The Sovereign Wealth Fund Discount: Evidence From Public Equity Investments
Universita di Torino
Sovereign Investment Lab, Baffi CAREFIN Centre, Bocconi University
University at Buffalo
Sovereign Investment Lab, Baffi CAREFIN Centre, Bocconi University
William L. Megginson
University of Oklahoma
Visiting Professor, Universite Paris Dauphine
We document that announcement-period abnormal returns of sovereign wealth fund (SWF) equity investments in publicly traded firms are positive but lower than those of comparable private investments. Further, SWF investment targets suffer from declining return on assets and sales growth over the following three years. Our results are robust to controls for target and deal characteristics and are not driven by SWF target selection criteria. Larger discounts are associated with SWFs taking seats on boards of directors and with SWFs under strict government control acquiring greater stakes, supporting the hypothesis that political influence negatively affects firm value and performance.
The Sovereign Wealth Fund Discount: Evidence From Public Equity Investments – Introduction
The past fifteen years have seen a resurgence of government ownership of firms. In contrast to the old model of state-led entrepreneurship, in which the state owned and ran companies by ministerial diktat, today the most important government stock buyers tend to act primarily or solely as investors. Megginson and Fotak (2014) report that over the 2001–2012 period governments acquired more assets through stock purchases ($1.52 trillion) than they sold through share issue privatizations and direct sales ($1.48 trillion), testifying both to the growing role of governments in the economy, despite multiple worldwide privatization waves, and to the changing nature of government involvement. Among state-owned investors, sovereign wealth funds (SWFs) play an especially prominent role, with investable assets estimated at over $4 trillion and growing faster than any other institutional investor group. The rapid rise of SWFs begs a question: can state-sponsored funds, such as SWFs, ever act as objective, commercially driven long-term global investors, managing their nation’s wealth as investment fiduciaries of their citizens? Our paper addresses this issue by studying the impact of SWF investment on firm value.
By some measures, SWFs have already been extensively researched. Yet extant empirical research offers incomplete evidence about the impact of Sovereign Wealth Fund investments on the value of publicly traded companies. Studies that examine SWF investments using event-study techniques (Dewenter, Han, and Malatesta 2010; Kotter and Lel 2011) find positive announcement-period returns. Unfortunately, these results offer little insight into the role of SWFs as investors, as corporate finance research consistently documents positive announcement-period abnormal returns for all types of direct stock purchases by institutional investors.1 In addition, the debate on the impact ofSWFson firm value is far from settled: Knill, Lee, and Mauck (2012) find evidence of SWFs not providing the same monitoring benefits as other institutional investors. To determine how the identity of the investing SWF impacts target firm value, we develop and test hypotheses comparing Sovereign Wealth Fund stock purchases to those made by private financial investors and then explain the differential impact, while accounting for differences in target selection and investment characteristics.
On the one hand, SWFs have the capability and incentives to monitor portfolio firm managers and increase firm value by engaging actively in the governance of target companies. While other institutional investors at times play a similar monitoring role, the lack of explicit liabilities, the long-term investment horizon, the low need for short-term liquidity, and the capability of SWFs to acquire large stakes represent qualitative differences with respect to private financial investors, which could be reflected in higher relative valuations of investment targets. However, there also may be a negative side to SWFs’ investments, since sponsoring governments may impose noncommercial, political objectives, not fully consistent with the shareholder wealth maximization typically pursued by private firms. Alternatively, political concerns about state investor meddling may induce SWFs to refrain from taking an active corporate governance role in target companies, especially when investing abroad. SWFs might thus tend to be passive investors who, at best, do not contribute to the effective monitoring of target firm managers and, at worst, help to entrench underperforming management teams. As a consequence, investments by SWFs might create less value for target firms than do comparable investments by private-sector investors, who are not affected by political objectives and can exercise unconstrained ownership and control rights.
We test these contrasting predictions using a manually constructed dataset of 1,018 investments by SWFs (or by SWF-owned investment subsidiaries) in publicly traded firms, over the 1980–2012 period, and a “benchmark” control sample of 5,975 stock purchases by private financial investors. We document strong, robust evidence of a statistically and economically significant “SWF discount” wherein SWF stock purchases have a smaller valuation impact on target firms than do comparable stock purchases by private investors. Announcements of SWF investments are associated with a positive mean abnormal return of 0.84%, compared with the 4.82% mean abnormal return generated by the private benchmark investors. We restrict the benchmark sample to the same acquirer and target countries, as well as to the same time frame, yet Sovereign Wealth Fund acquisitions differ significantly from those by private financial investors: SWFs tend to target larger (higher total assets) and more profitable (higher return on assets) firms, but tend to buy smaller stakes and acquire control less frequently. Accordingly, we decompose this total discount into three components, due to, respectively, target characteristics, deal characteristics, and, most importantly, the fact that the investor is a Sovereign Wealth Fund. We find that differences in target characteristics account for a large portion (approximately four-fifths) of this discount.Yet, even after controlling for these target and deal differences, the estimated “Sovereign Wealth Fund discount” is statistically and economically significant, with a mean of ?1.31%. Conservative back-of-the-envelope estimation translates that into an average discount on firm market capitalization in excess of $60 million for each SWF (rather than for each private-sector) investment in a publicly traded firm, or an aggregate discount of $60 billion in the sample we study.
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