International Variation in Sin Stocks and its Effects on Equity Valuation

Larry Fauver and Michael B. McDonald IV

Joshua Dopkowski Gustavo Martinez

Sonoma State University, EMBA C5

Overview

• Introduction

• Terms

• Strategy

• Hypothesis

• Conclusion

Introduction• Do social attitudes towards sin stocks have an impact on

the equity values of firms producing these goods?

• Past work has generally examined sin stocks in only one nation at a time and assumes that all cultures regard sin stocks similarly; a uniform definition of sin.

• This assumption is likely wrong given cultural differences.

• The article develops an empirical method to distinguish the attitudes of different nations and then apply this method to show how the differences in social attitudes manifest through the valuation firms.

Terms

• G20 Nations – 20 nations selected by their significance in the world economy.

• World Values Survey (WVS) – started 1981, biennial survey of thousands of citizens, 97 nations, hundreds of questions (measure morality)

• Sin Stock – Tobacco, Alcohol, Gambling and Weapons

• Arbitrage - the practice of taking advantage of a price difference between two or more markets

Terms• American Depositary Receipt (ADR) – A negotiable certificate

issued by a U.S. bank representing a specified number of shares in a foreign stock that is traded on a U.S. exchange.

• Sin Stock Dummy – stock of a company either directly involved or associated with activities considered to be unethical or immoral.

• Tobins’Q (Q Ratio) – the combined market value of all the companies in the stock market should be about equal to their replacement costs.

Q Ratio= Total Market Value of Firm Total Asset Value

Strategy • Classification of Sin and Non-Sin nations.– Use of WVS in G20 to determine social views of

Sin in all 20 nations.– Composite Measure: Legal, Social, Consumption

• Hypotheses & Data – Three Hypotheses– Tobin’s Q

• Results & Conclusion

Number of firms and potential sin firms in G20 nations.

United States

United Kingdom

Russia Japan France Germany Canada Australia China0

20

40

60

80

100

120

Hypothesis 1

• Sin firms will have lower valuations in sin countries than in non-sin countries.– Result: a sin stock in a nation where these firms

are shunned have a Tobin’s Q that is .067 lower than comparable non Sin Firms.

– This leads to a statistically and economically significant 7.8% decrease in firm valuation.

Hypothesis 2

• Lower valuation in sin stock nations lead to higher equity returns in sin vs. non-sin nations.– Result: when all the industries are combined using sin

stock measure based on social norms, there is a significant aversion to these stocks that leads them to have excess returns.

– This supports hypothesis 2 and the view that differences in returns between sin stocks in sin nations and non-sin nations are significant and are likely driven by social norms between these types of countries.

Hypothesis 3

• Differences in equity returns are either arbitraged away over time or persist due to restrictions with international capital flows.– Results: The coefficient on the ADR is larger than

the coefficient on the industry variable suggesting that the benefits of having an ADR on average fully offsets the negative impact of being a sin stock in a country where social norms cause the stock to be poorly regarded.

Cross-Listing

Conclusion

• In nations where sin stocks are considered sinful, the average sin firm’s Tobin’s Q is 8% lower than that of the average non sin firm.

• In nations where sin stock are not considered sinful, the difference in Tobin’s Q between sin and non-sin firms is insignificant.

• It is important to take into account the differences in social and cultural traits, and how those differences affect investment distortions in certain industries.

It Costs Money To Believe In Sin

International Variation in Sin Stocks and its Effects on Equity Valuation

Larry Fauver and Michael B. McDonald IV

Gustavo MartinezJoshua Dopkowski