Monday, February 23, 2009

Weekly Hurriyet Column: The value of political connections, a la Turca

Below is the unedited version of my column for this week. You can read the final version at Hurriyet's authors archive. Judging by user response, this has been by far my most popular post to date, although most of the responses were AKP-sympathizers not too happy with my tone with the party. To give the more civil critiques some credit, they are right that it is not very scientific not to disclose the name of the companies perceived close to AKP. But I get a lot of disutility from getting sued, even when I am sure to win, as I figured out a couple of years ago, when some old pals wanted to turn me into pay, pal:)

As for my references to Suharto and Adolf, I know they are not very gentlemanly, but the last two months have proven me right, especially with the country turned into East Germany as depicted in Lives of Others.

The Treasury’s record tax levy against the Dogan Media Group (DMG) managed to bypass even the Central Bank’s 1.5% rate cut as the shocker of last week. It is true that given the past surprises, the real surprise would have been if the Bank had cut the policy rate in line with expectations, but the Treasury still deserves some credit for stealing the show.

It was only natural that the stock prices of DMG and other media companies of the Dogan Group dove on the news. After all, even though DMG is likely to fight the levy in a lengthy legal battle, there is a possibility of a huge cost item entering DMG’s balance sheet, which needs to be priced in, not only for DMG but also for other Dogan companies in the media sector. However, the sharp falls (more than 10% for each Dogan company and nearing 20% for DMG over the course of three days) are much more than simple accounting can account for. More interestingly, the mere fact that Petrol Ofisi, a non-media company in the Dogan group, also had a fall in excess of 10% hints that something deeper and more sinister might be going on.

That something may be the value of political connections. The notion that firms with political ties might be affected from the fate of their party would be a no-brainer to almost any Turk. But actually measuring political connections is no easy task. The trick is to find unexpected political events that have no obvious financial bearing on the firm so that any abnormal return (the difference between the expected and actual return) could solely be attributed to the political event and thus to the value of the political tie. The Dogan levy unfortunately does not pass this litmus test, but Turkey has seen its share of political events in the past two years, providing fertile testing ground.

In an exercise borne out of curiosity a few months ago, I tried to measure the value of political connections by following up on the fate of companies perceived to be close to AKP by the finance community (from a small survey I conducted) during the major political events since 2007: The e-warning at the end of April 2007, Tarhan Erdem’s July 19 survey showing AKP further ahead than thought, the AKP elections victory, the filing of charges with the Constitutional Court against AKP in March 2008 and the Court’s decision at the end of July. In AKP-positive events, the average cumulative abnormal return (CAR) turned out to be around 3%, with the effect almost doubling in AKP-negative events.

While the results above show the value of political connections, they do not demonstrate the destruction in value of being labeled by the AKP. Therefore, urged by the events of last week, I repeated the same exercise for Dogan companies. There does appear to be an AKP effect in the reverse direction, but only for the Constitutional court events, and much smaller in magnitude- less than 1% CAR. But then again, the hatchet has just been unburied, so we might have to wait for the next political shock.

I should say that this small exercise is by no means original: The first academic paper to demonstrate such effects showed that firms close to Indonesia’s Suharto were affected disproportionately by changes in the dictator’s health. Another looked at the Nazi seizure of power after the Reichstag fire, snap election and constitutional change by March 1933, when the Nazis decided to get off the democracy tram (no pun intended), and found that stock prices of firms that had tied their fortunes to the Nazis in the process surged.

It is comforting to know that AKP finds itself in such good company.

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