Corporate Profits and Investment in Light of Institutional and Stock Market Turmoil: New Evidence from the Warsaw Stock Exchange

Abstract:

Using a new quarterly panel of corporate, institutional, and macroeconomic data, we investigate the impact of economic property rights, stock market returns and stock market realized volatility as well as macroeconomic controls on corporate profitability and investment capacities for a sample of 238 firms quoted on the Warsaw Stock Exchange between 2007–2015. The obtained results indicated that both economic property rights and equity market realized volatility impacted firm profits and investment capacities in a negative fashion. Furthermore, we identified detrimental effects of domestic economic growth and global crisis, both of which dwarfed the beneficial effects of firm size and stock returns in the period under consideration. Given Polish public companies limited international engagement, they were isolated from long-term interest rate changes in the euro area. On the other hand, the domestic banking sector and foreign direct investment flows appear to have mitigated Polish firms’ business performance and growth.

Keywords::

• institutions
• return on assets
• investment
• transition
• stock market
• corporate finance

JEL Classification Codes::

• P34
• G31
• O16

Notes

¹ Including contract enforcement and property transferability, minority shareholder protection, and transparent asset valuation mechanisms.

² The efficient-market hypothesis posits that all available information is discounted and reflected in assets’ market prices and they can be altered by arrival of new information. In other words, if able to benefit from private information, investors have motivation to act on it and purchase specific assets, thus contributing to smoother trading and raising the levels of market efficiency. Friedrich August von Hayek (1945) observed that (financial) markets were likely the best mechanisms for information aggregation; recent empirical studies, even though mixed, indicated that markets generally are not purely efficient, as the hypothesis would have it, with behavioral economics linking the imperfect market mechanisms with human cognitive biases such as overreaction, information bias and erroneous and illogical reasoning (Kahneman and Riepe 1998; Kahneman and Tversky 1973). In the institutional context, market efficiency and institutions’ development may be argued to fuel each other. Put differently, the more transparent valuation mechanisms and the deeper the market (i.e., less prone to shocks and prolonged crises), the greater market discipline it demands and curbs rent-seeking behavior of managers. On the other hand, sturdier institutional structures, including legal protection of minority or foreign investors as well as effective and timely enforcement of contracts, help ensure development of financial markets’ pricing mechanisms and continuity of trade.

³ A domestic database for firm-level data.

⁴ The fixed effects capture the unobservable firm-level effects and sectoral influences (Hartwell and Malinowska 2018, 2019).

⁵ The correlation matrix is available upon request.

⁶ Data provided by https://strefainwestorow.pl/artykuly/20161213/nacjonalizacja-wig20-przybiera-na-sile-juz-75-indeksu-kontroluje-skarb-panstwa last access 16.12.2018

⁷ Arising from information asymmetries and agency problems caused by costly bureaucratic procedures and discretionary behavior of decision makers

⁸ Patents awarded to domestic entities (calculated per 1 million of residents) pointed to a negative difference amounting to 3.9 between 2009 and 2010

⁹ World Value Survey (2012) indicates that 54.2% of Poles had little confidence in the governmental strategy, while 25.5% of the people surveyed were entirely distrustful.

¹⁰ The National Bank of Poland's interest rates have remained unchanged since March 2015.

¹¹ Author's own calculations the long-term debt ratio comprises both domestic and international debts.

¹² Author's own calculations based on the sample used in the analysis.