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The Return and Volume Effects of Political-Risk Event on Foreign ...

The Return and Volume Effects of Political-Risk Event on Foreign ...

ong>Theong> ong>Returnong> ong>andong> ong>Volumeong> ong>Effectsong> ong>ofong> ong>Politicalong>-ong>Riskong> ong>Eventong> on Foreign JointVentures: Evidence from the Tiananmen Square CrisisABSTRACTThis research examines how political risk events affect the value ong>ofong> foreign investing firms.A unique event, the Tiananmen Square Crisis, is selected to examine this issue since we believethis Crisis exacerbates the political risk ong>ofong> doing business in China. We examine the impact ong>ofong> theCrisis on the stock returns ong>andong> trading volumes ong>ofong> U.S. firms with joint ventures in China. ong>Theong>results show that this Crisis indeed had a significant impact on U.S. firms with joint ventures inChina ong>andong> the market had reacted to this event in an efficient manner. ong>Theong> results also indicate theimpact ong>ofong> this Crisis on U.S. firms is relatively small in magnitude. Further, the sharp increase ong>ofong>joint ventures after the Crisis ong>andong> the significant results in high-risk group vs. the insignificantresults in low-risk group provide evidence suggesting that the effect ong>ofong> this Crisis is temporaryrather than long-term ong>andong> regional rather than national.i

ong>Theong> ong>Returnong> ong>andong> ong>Volumeong> ong>Effectsong> ong>ofong> ong>Politicalong>-ong>Riskong> ong>Eventong> on Foreign JointVentures: Evidence from the Tiananmen Square CrisisI. Introductionong>Theong> main purpose ong>ofong> this study is to examine the impact ong>ofong> political risk event on the valueong>ofong> foreign investing firms. In this study we choose a unique event, the Tiananmen Square Crisis(Crisis hereafter), as a proxy for the political risk ong>andong> examine the impact ong>ofong> the Crisis on thevalue ong>ofong> U.S. firms with joint ventures in China.ong>Theong> term "political risk" is defined as unanticipated government actions that have asignificant impact on business operations (Fitzpatrick, 1983 ong>andong> Simon, 1982). Other studies havedefined political risk as the ramifications on foreign investing firms caused by environmentalchanges such as acts ong>ofong> strikes, violence ong>andong> riots (Robock, 1971). Those two definitions aresometimes interdependent in which environmental changes can prompt government actions as muchas government activities can provoke environmental changes (Sethi ong>andong> Luther, 1986).ong>Theong> impact ong>ofong> political risk on the safety ong>andong> prong>ofong>itability ong>ofong> foreign direct investments isong>ofong>ten far greater than the normal cost disadvantages associated with overseas investments. This isespecially true in the previously centralized-economy ong>andong> communist countries. Models ong>ofong>political risk assessment, such as the political economy model (Sharma ong>andong> Gellenthien, 1992) ong>andong>the subjective business risk model (La Fabette, 1990), appear to concur in their predictions thatex-communism economies tend to have a considerably higher level ong>ofong> political risk than othertransitional economies.Several studies have identified the elements ong>ofong> political risk concerning foreign directinvestments in China.First ong>ofong> all, China has a greater degree ong>ofong> political instability ong>andong>1

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