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The effects of war risk on managerial and investorbehavior: Evidence from the Brussels Stock Exchange in

the pre-1914 era

Gertjan Verdickt

May 15, 2019

Gertjan Verdickt The effects of war risk May 15, 2019 1 / 27

The Uneasiness in Europe

The general beliefs of Europe that war is improbable this year is probablywell founded ... but we should be wanting in our duty if we did not point

out that some lowering clouds are settling over Europe(The Economist, July 1887)


The French declaration of war against Madagascar

The English have no right to prevent the French from conqueringMadagascar if they can. . . . It is natural, therefore, that the British

should sympathize with the Malagasy in the coming war.(The Economist, November 1894)


Motivation

Newspaper archives are a detailed source of narrative history

Measuring disaster risk is a challengeI Using the start of the crisis misses the buildup to the eventI Difficult to continuously track changes in risk

Solution: Use The Economist as proxy of European news coverageI Turn to the build-up to the First World War as the risk playgroundI Focus on the Brussels Stock Exchange (BSE)

Do manager mitigate war risk?How do investors respond to a rising threat in war?


Previous literature

Dividends:

Dividends were a key information channel (Braggion Moore, 2011)

Dividend cuts have a negative impact on prices (Turner et al. 2013)

What about the threat of war?

War threat:

Risk premia of Japanse bonds increase (Sussman et al, 2000)

War has a negative effect on prices (Berkman et al, 2011)

What with international evidence?


A unique time period

January 1885 - June 1914

Characterized as a period of ”mounting tension”

Changing alliances and intensifying arms race

Exogenous to economic environment and business cycle behavior

Globalization reached peak levels before World War I

News dissemination: no internet, TV, telegraph,...

British newspapers were sold in Europe and the US



Belgium was always neutral in military conflicts ....BUT:

Trade accounted for more than 80pct of GNP

Highest increase in exports in Europe

BWP had trade as one of its key items on the program

Foreign companies paid in stocks for their export



Brussels Stock Exchange

One of the first countries to industrialize in Europe

Large inflow of (foreign) capital and investors

Downside: vulnerable to (military) shocks abroad

Top 10 of largest stock exchanges in the world

Diversified in terms of sectors

Stock listings from 26 different countries


War risk measure

Monthly count of war-related articles

”War” or ”Military”I THREAT : “risk” “concern” “uncertain” “threat” ”fear” “tension”I ACT : “invasion” “start” “beginning” “battle” ”army” “outbreak”

Articles must also discuss, at least, one country:I A main trade partner of BelgiumI A large number of foreign stock listings

In practice: BEL, FRA, GER, ITA, NL, SPA, RUS and UK


War risk measure


War risk measure

Choice of words

Uni- and bigram analysis of 4 books on World War 1

Following Caldara and Iacovello (2018)

Audit studyI Total number of articles 100,803I Number of articles in selected sections: 68,064 (67.52 pct.)I Relevant articles: 2,249 (2.36 pct.)

Robustness test for other words: +-98 pct. are in WRMsI Mobilization: 5 additional articlesI Danger: 28 additional articlesI Attack: 4 additional articles


War risk measure

Why for The Economist?

Weekly magazine

One glossary

Quality and depth

Key assumption

The Economist is a good proxy for European war news coverage

I do not require investors read The Economist

Crafts and Mills (2013) and Ferguson (2006)


Research question

1. How do firms mitigate the effect of war risks?2. What is the impact of a rise in war risk on stock prices?


Methodology

Regression model:

Yt = α + βThreatt + βActet + βXt + εt

where Y is dividend growth

Act is the residual from Threat regression

where X are control variables


Dividend policy

Pooled regression and panel with sector and country fixed effects

*, **, and *** represent significance at the 10pct, 5pct and 1pct


What do managers do?

Is dividend policy adjustment a spurious finding?


Equity IPO



Bond IPO



Stock delisting



Research question

1. How do firms mitigate the effect of war risks?2. What is the impact of a rise in war risk on stock prices?


Methodology

Predictive regressions:

Yt,t+h = α + βThreatt + βActet + βXt + εt

where Y is expected returns

Act is the residual from Threat regression

where X are control variables


Expected returns

Pooled regression through GMM procedure

*, **, and *** represent significance at the 10 pct., 5 pct. and 1 pct.


Local or global effect?

Are other countries affected by war risk?


Other European countries

Panel data with sector and country FE


Includes Austria, Luxembourg, Greece, Servia, Portugal and Poland


Non-European countries

Panel data with sector and country FE


Includes Argentina, Brazil, Cameroon, Canada, China, Congo,...


Key take-aways

War risk does matter!

Managers mitigate war risk:

They adjust dividend policy

They postpone key firm financing decisions

Foreign firms more likely to delist

Investors respond to war risk:

Countries that are mentionedI Threat: Mean-reversionI Act: Negative drift

European countries that are not mentioned:I Threat: No relationshipI Act: Proximity to conflicts


Still relevant?


Questions?


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