Assessing impact of regulatory risk on shareholders’ wealth

ABSTRACT

Research indicates that regulatory risk increases required return on investment by investors and causes underinvestment in industries with high sunk costs. The effects of regulatory changes may be measured by estimating the abnormal returns associated with the event. The results may suggest to regulators what should be encouraged or avoided. This article utilizes a fixed effects regression to examine abnormal returns from changes in Philippine nationalization regulations. The results are consistent with extant literature. Supreme Court decisions, which increased uncertainty and regulatory risk, produced negative abnormal returns. The initial release of draft implementing rules did not produce statistically significant effects, but a succeeding draft favouring liberalization, produced positive abnormal returns.

KEYWORDS:

• Regulatory risk
• regulatory impact assessment
• nationalization
• fixed effects regression

JEL CLASSIFICATION:

• G14
• G18
• G38
• K20
• K22

Disclosure statement

No potential conflict of interest was reported by the author.

Notes

¹ http://markets.ft.com/research/Lexicon/Term?term=regulatory-risk

² See Ernst & Young (2008, 2009, 2010, 2013).

³ http://markets.ft.com/research/Lexicon/Term?term=regulatory-risk

⁴ See Ernst & Young (2008, 2009, 2010, 2013)

⁵ Defined as ‘a decision by a country’s government to allow foreigners to purchase shares in that country’s stock market’.

⁶ Republic Act No. 7042, Section 7 (1991); Republic Act No. 8179, Section 2 (1996).The Foreign Investment Negative List has two components: (1) List A, which enumerates areas reserved to Philippine nationals by mandate of the Constitution and specific laws; and (2) List B, which lists activities and enterprises regulated pursuant to law. Amendments to List B may be made upon recommendation of the Secretary of National Defense, or Health, or Education, Culture and Sports, indorsed by the NEDA, or upon recommendation motu proprio of NEDA, approved by the President, and promulgated by a Presidential Proclamation. [Republic Act No. 7042, Section 8 (1991); Republic Act No. 8179, Section 3 (1996).]

⁷ Including voting and non-voting shares.

⁸ Opinion No. 18, dated 19 January 1989.

⁹ G.R. No. 176579, 9 October 2012.

¹⁰ G.R. No. 179 October 6579, 2012.

¹¹ Dated 25 March 2010.

¹² Default spread and dividend yield cannot be utilized as explanatory variables in this article due to data scarcity and simultaneity bias issues.

¹³ The constant used to scale the residuals is derived as follows:$\mathrm{F}\mathrm{o}\mathrm{r}\mathrm{a}\mathrm{n}\mathrm{y}\mathrm{c}\mathrm{o}\mathrm{n}\mathrm{s}\mathrm{t}\mathrm{a}\mathrm{n}\mathrm{t}\mathrm{s}a\mathrm{a}\mathrm{n}\mathrm{d}b,Var\left(aX+b\right)=a^{2}Var\left(X\right)$ (Wooldridge 2009).$\mathrm{S}\mathrm{o}\mathrm{l}\mathrm{v}\mathrm{e}\mathrm{f}\mathrm{o}\mathrm{r}a,\mathrm{g}\mathrm{i}\mathrm{v}\mathrm{e}\mathrm{n}\mathrm{t}\mathrm{h}\mathrm{a}\mathrm{t}:Var\left(aX\right)=Var\left(Y\right),$$a^{2}Var\left(X\right)=Var\left(Y\right),$$a=\sqrt[2]{\frac{Var\left(Y\right)}{Var\left(X\right)}}.$

¹⁴ The expected value of the disturbances is zero. It assumes that the model is not mis-specified.

¹⁵ The disturbances of regression model are heteroscedastic.

¹⁶ Between returns of Nikkei 225 and Hang Seng indices for Event 3.

¹⁷ Except for Event 2 and 3 for DJIA returns.

¹⁸ Statistically significant with negative sign for Events 2, 3, and 4.

¹⁹ Except for Event 2 and 5.

²⁰ See http://www.interaksyon.com/business/52425/supreme-court-clarifies-foreign-ownership-ruling-paves-way-for-softer-sec-guidelines

²¹ Notes: The indications ‘Y’ and ‘N’ denote statistically significant and insignificant regression coefficients, and the symbols (+) and (–) denote the sign of these coefficients, respectively. Robust standard errors were used. Results based on significance level of 0.1.

²² Up to 10 lags were used for each control variable.