatively calm in the geopolitical storm. Financial Times. https://www.ft.com/content/d194a8a2-60c1-4afe-83bf-44e529e16d40
Sonnenfeld, J. and Tian, S. (2022). Some of the Biggest Companies Are Leaving Russia. Others Just Can’t Quit Putin. Here’s a List. The New York Times. https://www.nytimes.com/interactive/2022/04/07/opinion/companies-ukraine-boycott.html
Sonnenfeld, J., Tian, S., Sokolowski, F., Wyrebkowski, M., and Kasprowicz, M. (2022). Business Retreats and Sanctions Are Crippling the Russian Economy. http://dx.doi.org/10.2139/ssrn.4167193
Stockholms Handelskammare. (2022). Regionala handelsmönster med Ryssland. https://www.mynewsdesk.com/se/stockholmshandelskammare/documents/siffror-se-ru-punkt-pdf-420259
Swedish Chamber of Commerce. (2024). Förslag på åtgärder mot kringgående av sanktioner. https://www.kommerskollegium.se/globalassets/publikationer/rapporter/2024/forslag-pa-atgarder-mot-kringgaenden-av-sanktioner.pdf
S&P Global. (2024). Sanctions against Russia – a timeline. https://www.spglobal.com/marketintelligence/en/news-insights/latest-news-headlines/sanctions-against-russia-8211-a-timeline-69602559
Tidningen Näringslivet (2023). Svensk export till Rysslands grannar rusar. https://www.tn.se/naringsliv/30641/svensk-export-till-rysslands-grannar-rusar/

Disclaimer: Opinions expressed in policy briefs and other publications are those of the authors; they do not necessarily reflect those of the FREE Network and its research institutes.

Does the Russian Stock Market Care About Navalny?

Posted on March 29, 2021 | Policy Brief

Moscow citi in the sunset representing Russian stock market and Navalny

Alexei Navalny is the most prominent opposition leader in Russia today. During 2020, he entered not only the domestic Russian news flows, but was a major news story around the world following his horrific Novichok poisoning in August. This brief investigates the response in the Russian stock market to news about Navalny. For many significant Navalny news stories, the stock market experienced large negative returns that are not explained by the regular factors that move the market. Although the causality and permanency of these negative excess returns in the stock market are difficult to pin down completely, a first look at the numbers suggests that the short-run drops in the stock market on the days with most significant news regarding Navalny translates into several billion dollars in lost market value on the Russian stock market. In other words, for people that care about their stock market investments and the health of the Russian economy more generally, it makes a lot of sense to care about the health of Navalny.

Introduction

Alexei Navalny has become the leading political opponent to the current regime in Russia. His visibility (and possibly support) has been growing as he has endured poisoning, recovery in hospital, and court rulings that have imposed a harsh prison term. At the same time, Navalny and his team have posted new material online to make his case that both the president and other Russian leaders are seriously corrupt.

The question addressed in this brief is whether the news regarding Navalny affected the Russian stock market. The reasons for such a response may vary between different investors but could include a fear of international sanctions against Russia; an aversion to keeping investments in a country that put a nerve agent in the underwear of a leading opposition leader; or that news of a national security service poisoning one of its own citizens could trigger domestic protests that create instability.

This brief only investigates if Navalny-related news or events are taken into account at the macro level in the stock market and if so, how important the news seem to be relative to other news as drivers of the stock market index. However, there is a long list of related questions that are subjects for upcoming briefs that include differential effects across sectors and companies as well as identifying what dimensions of the news stories investors responded to.

Navalny in the News

Since August 2020, news regarding Alexei Navalny’s health and his role as the most important opposition leader in Russia have featured prominently in media around the world. There are different ways to analyze the significance of Navalny in the news and here the readily available measure provided by Google trends will be used. Figure 1 shows a global search on the keyword “Navalny” over the period July 1, 2020 to March 13, 2021 relative to total searches, where the maximum level in the period is normalized to 100 and other values are scaled to this. While the numbers on the graph are just relative measures, not telling much about the actual popularity, or market relevance of searches, the spikes in Figure 1 have very clear connections to major news stories as will be detailed below.

Figure 1. Google trends on Navalny

Source: Google trends, global search on Navalny on 2021-03-18

Four episodes stand out in Figure 1 and are marked by red numbers:

1 (August 20-25, 2020) is associated with Navalny falling ill on the flight from Tomsk to Moscow which led to an emergency landing in Omsk and then going to Germany for specialist treatment where it was stated that he had been poisoned.

2 (September 2-3, 2020) is when the German government said that the poison Navalny was exposed to was Novichok, which was also confirmed by laboratories in Sweden and France.

3 (January 17-25, 2021) is an extended period covering the arrest of Navalny as he returned to Russia on January 17; the publication of the YouTube video on “Putin’s palace”; and the street protests that followed.

4 (January 31-February 5) is a period covering a new weekend of public protests and then on February 2, Navalny being sentenced to prison for not complying with parole rules when he was in a coma in Germany. At the tail end of this period, Navalny’s chief of staff announced that street protests will be suspended due to thousands of arrests and police beatings.

Russian Stock Market Reactions

Using stock markets to investigate the value of political news is not new; for example, Fisman (2001) looks at how news regarding Suharto’s health differentially impacted firms that were connected to Suharto versus those that were not. On a topic more closely related to this brief, Enikolopov, Petrova, and Sonin (2018), show that Navalny’s blog posts on corruption negatively affect share prices for the exposed state-controlled companies. Looking at the overall stock market index rather than individual shares in Russia, Becker (2019) analyzes stock market reactions to Russia invading Crimea.

To get a stock market valuation effect of Navalny news that is as clean as possible, we need to filter out other factors that are known to be important drivers of the stock market. In the case of Russia’s dollar denominated stock market index RTS (short for Russia Trading System), we know from Becker (2019) that it is sensitive to movements in global stock markets and international oil prices. The former factor is in line with other stock markets around the world and the oil dependence of the Russian economy makes oil prices a natural second factor (see Becker, 2016).

Figure 2 shows how the RTS index moves with the global markets (proxied by S&P 500 index) and (Brent) oil prices in this period. The correlations of returns are around 0.4 between the RTS and both S&P500 and oil prices respectively. This figure is also the answer to the obvious argument that the stock market was doing very well in the time period of Navalny in the news, so he could not be a major concern to investors. As we will show below, this argument goes away when the effects of the exogenous factors are removed.

To filter out these exogenous factors, we follow the approach in Becker (2019) and regress daily returns on the RTS on daily returns of the exogenous variables. We then compute the residuals from the estimation to arrive at the excess returns that are utilized in the subsequent analysis. For more details on this, see Becker (2020). Since the estimated model provides the foundation for the subsequent analysis, it is important to note that all of the coefficients are statistically significant, and that results are robust to changes in the estimation period and exclusion of lagged values of the exogenous variables.

Figure 2. RTS and exogenous factors

Source: Data on RTS from the Moscow Exchange (MOEX), S&P500 from Nasdaq, and Brent oil prices from the US energy information administration.

With a time-series of excess returns for the Russian stock market, we can look at the stock market reactions to the four Navalny episodes identified in Figure 1. These periods cover some days for which we cannot compute excess returns since there are days when there is no trading, but all dates in the period are shown in Figure 3 to provide a full account of what stock market data we have for the events. In addition to excess returns during the events that are shown in blue, the day before and the day after the events are shown in light grey. In the first three episodes, the cumulative returns during the events windows were minus 6.2, minus 2.4, minus 6.0 percent, while in the fourth event window it was plus 0.8 (although in this period, the day after Navalny was sentenced to jail, the excess return was minus 1.7).

The correlations between news and excess returns in this brief are based on daily data. Since many things can happen during a day, the analysis is not as precise as in the paper by Enikolopov, Petrova, and Sonin (2018), where the authors claim that causality is proven by the minute by minute data. Although we have to be more modest in claiming that we have identified a causal relationship going from Navalny news to negative stock market returns, the daily data used here provides enough evidence to claim that there is a strong association pointing in this direction. If we take all four events and translate the cumulative excess returns in percent (which is 14) into dollars by using the market capitalization on the RTS at the time of the events (on average around 200 billion dollars), this amounts to a combined loss in market value of over 27 billion dollars.

Figure 3. Excess returns and Navalny news

Source: Excess returns from author’s calculations based on data from the Moscow Exchange (MOEX), Nasdaq, and the US energy information administration. The chart indicates days for which we cannot compute excess returns since not all days are trading days.

We may think that excess returns of this magnitude are common and that what we pick up for the four Navalny episodes are regular events in the market. To investigate this and other potential factors that have been important to explain excess returns in this time period, Table 1 provides a list of all the days when the excess return in the market was minus 2 percent or worse. Between August 2020 and mid-March 2021, there were eight such days. The table also shows what could be an associated Navalny event on or close to those dates as well as other competing factors or news that could explain the large negative returns on these days.

Out of 8 days with strong negative returns, the first three days are very clearly associated with major news regarding the poisoning of Navalny. The fourth day is close to Navalny’s release from the hospital but also when there are discussions about U.S. views on Iran and Ukraine. Two of the days are in the time period of the protests following Navalny’s video on “Putin’s palace” and two more days are related to important international institutions speaking out regarding first the poisoning with Novichok and then about the prison term of Navalny.

Although we would need a more fine-grained look at market data to make a final judgment on the most important drivers of the excess returns of a specific day, the fact that every single day with large negative excess returns is on or close to a Navalny news story is again pointing in the direction of a stock market that reacts to news about Navalny. Furthermore, the most significant drops with less competing news are associated with events that have a direct connection to Navalny’s health and how his life was put in danger. In the list of competing news are Nord Stream, Biden affecting the oil and gas industry, and a law regarding the taxation of digital currencies. They are likely to be of at least some relevance for stock market valuations and could account for certain days or shares of poor performance of the RTS, but it is hard to ignore the general impression of Navalny being important for the stock market in this period.

Table 1. Days with RTS excess returns of minus 2% or worse (August 1, 2020 to March 12, 2021)

Source: Excess returns from author’s calculations based on data from the Moscow Exchange (MOEX), Nasdaq, and the US energy information administration. News comes from internet searches on Navalny and relevant dates.

Conclusions

Although it is difficult to prove causality and rule out all competing explanations, this investigation has shown a strong association between major news regarding Navalny and very poor performance of the Russian stock market. Every day since August 2020 that had excess returns of minus 2 percent or worse is more or less closely associated with significant news on Navalny. More than that, almost all days with significant Navalny news during this period, – as captured by high search intensity of Navalny on Google, – are associated with a poorly performing stock market. In particular, this holds for the day of his poisoning and the following days with comments by international doctors, politicians, and institutions regarding the use of Novichok to this end.

It could be noted that a 1 percent decline in the RTS equates to a loss in monetary terms of around 2 billion USD in this time period since the market capitalization of the RTS index was on average around 200 billion USD. The combined decline in the events shown in Figure 3 is 14 percent and for the days listed in Table 1, it is 21 percent, i.e., corresponding to market losses of somewhere between 28 and 42 billion USD. Even if only a fraction of this would be directly associated with news on Navalny, it adds up to very significant sums that some investors have lost. One may argue that the losses are only temporary and recovered within a short time period (which would still need to be proven), but for the investors that sold assets on those particular days, this is of little comfort. At a minimum, events like these contribute to increased volatility in the market that in turn has a negative effect on capital flows, investments, and ultimately economic growth (Becker, 2019 and 2020). For anyone caring about the health of their own investments or the Russian economy, it makes sense to care about the health of Navalny.

References

Becker, Torbjörn, 2016. “Russia and Oil — Out of Control”, FREE policy brief.
Becker, Torbjörn, 2019. “Russia’s Real Cost of Crimean Uncertainty”, FREE policy brief, June 10.
Becker, Torbjörn, 2020. “Russia’s macroeconomy—a closer look at growth, investment, and uncertainty”, Ch 2 in Putin’s Russia: Economy, Defence And Foreign Policy, ed. Steven Rosefielde, Scientific Press: Singapore.
Enikolopov, Ruben, Maria Petrova, and Konstantin Sonin, 2018, “Social Media and Corruption”, American Economic Journals: Applied Economics, 10(1): 150-174.
Fisman, Raymond, 2001, “Estimating the Value of Political Connections.” American Economic Review, 91 (4): 1095-1102.
Google trends data.
Moscow Exchange (MOEX), RTS index data.
Nasdaq, S&P 500 data.
U.S. Energy Information Administration, 2021, data on Brent oil prices.

Disclaimer: Opinions expressed in policy briefs and other publications are those of the authors; they do not necessarily reflect those of the FREE Network and its research institutes.

Russian Financial Markets, Pension Funds and ETFs

Posted on December 18, 2017 | Policy Brief

In this brief, I consider problems arising from the virtual non-existence of index funds and/or Exchange Traded Funds (ETFs) in the Russian financial markets. While the Russian economy requires cheaper money for firms’ investments and better options for pensioners, there are almost no instruments that allow stocks for long-term value acquisition by the pension funds. I argue that more passive options and better representation of Russian stock indices may be beneficial for both the real economy and future pensioners.

Russian financial markets

In Russia, banks play a more important role in the economy than financial markets (see Danilov et al., 2017). Comparing the two, we observe bank assets to GDP ratio of about 100%, and financial markets to GDP of less than 45%. The current proportion of sources of corporate and household financing (2/3 of banks and 1/3 of financial markets), and the value of financial markets to GDP, is similar to Germany. However, the banking system in Russia is smaller and less stable. For example, it attracts passives that are very short-term, with average duration of less than 3 years.

One of the causes of the underdeveloped financial markets is the low amount of money in non-government pension funds, and the restrictive regulation that requires them to protect initial capital of future pensioners. This reduces the investment opportunity set of these pension funds, as volatile stocks are unattractive to them, and instead the funds mostly choose to invest in bonds. This is specific to the Russian market: for example, there are no such restrictions in the European approach (European Commission, 2017). However, both in developed countries and in emerging markets, stocks provide higher long-term returns than bonds. Thus, future pensioners in Russia lose on the upside, and the economy sticks to banks as the main source of investment.

The macro economy is also less effective due to the small financial markets. In the data (see Cournède et al., 2015), we see a positive correlation between the growth of outstanding stocks/bonds and the economic growth for low enough levels of total value of financial markets. While causality goes in both directions (higher GDP means need for more financial instruments), this is a compelling reason to develop financial markets.

Finally, people in Russia do not “believe” in stocks and bonds. If one compares the deposit rate in a bank with the yields of the same bank, the former is almost uniformly lower than the latter. Yet, even in the case of Sberbank, the largest bank in Russia, individuals prefer to keep their money in deposits or in foreign currency. This is a signal of low financial literacy, as well as of low income, or lack of trust; this is evident in many surveys (S&P, 2015).

Therefore, our research question is: what could be done to make the Russian market more attractive to domestic investors, and make them invest and save for pensions?

Indexing

There are many papers regarding diversification and investment opportunities of individual investors. As recent research shows (see Bessembinder, 2017), individual stocks are not good for investment even on US market. Namely, most stocks return less than Treasury bills at monthly horizons. Due to this property of financial markets, it is important that domestic investors have access to wide indices.

Moreover, Berk and Binsbergen (2015) demonstrate that active mutual funds generate as much of profits as they retain as fees. This means that individual investors are better off if they choose passive options, like index funds or Exchange Traded Funds (ETFs), as their main investment vehicle. Index funds and ETFs mostly invest in one index, say S&P500 of the 500 largest US stocks, and their explicit mandate is to stick to this index. Index funds can only be bought through a broker, while ETFs are traded on an exchange, like stocks. This makes them different in terms of possibility of active portfolio rebalancing. However, both are very passive by nature.

These arguments lead to the first conclusion: to improve investment opportunities of pension funds and individual investors, as well as the macroeconomic stability, the regulator might motivate institutional market participants to provide more passive, diversified, and stock-based portfolios.

ETFs and robo-advising in Russia

One way to increase the number of passive options is to allow more ETFs in Russian stock exchanges. As ETFs and their availability to investors have to be confirmed by the regulator (the Central Bank), one cannot immediately add new ETFs to the market. Index funds are another option. However, they have a long and sad history in the Russian market: most (about 95%) of the so-called “index funds” deviate from their benchmarks and do not follow indices. This has to do with the openness of the funds: while mutual funds and index funds have to report their stock/bond/cash holdings once a quarter, ETFs publish it daily. So one can check that ETFs follow their mandates with ease. Moreover, ETFs are usually cheaper and thus save returns for investors.

While existing ETFs on the Moscow Stock Exchange already cover a wide range of markets and even some sectors (including the Russian stock market, US S&P500, Europe and China), they are still too small in terms of assets under management (about $150 millions) and are issued by one company (FinEx). Currently, FinEx ETFs are almost the only option to invest passively, and to diversify, in the Russian market. At the same time, in most markets, index funds are marginally better saving/retirement/investment vehicle as they require less trading fees and thus save returns for low-income investors.

Regulators can facilitate the process of indexation in at least two following ways: (i) allow introduction of more index funds or ETFs in the market (requires regulator’s supervision and confirmation); and (ii) provide incentives to brokers and financial advisors to make them their first recommendation to individual investors and pension funds (as is done in the US, see BNY Mellon, 2016).

Another way to cater to low-income investors is robo-advising – an ongoing revolution in the financial markets. This tool allows investors to get wealth management advice for a small fee (about 0.15% in the best case), and it mostly invests in low-cost, passive ETFs that allow diversification of investments. While this is still new for Russia (and done by FinEx with partners from banks), it has become more widespread in developed markets. Assets under management with robo-advisors increase rapidly and now exceed $220 billions. This tool is useful for investors who are not financially literate, do not have economic or financial education, but still need good investment opportunities. In Russia, robo-advising may become a norm for so-called “non-qualified” investors – people with low enough savings and no educational certificates on financial markets. The regulator has not yet confirmed this, but we see many signs that it will go in this direction. One problem for this market is that it is still not official, and human financial advice is considered as a norm for non-qualified investors if they would like to expand their investment universe to say derivatives.

A big positive side of robo-advising is the reduction of human errors. As Richard Thaler, Nobel Prize winner of 2017, has persuasively shown in his research that humans make many judgement errors. These mistakes lead to lower returns on investment, too much trading that eats returns due to fees, and higher wealth inequality. Robo-advisers avoid all that and allow individual investors to save and invest more long-term.

The second conclusion is: regulators should help the financial industry to develop better robo-advising software that uses ETFs; use these robo-advisers as replacement for human advisers; and advertise this as the option for long-term investment, including pension funds.

Conclusion

Russian financial markets should provide more financial instruments to Russian firms and higher flexibility for investors. The Central Bank as the supervisor of financial markets, and the Ministry of Economic Development as the main government branch responsible for economic growth, may take additional steps to increase availability of passive investment options for Russian citizens. Reforms of incentives of brokerage firms might be needed, yet the ultimate goal is to improve well-being and pensions, and probably make good use of the money of long-term domestic investors. One possible option is to widen already existing ETFs market and allow individual investors to use robo-advising to invest in many instruments, even if these investors are not highly qualified or wealthy.

References

Bessembinder, Hendrik, 2017. “Do Stocks Outperform Treasury Bills?”, Journal of Finance, Forthcoming. https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2900447.
Berk, Jonathan B. and Jules H. van Binsbergen, 2015. “Measuring skill in the mutual fund industry”, Journal of Financial Economics, vol. 118, issue 1, 1-20. https://econpapers.repec.org/article/eeejfinec/v_3a118_3ay_3a2015_3ai_3a1_3ap_3a1-20.htm.
BNY Mellon, 2016. “Accelerating Growth: The Department of Labor Conflict of Interest Rule and its Impact on the ETF Industry”, memo. https://www.bnymellon.com/_global-assets/pdf/our-thinking/accelerating-growth-the-dol-conflict-of-interest-rule.pdf
Cournède, Boris; Oliver Denk, and Peter Hoeller, 2015. “Finance and Inclusive Growth”, OECD economic policy papers. http://www.oecd-ilibrary.org/economics/finance-and-inclusive-growth_5js06pbhf28s-en?crawler=true
Danilov, Y.A.; A.E. Abramov and O.V. Buklemishev, 2017. “Reform of financial markets and non-banking financial sector” (in Russian), Policy report. https://csr.ru/wp-content/uploads/2017/07/Report-Financial-markets-v2-web.pdf.
European Commission, 2017. “Pan-European Personal Pension Product (PEPP)”, memo. http://europa.eu/rapid/press-release_MEMO-17-1798_en.htm
S&P Global Finlit Survey, 2015. http://gflec.org///initiatives/sp-global-finlit-survey/

Effects of International Taxation on Firm Valuation: Evidence from Japan’s 2009 Tax Reform

Posted on October 27, 2014 | Policy Brief

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This brief highlights the results of a study of Japan’s 2009 adoption of a territorial tax regime exempting corporations’ foreign earnings from domestic taxation. We examine stock market reactions to events leading to the adoption of a dividend exemption system. We use an event study methodology leveraging firm characteristics and accounting for confounding effects from recent financial market developments. We find that relative to other Japanese multinationals, firms facing lower effective tax rates on their foreign operations benefit disproportionately from the reform. Surprisingly, firms with less foreign exposure and fewer opportunities for tax avoidance experience relatively larger abnormal returns overall. We attribute these gains to a combination of enhanced opportunities for international expansion among smaller domestic firms, direct tax savings on undistributed foreign earnings, and general cultural biases against tax planning.

As firms’ operations have expanded their global reach, corporate taxation has become inextricably tied to the taxation of multinational firms’ (MNCs’) foreign earnings. Correspondingly, international tax issues including tax avoidance, tax competition, and multinational competitiveness have dominated discussions on corporate tax reform. Much of the debate focuses on the choice over worldwide (residence-based) versus territorial (source-based) taxation. This brief summarizes a study by Bradley, Dauchy, and Hasegawa (2014) in which we aim to capture the full range of possible effects of Japan’s 2009 adoption of a 95 percent foreign dividend exemption system on firm after-tax profitability by examining stock market reactions around key events leading to the reform. More specifically, our study looks into abnormal stock returns (ARs) defined as extra-normal firms’ returns below or beyond what the market would have predicted, absent the event. ARs surrounding key event dates leading to the reform are used to quantify current and future tax savings on repatriated earnings as well as benefits flowing from firms’ enhanced ability to compete in foreign markets.

Japan’s 2009 Tax Reform

From 2003 to 2009, 10 OECD countries switched from worldwide to territorial tax regimes; the latest and most consequential among these being Japan and the United Kingdom. Motivated by a desire to encourage domestic reinvestment of accumulated foreign earnings, and to enhance Japanese firm competitiveness in foreign markets through reduced tax and compliance costs, the Japanese dividend exemption system arose from a short succession of tax policy discussions. Given the tightly structured nature of Japan’s annual tax reform process, the most informative and authoritative events in the sequence that we consider, are thus the initial May 9, 2008 announcement. The Ministry of Economy, Trade, and Industry (METI) was then instructed to analyze the consequences of adopting a territorial tax regime. This announcement was followed by two subsequent Cabinet meetings, in which details of the proposed reform were refined and ultimately endorsed on June 27, 2008 and January 23, 2009, respectively.

Our data and identification strategy

For our analysis, we use data from Datastream, which consist of daily stock market returns for the largest quartile (by market capitalization) of publicly listed Japanese, U.S., and German firms. These data are combined with annual financial statement information from Orbis on each publicly listed Parent Corporation and all of their foreign subsidiaries. Adapting the standard market model event study methodology, returns on U.S. and German market portfolios are incorporated in our determination of abnormal Japanese stock returns. This is to control for potential confounding events associated with the global financial crisis. Conversely, we also study possible spillover effects of the reform in the U.S. and German markets. The idea is to identify whether the Japanese reform may have affected the prospects for adoption of a territorial tax regime in the U.S.—which now accounts for around 80 percent of GDP among the remaining OECD worldwide regimes – or how this may have affected U.S. and German firm competitiveness, the latter being subject to a dividend exemption system very similar to Japan’s under Germany’s long-standing territorial tax system. Significant differences in investor reactions across the Japanese, U.S., and German markets around our event dates are hence informative about the different channels by which the Japanese reform was perceived to impact firm after-tax profitability.

Figure 1. Cumulative Abnormal Returns on May 9, 2008, by Firm Nationality and Multinational Status.

Notes: This figure plots cumulative abnormal returns (CARs) within a 5 trading-day window centered around the May 9, 2008 event, defined as the sum of daily ARs. ARs are the mean cross-sectional prediction errors derived from estimation of the standard market model including market portfolio returns drawn from the Japanese, U.S., and German exchanges over the last 250 trading days ending 20 days before the first event. Tests of statistical significance (in red) follow Kolari and Pynnönen’s (2010) “adjusted BMP” methodology.

Moreover, we leverage the location of foreign subsidiaries and financial statement characteristics of both parents and subsidiaries to estimate in a single step the contribution to ARs from particular firm attributes. Among these, we emphasize simple distinctions between domestic and multinational firms, or the ownership of at least a single subsidiary in a tax haven, as a proxy for tax planning sophistication. A direct measure of tax savings on the repatriation of accumulated foreign earnings is calculated as the difference between the average effective tax rate on domestic and foreign operations. Further interactions of this potential tax savings rate with measures of intangible intensity are intended to distinguish prospects for future tax savings on intangibles-facilitated income reallocation.

Unexpected Winners

A striking point that emerge from Figure 1 is that Japanese market reactions generally appear larger in magnitude among domestic firms than MNCs. Statistically-significant 1-2 percent cumulated abnormal returns (CARs) observed among the former group appear to validate one of the Japanese reform’s objectives of facilitating expansion of smaller firms into overseas markets (Toder, 2014).

It is also noteworthy that the positive effect on Japanese firms is unmet by comparable reactions in either German or U.S. markets, such that the observed effect in Japan is more credibly attributable to the METI announcement — itself evidently either ignored or perceived as unimportant for U.S. and German firm profitability.

Table 1. Cumulated Event Date AAR Effects by Nationality and MNC Status

Notes: Significance levels are designated as *** (1 percent), ** (5 percent), and * (10 percent). Cumulated marginal effects measure ARs averaged over each three-day event window (AARs) and summed across Cabinet meeting dates.

These results appear to be reinforced after accounting for key firm characteristics, albeit in a nuanced way. Over the course of the full sequence of three Cabinet meeting dates, Japanese MNCs experienced significantly worse cumulated average abnormal returns (AARs) than their domestic counterparts, equal to a difference of 3.8 percent of market capitalization through the end of the January 23, 2009 event window (see Table 1).

As Predicted, Firms with Larger Tax Savings Potential Are Net Winners

Underlying these differences by multinational status, the rate of anticipated tax savings resulting from the reform is nevertheless associated with substantial positive effects on Japanese MNC valuations, with the largest such contributions arising around the last Cabinet meeting date. Over the course of all three events, a 10-percentage point increase in the tax savings rate was associated with AARs of 0.31 percent (top panel of Table 2). Applied to the set of Japanese firms in our sample with an observed average tax savings rate of 21.5 percent, this implies aggregate savings just slightly in excess of predicted tax savings on the repatriation of ¥17 trillion in undistributed earnings held by foreign subsidiaries of Japanese firms in fiscal 2006 according to the best available estimates prior to reform (METI, 2008).

Table 2. Cumulated Event Date AAR Effects among MNCs, by Nationality

Notes: See notes for Table 1.

More sophisticated or tax aggressive firms with subsidiaries located in tax havens performed relatively worse than other Japanese MNCs, while firms in industries characterized by heavier reliance on intangibles likewise saw no additional gains in relation to potential tax savings on future shifted earnings.

Conclusion

Our study reveals that the Japanese adoption of a territorial regime was, at least initially, perceived as being disproportionately valuable for firms that might previously have been deterred from expanding overseas due to international tax compliance issues and lack of competitiveness under the previous worldwide regime, consistent with one of the motives for the reform. More tax savvy Japanese MNCs may have benefited disproportionately less, in part, because the previous regime was not limiting their ability to borrow from their affiliates, or simply because of a lack of interest in tax planning, as is widely reported among tax practitioners.

Our study confirms the importance of the most direct source of gains from adoption of a territorial tax regime – namely, the tax savings on immediate repatriations. At the same time, it highlights the perceived benefits among aspiring entrants into foreign markets of reductions in tax compliance costs and enhanced competitiveness in foreign markets.

▪

References

Bradley, Dauchy, and Hasegawa. CEFIR/NES WP Series, No. 201, September 2014. http://www.cefir.ru/index.php?l=eng&id=35
Kolari, J. and S. Pynnönen (2010), “Event Study Testing with Cross-sectional Correlation of Abnormal Returns,” Review of Financial Studies, Vol. 23, No. 11, pp. 3996–4025.
Ministry of Economy, Trade and Industry of Japan (2008), “Repatriations of Foreign Profits by Japanese Enterprises: Toward the introduction of a dividend exemption regime (In Japanese: Wagakuni Kigyo no Kaigairieki no Kanryu nitsuite).” http://www.rieti.go.jp/en/columns/a01_0387.html#note2.
Toder, Eric (2014), “Review of the Conference on What the United States Can Learn from the Experience of Countries with Territorial Tax Systems,” Urban Institute, Washington D.C., June 18. http://www.urban.org/publications/413159.html