The AIOC’s Stock Market reaction to nationalisation: Event Analysis and empirical results


Oil Nationalisation and Managerial Disclosure: The Case of Anglo-Iranian Oil Company, 1933-1951

Chapter 5: The AIOC’s Stock Market reaction to nationalisation: Event Analysis and empirical results



This chapter examines the AIOC‟s stock market reaction to nationalisation. As
previously discussed in Chapter 2, the AIOC operated in Iran on the basis of a concession for oil drilling rights granted by the Iranian Government and thus the company had the most noticeable and strongest British government connections, because it was dealing with a strategic asset in a strategic area. From 1947 onwards the renegotiation of the concession became a source of dispute between the AIOC and successive Iranian governments. The difficulty in reaching a reasonable solution that satisfied both parties was the precursor to the Bill approving the nationalisation of the AIOC‟s major assets by Musaddiq in May 1951. As a consequence, the impatience of political groups opposed to the company‟s domination of the country‟s oil resources intensified, providing momentum to Musaddiq‟s National Front coalition and the passage of the nationalisation act. Behind the scenes meanwhile, the AIOC worked closely through its channels of influence to undermine Musaddiq, including the abortive coup that preceded the successful one carried out by the CIA in 1953. These events worsened the relationship between Iran and AIOC, and the company never regained its previous influence in Iran. From the point of view of the AIOC and its shareholders, nationalisation would
appear to be explicitly bad news that implied a serious failure in the company‟s policy. In the months following nationalisation, however, the AIOC management, in public pronouncements at least, displayed confidence about the subsequent recoverability of the lost assets. Such confidence was potentially well grounded. Working through international legal and political institutions, and in Iran, through the Shah and other institutions, including the parliament (Majlis), the media and police, the AIOC exercised considerable influence in the period prior to nationalisation. Meanwhile in the shorter run, a further reason for the AIOC‟s confidence was its control of the oil industry through resources not subject to nationalisation legislation, such as technical expertise and control over refining, tankers and other distribution channels. This chapter therefore examines how two key events associated with the nationalisation were perceived by the London Stock Market. These were the nationalisation itself on 1st May 1951, a major theme running over a longer course in the 1950‟s, and the publication of the AIOC annual report on 16th November 1951, which influenced shareholders‟ confidence regarding their investment in the company. The response of the London‟s Stock Exchange to nationalisation and to the information content disclosed by Fraser to the AIOC investors is important for several reasons. Firstly, as illustrated in the previous chapter, around 80% of the company‟s operational assets were affected by nationalisation. Secondly, from a range of evidence arising from the AIOC annual reports and historical sources including the British press, it can be clearly seen that Fraser regarded the shareholders‟ interests to be superior and taking preference over the interests of Iranian and other stakeholder groups. Thirdly, the first annual report to be published post nationalisation, 1950, was delayed so that Fraser and his advisors could draft a convincing response to the nationalisation, consistent with representing shareholders as being protected by international law. Finally, and perhaps most importantly, there is the possibility that the market priced shares according to sources beyond those immediately communicated by the company and the financial press. For example those with a detailed knowledge of the company‟s operation and diplomatic situation might have concluded that Musaddiq‟s medium- term position was very weak, notwithstanding the popular reaction in Iran to the nationalisation event itself. To assess the potential threat to the AIOC‟s assets posed by the nationalisation legislation of May 1951, this chapter aims to evaluate the relative bargaining strength of the AIOC and Musaddiq‟s government in economic terms. To do so, it uses an event study methodology, comparing the stock market response with key events in the political negotiation calendar preceding and subsequent to the nationalisation. The AIOC stock price is used as a barometer to test the extent of belief in the longrun durability of the nationalisation act, factoring in the relative strength of the political positions of both sides. Event studies involve constructing indices of relative share price performance
around specific events and testing the statistical significance of their impact from an information and economic value point of view. Event studies are popular in various fields including accounting, finance and management, but nevertheless have not been widely applied in historical research. Nonetheless, historical analysis should feature prominently in empirical accounting research, a major motivation behind this analysis.

The importance of this investigation is threefold. Firstly, this examination
provides the opportunity to assess the economic impact of nationalisation within a political context where studies linking stock market reaction to political events are rare. Secondly, this investigation is useful in evaluating and analysing the information content of annual report disclosure during the company‟s nationalisation (which was by all accounts a major political crisis during that era). Finally, this study gives indications of the level of market efficiency and tests how good the market is at anticipating bad news. The structure of the chapter is as follows. Section 1.2 sets up the event study methodology with emphasis on the reasons behind its choice, then giving an explanation of the test procedures and the determinants of market efficiency. This section also discusses the market data used in more detail, followed by an explanation of the FT30 Index and the AIOC return index. Finally, the section explains the market adjusted model and outlines the hypothesis for testing. Section 1.3 presents the historical background for the major events leading to significant and insignificant losses in Iran during the 1950‟s, defines the event window and provides statistical evidence illustrating the stock market reaction of the AIOC during the political crisis. Finally, section 1.4 draws conclusions and summarizes the findings.

The impact of nationalisation on the AIOC has been the subject of considerable debate among different scholars and this has provided motivation for this thesis to study its economic impact on the AIOC‟s security value, market efficiency and social welfare. The following section reviews event study methodology and market efficiency, highlighting their importance and the assumptions underlying their application. 5.2.1

Event Study
Since Ball and Brown (1968) and Fama et al. (1969), event studies have become a major part of empirical research in finance and many other disciplines. Indeed, event studies have been used in multiple settings[662]. McWilliams and Siegel (1997) argued that the event study method is a powerful tool that can help researchers assess the financial impact of changes in corporate policy. Furthermore, the event study obviates the need to analyze accounting-based measures of profit. Event studies use financial market data to assess the impact of specific events on the value of the security. They provide an ideal tool for examining the information content of disclosures[663], and also act as a direct test of market efficiency[664]. Given the rationality of the efficient market and the immediate impact of an event on security prices, an event‟s economic impact can be constructed using stock prices over a short period of time[665]. The event study method has become popular because it responds to the need to analyze stock prices to reflect the true value of firms by incorporating all the relevant information. Furthermore, the method is relatively easy to implement, because the only data necessary are the names of publicly traded firms, event dates, and stock prices. Yet, there are demerits of using event study methodologies in assessing the financial impact of changes in corporate policy. For instance, the event study method has been criticised for not being a very good indicator of the true performance of the firms. Moreover, there are measurement problems associated with the difficulty of observing true stock prices and market index levels at the end of short measurement intervals. The sample used in event studies will typically be non-random and correcting for thin-trading may affect the results[666]. Furthermore, benchmark parameters are sometimes computed unconditionally without excluding the estimation and test period and then the estimated parameters will be biased[667]. However, it is well established that the event study method is a useful tool which has its own merits. It depends heavily on a set of rather strong assumptions[668] that are reviewed below:

(a) Markets
are efficient Fama[669]
asserted that the “cleanest evidence on market efficiency comes from
event studies, especially event studies on daily returns”. He explained that event studies can give a clear snapshot of the speed of adjustment of prices to information through the abstracts from expected returns to measure abnormal daily returns. Market efficiency implies that stock prices should incorporate any financially relevant information that is newly revealed to the market. It does this by identifying the period over which the impact of the event will be measured, which is commonly known as the “event window”.

(b) The event was unanticipated
The second assumption is based on the idea that the market previously did not
have information on the event and traders gained information from the announcement. Security prices may not adjust or anticipate the event beforehand and consequently the security prices will not adjust before the event date and may take a longer period to fully reflect the event‟s information, even after the “event date”. Therefore, there is a possibility that the market price shares according to sources beyond those immediately communicated by the company and the financial press.

(c) Confounding Effects
The third assumption is perhaps the most critical assumption of the event study methodology; it is based on the impact of confounding events during the event window. By looking at a series of events, there is a confounding event problem because of the difficulty involved in measuring the impact of managerial decisions[670]. Therefore, it is crucial to control for the effect of confounding effects to avoid uncertainties about the validity of the empirical results and conclusions drawn. For instance, declaration of dividends is considered to be a major confounding event which might have an impact on the share price during an event window. Thus, the event study method was developed to measure the effect of an unanticipated event on stock prices. Using the event analysis method enables the researcher to assess the extent to which security price performance around the time of the event has been abnormal[671]. Therefore, the impact of an event can be investigated by measuring the security‟s return over the event date to enable us to compute the difference between the observed return on the event and the expected return before and after the event date. Any significant difference will be interpreted as an abnormal return or loss. With the determination of abnormal returns, the researcher can infer the significance of the event in order to assess managerial decisions and trace the course of managerial behaviour[672]. In a nutshell, these abnormal returns are assumed to reflect the stock market’s reaction to the arrival of new information.

662. For example, in accounting, see Toms, Information content of earnings in an unregulated market: The cooperative cotton mills of Lancashire 1880-1900; in management, see McWilliams and Siegel, Event studies in Management research: Theoretical and Empirical issues; in economics and finance, see Mackinlay, Event studies in Economics and Finance.

663. Mackinlay, Event studies in Economics and Finance, 16.

664. Brown and Warner, Measuring security price performance, 205.

665. Mackinlay, Event studies in Economics and Finance, 13.

666. Strong, Modelling abnormal returns: a review article, 542-544.

667. Ibid, 539.

668. Brown and Warner, Measuring security price performance; Brown and Warner, Using daily stock

669. Fama, Efficient capital markets: II, 1607.

670. McWilliams and Siegel, Event studies in Management research: Theoretical and Empirical issues, 639.

671. Brown and Warner, Measuring security price performance, 205.

672. McWilliams and Siegel, Event studies in Management research: Theoretical and Empirical issues, 626.



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