Stock market reaction to FDI announcements : evidence from the Israeli Stock Market

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Master Thesis

Stock Market Reaction to FDI Announcements:

Evidence from the Israeli Stock Market

Gil Gershfeld

Student Number: 11081813

Supervisor: Dr. Florian Peters

Master in International Finance

University of Amsterdam, Amsterdam Business School

August 2016

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Acknowledgments

I would like to express my deepest gratitude to Dr. Douglas van der Berghe for allowing me use the database of Investment Consulting Associates for the purpose of conducting this research and for giving me the time to work on it during my internship. I am also very thankful to my supervisor Dr. Florian Peters who guided and supported me from the very start of this research.

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Abstract

Foreign Direct Investments (FDI) has grown rapidly since the early 1980’s becoming an important source of private foreign finance for developing countries. The causal relationship between FDI, economic growth and the stock market documented in the literature implies that (1) FDI stimulates economic growth (2) economic growth exerts positive impact on the stock market and (3) the implication is that FDI is likely to promote a positive stock market development. In this paper, I estimate the stock market reaction to FDI announcements by examining the immediate market movements of the Israeli stock market following 72 FDI announcements of foreign companies for a time span of thirteen years. The results of my analysis indicate that the market reacts negatively mainly to FDI announcements of technological companies, well-respected companies and for large CAPEX announcements. Even though the negative market reaction to FDI announcements might be counterintuitive at first, it could be explained simply by the notions of competition and market efficiency. If foreign investments are to create more competition for Israeli listed companies and erode their future profits, then, due to market efficiency, we should expect to see that the stock prices of the Israeli companies go down at the moment of the announcements. Of course, on the aggregate level, this should be translated to an overall negative market reaction. In addition, I also find that my results vary at times of economic growth and decline and for the time period before Israel became an OECD member and afterwards.

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Foreign Direct Investments (FDI) has grown rapidly since the early 1980’s becoming an important source of private foreign finance for developing countries. It is different than other external sources of private capital in that it is driven mainly by investors’ long-term prospects for making profits in productive activities. In contrast, foreign bank lending and portfolio investments are often motivated by short-term profits and are more influenced by short-term variables (e.g. interest rate changes). Though FDI is an important economic factor for all countries, it is especially important for developing countries as it is a way of transferring production technology, skills, innovative capabilities, and managerial practices between developed and developing countries (Mallampally & Sauvant, 1999).

FDI is defined as an investment made to acquire lasting interest in enterprise operating outside the economy of the investor. Furthermore, the investor’s purpose is to gain an effective voice in the management of the enterprise (Balance of Payments Manual, 1993). Some degree of equity ownership is almost always considered to be associated with an effective voice in the management of an enterprise; the IMF (International Monetary Fund) suggests a threshold of 10 percent of equity ownership to qualify an investor as a foreign direct investor.

Historically, there has been a quite a lot of controversy regarding the role of FDI in promoting economic growth. Up until the 1980’s, many foreign companies received a hostile welcome in host countries and were blamed for many domestic national problems (Lall, 2000). In recent years, with growing economic globalization, the positive attitude towards FDI has improved and it is nowadays been considered one of the most important drivers for economic growth and development (Tripathi, Seth, & Bhandari, 2015). Nevertheless, there is still some controversy in the literature regarding the exact role of FDI in promoting economic growth.

Most of current research on FDI focuses on its effect on economic growth and its long-run co-integration with the stock market. The causal relationship between FDI, economic growth and the stock market documented in the literature implies that (1) FDI stimulates economic growth (2) economic growth exerts positive impact on the stock market and (3) the implication is that FDI is expected to promote positive stock market development (Faez, Parvarinejad , Orooei, & Lajevardi, 2014).

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In this paper, I measure the immediate reaction of the stock market to FDI announcements. The economic intuition for doing so goes as follows. Based on the efficient market hypothesis, we know that prices of stocks (and of stock markets) should reflect all available information (and in its semi-strong form, this should be done quite rapidly). Therefore, one could assume that the effect of FDI announcements of foreign companies should be reflected in the prices of not only the foreign companies themselves, but rather also in the prices of all of their competitors, suppliers, and in essence, in the price of any company that its future cash flow is likely to be affected by the announcement. The magnitude and significance level of the reaction should be the results of the size of the project, the number of expected jobs it would create, or other variables. One should expect to see a positive reaction, as we know that foreign investments are likely to promote economic growth and positively affect local companies.

Nevertheless, there could also be a possible negative market reaction to FDI announcements. In case the foreign investment would create more competition for local companies and erode their expected future profits, then one should expect that their market prices would go down following the announcement. If the foreign companies are large enough to affect the local stock market, then we should see an overall negative market reaction to FDI announcements.

It is important to bear in mind that a market reaction is not likely to be detected in the stock market of any host country. In large enough stock markets, the market reaction is likely to be swallowed up because of the high trading volumes and the daily number of transactions. Therefore, when trying to measure the market reaction to FDI announcements, is it crucial to use a relatively small stock market with limited number of daily transactions, such as the Israeli stock market.

Moreover, it is also important to use a relatively developed and efficient stock market. As discussed previously, this paper is built upon the assumption that markets are efficient. This is a necessary assumption in order to see if markets are indeed affected immediately following FDI announcements.

The rest of this paper is organized as follows. Section II covers the theoretical framework. It begins with the literature review, then it continues with a short background on the Israeli economy and lists the main hypotheses. Section III describes the data used in this research. Section IV presents the empirical analysis and

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results. In section V, I discuss the limitations of the research, and suggest possible extensions. Finally, section VI concludes the paper.

II. Theoretical Framework

This paper examines whether companies’ FDI announcements lead to an excess return in the Israeli stock market. It is therefore build upon three main groups of studies; the effect of FDI on economic growth, the relationship between economic growth and the stock market and finally, the combination between the two - the relationship between FDI and the stock market.

In addition, in the end of this section, I give a short introduction to the Israeli economy and its most important sectors. As well, I discuss briefly the potential consequences of Israel joining the OECD in September 2010 and present the main hypotheses.

Literature Review

The Effect of FDI on Economic Growth

The vast literature on FDI and development has not been completely decisive. Until the 1980s, the general approach in developing countries reflected considerable suspicion and reservation towards FDI. Foreign companies have encountered hostility and resentment in many countries that host foreign investments, but especially in Least Developed Countries (LDC), where they were blamed for the national economic problems, and were associated with the historical sins of colonial domination (Lall, 2000) and (Caves, 1982). In later years, nevertheless, the debate has faded away. By the beginning of the 1990’s, the attitude towards FDI has changed. Foreign investments received a warm welcome by both the academic development literature and by part of the national governments that were traditionally hostile towards FDI.

There are a few possible explanations for this change in attitude. First, the experience of a few successful developing countries relying heavily on foreign investments, while others restricted FDI and failed, led to rethinking of the role of FDI in developing countries. Moreover, the more advanced developing countries had the ability to absorb cutting-edge technological transferred by the foreign companies, and to attract R&D investments. This changed the behavior of foreign companies themselves. They started investing in more advanced technologies and opened R&D facilities in developing countries, which helped to improve the way foreign

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investments were perceived in the developing countries. (Lall, 2000). Second, the Asian financial crisis, in the late 1990’s, showed that FDI was a more stable and long-term source of income for developing countries in difficult periods than other forms of capital (Lall, 2000) and (Kirabaeva & Razin, 2009).

In recent years, with growing economic globalization, the positive attitude towards FDI has improved even further. FDI is nowadays been considered one of the most important drivers for economic growth and development (Tripathi, Seth, & Bhandari, 2015). Foreign investments have been proven to be an important vehicle for the transfer of technology, contributing relatively more to growth than domestic investments (Borensztein, De Gregorio, & Lee, 1998). Nevertheless, the causality between FDI and economic growth is not completely clear.

On the one hand, there is a vast evidence for the positive effect of FDI on economies worldwide. Guoming & Bing (2005) looked at the spillover effects of FDI on innovation capability in China and found positive effects of FDI on number of domestic patent applications. Also, Cheung & Lin (2004) showed that FDI can benefit innovation activity in the host country via spillover channels such as reverse engineering, skilled labor turnovers, demonstration effects and supplier-customer relationship. Ke (2005) has also showed that there are more positive effects on China’s economy than negative ones. Agrawal (2015) investigated the long-run equilibrium relationship between FDI and economic growth in the BRICS economies and found a positive significant relationship. Thus, showing the FDI, indeed, leads to economic growth.

On the other hand, Chakraborty & Basu (2002) used structural co-integration model with vector error correction mechanism and found that GDP in India is not Granger caused by FDI; the causality runs from GDP to FDI and not the other way around. Similarly, Chakraborty, Chandana, Nunnankamp & Peter (2006) showed that the growth effects of FDI in India vary widely across sectors and is even cannot be detected in some. Investing FDI and domestic investment (DI) at Sub-Saharan Africa for the period of 1990-2003, Adams (2009), found that DI is positive and significantly correlated with economic growth in both OLS and fixed effects estimation; however, FDI is positive and significant only in the OLS estimation.

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The Relationship between the Stock Market and Economic Growth

The link between the stock market and economic growth has been a long source of debate in economic literature. Already in 1891, Bohm Bawerk pointed out that capital markets play an important role in promoting economies (Hongbin ). Historically, economists focused mainly on banks (instead of on capital markets). Bagehot (1873) and Schumpeter (1912) emphasized the importance of the banking sector in economic growth and highlighted the circumstances of which banks can encourage innovation and future economic growth. In contrast, Lucas (1988) stated that economists over-stress the role of the financial system in promoting growth (Levine & Zervos, 1996).

In the past 30 years, economists have tried to empirically examine this question. King & Levine (2003) presented evidence consistent with Schumpeter’s view that the financial system can promote economic growth and that the level of financial intermediation is a good predictor for long-run rates of economic growth, capital accumulation, and productivity improvements. Levine & Zervos (1996) using a cross-country growth regression, found a strong empirical association between stock market development and long-run economic growth. Hongbin used co-integration and causality analysis and found evidence for positive and significant causal relationship between stock market developments and economic growth in the long-term in China. Gayathri & Kakaivani (2014) have also found positive relationship between stock market growth and economic development in developing countries.

The Relationship between FDI and the Stock Market

Several researchers have already tried to explore the relationship between foreign direct investments and financial markets. Alfaro, Chanda, Kalemli-Ozcan, & Sayek (2003) used a cross-country data between 1975 and 1995 and showed that FDI alone plays an ambiguous role in contributing to economic growth. Nonetheless, they showed that countries with well-developed financial markets gain significantly from FDI. ARČABIĆ, GLOBAN, & RAGUŽ (2013) investigated the existence of both long and short-term relationships between FDI and the stock market in Croatia using a co-integration analysis and a two-variable VAR model. They found no evidence for a long-run relationship, however, they did prove that the stock market to be an important short-term factor of FDI. Faez, Parvarinejad, Orooei & Lajevardi (2014) also used a co-integration approach to investigate the role of FDI on the stock market

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in Iran. They found that one percent increase in foreign direct investment is associated with 0.409 percent increase in market capitalization in the host country. Baker,Foley & Wurgler (2004) examined whether and how stock market mispricing affects FDI. Their empirical results support the cheap capital view1: FDI flows are unrelated to host country stock market valuations, as measured by the aggregate book-to-market ratio, but are strongly positively related to source country valuations.

A Short Introduction to the Israeli Economy

Israel is a well-developed technology-advanced market economy. It is ranked number 40 worldwide in the Gross National Income Per capita of the World Bank with a GNI of $35,400 per capita2. It also has a consistent high ranking in terms of technological readiness, venture capital availability and the quality of its research institutes (The Israeli Economy Today).

The employment rate has increased steadily over the last 13 years, since 2007, exceeding the OECD average (see figure 1). The economy is growing in a moderate rate for 13𝑡ℎ consecutives years. Nevertheless, the rate of real GDP growth per capita has fluctuated quite a lot over the years, including even a short period of negative growth following the financial crisis. The slowdown in real GDP per capita in recent years (see figure 2) is likely to be a consequence of weaker exports and investments, partly due to the appreciation of the Israeli Shekel since 2012 (Giorno & Jarrett, 2016).

An interesting artefact about the Israeli economy is that it is known to be an industrial economy with the majority of its manufacturing, including many traditional fields, based on cutting-edge, sophisticated research and development (R&D) and high-tech process. The Israeli high-tech sector and its innovation spirit plays an important role in the Israeli economy leading to that Israel spends more on R&D than any other OECD country as a percentage of GDP (see figure 3).

According to an Ernst & Young report from 2014, the high-tech and life science industries have a vital importance for the Israeli economy, accounting for more than 50% of Israel’s export. Moreover, Israel is ranked in the fifth place

1_{The cheap capital theory views FDI flows as a natural use of relatively low cost capital available to}

overvalued firms in the source country.

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worldwide in VC’s & PE investments in high-tech companies, larger than any other European country.

Therefore, it seems logical to assume that if the high-tech sector plays such an important role in the Israeli economy, so would be the relative importance of foreign investments in Israeli high-tech companies out of all foreign investments in Israeli companies. Thus, we can speculate that the effect of FDI announcements on the Israeli stock market is driven mainly by FDI announcements of high-tech companies.

As can be seen in figure 2, in recent years, Israel has experienced periods of decline in real GDP growth and periods of surge in real GDP growth. It is therefore interesting to investigate whether the effect of FDI announcement on the stock market is different in periods of a decline in GDP growth compared to periods of an increase in GDP growth. More specifically, macroeconomic news is known to have a stronger impact on companies’ cash flow and earnings expectations during a recession as compared to expansions (Kreutzmann, 2010) and (Hess & Kreutzmann, 2009). As FDI can be considered as a macroeconomic variable, one can postulate that FDI news (announcements) have also a stronger impact on stock market during times of recession.

Israel Joins the OECD

The organization for Economic Co-operation and Development (OECD) was established on 30 September 1961 after the US and Canada joined the Organization for European Economic Cooperation (OEEC)3 in signing the new OECD convention. In 1964, Japan was the first country to join the OECD. Currently, there are 35 member OECD countries worldwide, and there are many others, such as Colombia, Latvia and Costa Rica that are eager to become a member. Most of the member states are considered to be developed economies, however, also a few emerging economies are part of the organization like Chile, Mexico and Turkey (About the OECD, 2016). In essence, one could see the membership in the OECD as an inflection point that distinguishes the developed economies from the developing ones.

In order to become a member of the OECD, a country must meet certain international standards and requirements which in turn leads to it been potentially

3_{The OEEC was established in 1948 to manage the Marshall Plan for the reconstruction of Europe}

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seen as more attractive recipients for foreign investments (Iglesia, 2015). Additionally, according to the Secretary-General of the OECD, member countries can compare and exchange policy experiences, identify good practices and improve their economic performance. Thus, joining the OECD can be viewed as a signal for the creditworthiness of the economy, and one could expect that a country that is becoming an OECD member is likely to experience an increase in its foreign investments.

The open discussion with Israel for its membership in the organization began in May 2007. Thereafter, eighteen different committees reviewed Israel’s position on OECD legal issues and the degree of coherence of policies with those of OECD member countries. Israel has officially become an OECD member country on September 2010 in signing the OECD convention.

Following the above the discussion, it is interesting to investigate whether the acceptation of Israel into the OECD in September 2010 had any influence on the importance of foreign direct investments on the Israeli stock market.

Hypotheses Development

The unique characteristics of the Israeli economy and the different economic cycles that Israel has experienced in the last fifteen years might alter the effect of FDI announcements on the stock market. We therefore should isolate and investigate those features using a few different hypotheses.

As a consequence of the importance of the high-tech sector to the Israeli economy, we examine in the first hypothesis the effect of FDI announcements by technological companies. The second hypothesis explores the effect of different economic cycles on the stock market following FDI announcements. Whereas, the third hypothesis, considers whether there is a change in the market reaction before and after Israel joined the OECD.

HI: The effect of FDI announcements on the Israeli stock market is driven by

announcements of technological companies

HII: The effect of FDI announcements on the Israeli stock market is stronger during

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HIII: There is a significant difference in the effect of FDI announcements on the

Israeli stock market before the period Israel joined the OECD and after.

III. Data Sample Period

This paper covers 72 announcements of foreign direct investments in Israel occurred within 13 years starting from January 2003 and ending in December 20154. The sample period starts when the first FDI announcement in Israel was recorded in the database and ends when the last FDI announcement was recorded. It covers the time period of 9 years and 8 months before Israel has become an OECD member, and another 5 years and 4 months after the acceptance of Israel into the OECD.

The Primary Source of Data

The primarily source of data for this is paper is fDiMarkets.com, part of the fDi intelligence portfolio (a division of the Financial Times). The database is used by government departments involved in investment promotion, multinational companies, consultants and academics to assess and analyze global and local FDI’s trends. It is a chief bank of information on the globalization of companies, and it tracks cross border Greenfield investments across different sectors and countries worldwide. The database also allows to conduct different type of FDI analysis, such as the number of investment projects, jobs created due to FDI projects and the capital invested (fDiMarkets/About us, 2016).

The database tracks cross border investment in a new physical project or an expansion of an existing investment which have created new jobs and/or capital investment. Joint ventures were only included in the database if they led to a new physical operation (i.e. actual investment that have taken place, not only an agreement for collaboration between two enterprises). The database does not cover Mergers & Acquisitions (M&A) and other sources of equity investments.

The data included in the fDiMarkets.com database is collected in real time (when an announcement by a given company has taken place) and goes through a rigorous control process before being publish at the end of every month. The information on capital investments and jobs created associated with an FDI project is

4_{As will be explained below, the database includes 177 announcements; however, I could only find}

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a potential caveat as companies do not always publish the information regarding these two variables. FDiMarkets.com conducts a proprietary econometric model in order to estimate the amount of capital invested and/or jobs created in case the information on the two is not released as part of companies’ FDI announcements.

The main problem of the database is that it only provides monthly information on companies’ FDI announcements (i.e. it only provides a month and a year – not the exact day of the FDI announcement). This is extremely problematic since one needs the exact day of the announcement in order to measure the exact market reaction to it. In order to find exact announcement dates, I used a Bloomberg terminal. The terminal enabled me to go over each and every announcement that was recorded in the database, and to pinpoint its exact date and hour. In the original database there are 177 announcements, however, using the Bloomberg terminal, I could only find the exact dates of 72 announcements.

In order to control for the level of recognition of and respect for the different companies, the dummy variable “famous” was created. The idea is that FDI announcements of well-recognized and respected companies are more likely to cause a market reaction in the host country (irrespectively of industry, investment size or the number of jobs that the FDI project is expected to create). The variable was created using the annual ranking of Fortune, which ranks the world’s 100 most admired companies (see table 3). The dummy variable takes the value of 1 in case the FDI announcement is by a company that is part of the list and 0 otherwise.

In addition, daily returns for all indexes; Tel Aviv 25, Tel Aviv 100, NASDAQ, Dow-Jones and the S&P 500 were collected via Yahoo Finance.

IV. Empirical Analysis

The methodology used in this paper is motivated by Zussman and Zussman (2005) where the authors used stock market data to evaluate the effectiveness of the Israeli counterterrorism policy. They regressed the daily percentage change of the Tel Aviv 25 index on a constant and on a dummy variable that took the value of 1 in case of assassinations and 0 otherwise. Thereafter, they included more dummy variables that captured the different effects of assassination on junior targets or senior targets.

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Similarly, in my analysis, the dependent variable in each regression is the daily percentage change in the Tel Aviv 25 index. It is the most important index in Tel Aviv stock exchange. It tracks the prices of the shares of the 25 companies with the highest market capitalization in the market (Market Cap Indices). All regressions include on the right-hand side the daily percentage change in the NASDAQ after adjusting to the Israeli Shekel and a constant5. The percentage change in NASDAQ was included in the regressions in order to control for external events that might have an influence on the Israeli market6. As been mentioned in Zussman and Zussman (2005), the Israeli economy is highly integrated with the rest of the world, and thus the coefficient for NASDAQ is expected to be positive and significant, and indeed it is in all regressions. Moreover, robust standard errors have been used in all regressions.

As a first step before running the regressions, I present in figure 6 the average daily percentage change in Tel Aviv 25 index for the 5 days before and after an announcement have taken place. The figure clearly shows a decline in the market in the days before the announcement (with a small upwards correction from t-2 to t-1), then a large negative decline in the day of the announcement of around 0.44%, followed by an upward market correction in the next four following days. The pattern suggests that there might be some private information leaking in the days prior to the announcements.

Table 4 shows 7 different regressions where I regress the percentage change of Tel Aviv 25 on a constant, the percentage change in the NASDAQ and a dummy. The percentage change in the NASDAQ has a value of 0.16 and it is statistically significant at the 1% level. The constant takes the value of 0.00 and it is also significant at the 5% level. Moreover, all regressions have an adjusted 𝑅2_{in the}

range of 0.036 to 0.039. The first column in table 4 includes a dummy variable that takes the value of 1 in case of an FDI announcement and 0 otherwise. The coefficient has a value of (-0.004) and it is statistically significant at the 1% level. It seems that FDI announcements are negatively affecting the Israeli stock market. This is in line

5_{The daily exchange rate for the entire sample period was obtained from}

https://www.oanda.com/solutions-for-business/historical-rates/main.html

6_{Most dual-listed stocks of Israeli companies are listed in NASDAQ, thus its advantage over other}

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with figure 6 that showed a decline in the market previous to the announcement with a strong negative reaction at the day of the announcement.

In order to verify if this reaction is even stronger for FDI announcements with large capex and/or for announcements which are expected to create a large amount of jobs, I have created two additional dummy variables. The second column includes the dummy ‘Capex’. It takes the value of 1 only in case the announcement is larger than the mean of the announcements and 0 otherwise. This variable has a value of (-0.008) and it is also statistically significant at the 5% level. It appears that the monetary size of the project matters. The third column includes the dummy variable ‘Jobs’. It takes the value of 1 in case the expected amount of jobs creation is larger than the mean amount of jobs and 0 otherwise. The coefficient takes the value of (-0.002), however, it is statistically insignificant. According to the regression, the expectations regarding the number of jobs that the FDI project would create do not have any statistical influence on the market reaction.

First Hypothesis

Now, we proceed to examine the first hypothesis. The forth column includes a dummy that takes the value of 1 in case of announcements of technological companies and 0 otherwise. The fifth column includes a dummy that takes the value of 1 in case of announcements of financial companies and 0 otherwise. The value for the dummy of the technological companies is (-0.005) and is significant at the 1% level. However, the coefficient for the financial companies has a p-value of 0.58, and therefore it is not statistically significant. It seems as FDI announcements of financial companies do not play a role in explaining the negative market reaction. Furthermore, in order to control for the fact that many of the announcements are of technological companies, and that other sectors have only a few announcements per sector, I include in column 6 a dummy that takes the value of 1 for announcements of all non-technological companies and 0 otherwise. The coefficient has a value of (-0.003), however, it is only significant at the 10% level. Hence, it appears that the market reaction is indeed driven by the announcements of technological companies. In addition, I include in column 7 the dummy variable ‘famous’. It takes the value of 1 in case the announcements were of well-respected and recognized companies and 0 otherwise. The coefficient is (-0.005) and it is significant at the 1% level. It appears

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that the level of recognition of the companies also plays a role in explaining the negative market reaction.

Second Hypothesis

Table 5 and 6 present the regressions’ results of the second hypothesis. Table 5 shows the analysis for periods with a decline in real GDP growth. It includes 40 announcements in the years: 2004, 2007-2008, 2010-2011 and 2013. In total there are 1448 observations with an adjusted 𝑅2_{ranging from 0.034 to 0.037 for all}

regressions. The percentage change in NASDAQ remains constant with a value of 0.15 and it is significant at the 1% level. The constant term is insignificant for all regressions. In contrast to my initial expectations, most variables now become insignificant, with the exception of the variable “famous”, which takes the value (-0.007) and is significant at the 5% level. It appears that the only thing that still matters for the stock market in periods of economic decline is how recognize and well respected the company is.

Table 6 presents the analysis for periods with a rise in real GDP growth. It includes only 22 announcements for 1212 observations in the years: 2003, 2005-2006, 2009 and 2012. The adjusted 𝑅2_{is lower than in the case of a decline in GDP and}

constant at 0.02 for all regressions. The percentage change in NASDAQ is a bit lower with a coefficient of 0.13 in all regressions. The constant term now is highly significant but has a value of 0.00. In comparison with the entire sample period and especially with the regressions presented in the previous table, in this case most variables are highly significant. The variable for all announcement takes the value of (-0.007) and is significant at the 1% level. The variables that capture the announcements with large CAPEX and for expectation of creating many jobs are now both have a coefficient of (-0.12) and are significant at the 1% level.

Counterintuitively, in growth periods, the size of the project matters and the numbers of jobs that it will be expected to create matter more than in bad periods. The coefficient for technological companies is also significant at the 1% level with a coefficient of (-0.007). In addition, the coefficient for all non-tech. companies is also significant with a value of (-0.006) at the 5% level. The coefficient for the variable representing the announcement of financial companies remains insignificant. As well as the variable that represents all “famous” companies is insignificant. It seems that companies’ level of recognition does not play a major role in good economic times.

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Third Hypothesis

In the third hypothesis, I investigate the differences in the market reaction to FDI announcements before and after Israel joined the OECD. Table 7 presents the regressions for the period before Israel became an official member of the OECD. It includes 45 FDI announcements out of 1864 trading days for the period 2003- September 20010. The percentage change in NASDAQ remains constant and significant with a coefficient value of 0.11. The constant has a value of 0 across all regressions and is significant at the 5% level. The adjusted 𝑅2_{is ranging from 0.017}

to 0.019. The only coefficients that are significant at least at the 5% level are for FDI announcements of technological and “famous” companies, and take the value of (-0.005) and (-0.004) respectively.

Table 8 includes regressions for the period after Israel became an official OECD member. It shows the effect of 27 FDI announcements out of 1167 trading days for the time period of September 2010 - December 2015. All regressions in this table have a relatively high adjusted 𝑅2_{of 0.11-0.12. As well, the percentage change}

in NASDAQ is quite high and significant with a constant coefficient of 0.28. The constant term remains 0; however, it is no longer statistically significant. All announcements and large CAPEX announcements are significant at the 5% level with the values of (-0.005) and (-0.009), respectively. The variable that captures the effect of technological companies is no longer statistically significant at the 5% level. Nevertheless, the dummy variable that captures the effect of FDI announcement of well-respected and recognized companies is still significant at the 5% level with a value of (-0.006), a bit larger than in the previous table.

Robustness Checks

In order to verify whether my empirical results hold for different stock markets, I first re-run all regressions with the daily percentage change in the Tel Aviv 100 index as my dependent variable instead of with Tel Aviv 25 index. This index tracks the prices of the shares of the 100 companies with the highest market capitalization in the Israeli market. The results remain mainly the same, with a minor difference in the significance level of the different variables. In addition, my results were quite robust for using the S&P 500 index and the Dow-Jones index instead of using the NASDAQ.

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V. Limitations and Suggestions for Further Research Limitations

This paper has a few caveats in terms of its theoretical background and data collection. Firstly, there is no clear and concise theoretical background to support the results presented. In the introduction part, I suggest a few potential motivations for a possible market reaction based on the efficient market hypothesis. Nevertheless, I could not support my results with additional sound economic theory.

Secondly, by using the Bloomberg terminal to determine the exact announcement dates, the number of observations went down from 177 to 72. In my opinion, the loss of more than a 100 observations is quite noteworthy and could potentially alter my results. This means that by using the full sample size of 177 announcement dates, one might obtain completely different results and draw different conclusions regarding the effect of FDI announcements on stock markets.

Finally, in this paper, I use fDiMarkets.com as a prime source of data. It is a good and respected source been used by many multinationals, consultants and academics. Nevertheless, the website mentions that companies do not always release information on the investment amount or jobs creation, and in those cases, they estimate the numbers using a “proprietary econometric model”. The econometric model itself is not being published in their website, and therefore I could not evaluate its quality and detect any biases in the model’s results.

Suggestions for Further Research

This paper can be extended and improved upon in a few distinct ways. Firstly, in order to find the exact announcement dates, one could use another data source. There might be other announcements that were not captured by fDiMarkets.com, but could potentially be discovered using a different database.

Secondly, one could extend this research be using other countries with an economy which is relatively similar in size, such as Denmark or Finland7. By doing so, one could first try to detect a market reaction to FDI announcements. Second, examine if the market reaction is also driven by a dominant sector in the Finnish or Danish economies.

7_{According to World Bank data, in 2015, Israel had a total GDP of $296.075 billion. Denmark and}

Finland had relatively similar numbers with total GDP of $295.164 billion and $229.81 billion, respectively.

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Thirdly, one could compare the market reaction to FDI announcements in developed vs. non-developed financial markets. It would be interesting to investigate whether the market reaction in less-developed economies is different than in more developed ones.

VI. Conclusion

Foreign Direct Investments is considered to play a major role in promoting economic growth. The causal relationship between FDI, economic growth and the stock market has also been established and documented in the literature.

This paper offers a different approach for measuring the effect of FDI announcements on the stock market. I examine the reaction of the Israeli stock market (Tel Aviv 25 index) to FDI announcements. I focus on the period of January 2003 to December 2015. During this period, Israel has experienced times of decline and surge in economic growth. Moreover, in September 2010, it joined the Organization for Economic Co-operation (OECD).

My approach of measuring the immediate reaction of the Israeli stock market to FDI announcement is based mainly on the notion of efficient markets. If stock markets are efficient, then all available public information should instantly be reflected in the market prices of all companies (locally and abroad) that could potentially be affected by the FDI announcement. If the market price of many listed local companies is affected by the announcement, then there should be also an effect on the market index as a whole.

Using a unique database of 72 FDI announcements for a time period of thirteen years, my analysis finds a statistically significant negative market reaction of the Tel Aviv 25 Stock Exchange to FDI announcements of foreign companies. The main variables that drive the negative market reaction are announcements of technological companies and of well-recognized companies. As well, large CAPEX FDI announcements also negatively affect the market.

In times of decline in real GDP growth per capita, the only variable that is statistically negatively affecting the market is the level of recognition of the companies. In times of surge in real GDP growth per capita, most variables lead to a negative market reaction.

For the time period of January 2003 to September 2010, before Israel became an official member of the OECD, the only FDI announcements that negatively

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17

affected the markets were the ones of technological and well-respected companies with coefficient values of (-0.005) and (-0.004), respectively. After Israel joined the OECD, from September 2010 to December 2015, the announcements of technological companies did not affect the market anymore; however, the announcements of well respected-companies and large CAPEX announcements did negatively affect the market. Moreover, the explanatory power of the regressions for this time period (September 2010 to December 2015) is relatively good, with an adjusted 𝑅2_{of 0.12.}

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18 VII. Bibliography

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Faez, A., Parvarinejad , G., Orooei, M., & Lajevardi, M. (2014, May). Investigating the relation between degree of liquidity of firms with overreaction behavior of investors in Tehran Stock Exchange. Journal of Applied Science and Agriculture, 2492-2500.

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(2016). Gross national income per capita 2015, Atlas method and PPP. The World Bank. Guoming, X., & Bing, Y. (2005). The Spill-over Effect of FDI on China’s Innovation Capacity.

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21 VIII. Appendices

Figure 1. Employment rate. This figure plots the employment rates (in percentages) for Israel and the OECD average for the years 2003-2016. Source: OECD Economic Surveys Israel, January 2016.

Figure 2. Real GDP per capita growth. This figure plots the real GDP per capita growth (in percentages) for Israel and the OECD average for the years 2003-2013. Source: OECD Economic Surveys Israel, January 2016.

54 56 58 60 62 64 66 68 70 72 74 Israel OECD -5 -4 -3 -2 -1 0 1 2 3 4 5 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Israel OECD

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Figure 3. Gross domestic spending on R&D, total percentage of GDP for 2012. This figure presents countries’ level of spending on R&D relatively to the size of the economy for 2012.The figure shows that in 2012 more than 4% of the Israeli gross domestic spending is made on R&D, whereas in Mexico, it is less than 0.5% of GDP. Source: Main Science and Technology Indicators, OECD.

Figure 4. Foreign Direct Investments in Israel for 2003-2015, reduced sample size. This figure presents the number of FDI announcements per year made by non-Israeli companies for 2003-2015. For example, in 2008, 12 announcements were made by non-Israeli companies intending to invest in Israel. Announcements are included only in cases where I could find their exact announcement date using a Bloomberg terminal.

Source: fDiMarkets.com 0 0.5 1 1.5 2 2.5 3 3.5 4 4.5 0 2 4 6 8 10 12 14 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

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Figure 5. Foreign Direct Investments in Israel for 2003-2015, original sample size. This figure presents the original list of the number of FDI announcements per year made by non-Israeli companies for 2003-2015. For example, in 2008, 21 announcements were made by non-Israeli companies intending to invest in Israel. The figure shows all announcements that are included in the fDiMarkets.com database. Source: fDiMarkets.com

Figure 6. Percentage change in the Tel-Aviv 25 index before and after announcements. This figure shows the average percentage changes in the Tel-Aviv 25 index in the 10 days interval around announcement days. For example, ‘t-1’ is constructed as the average percentage change of the Tel-Aviv 25 index for the 1-day prior to announcements. Source: Based on the dataset collected by the author.

0 5 10 15 20 25 30 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 -0.50% -0.40% -0.30% -0.20% -0.10% 0.00% 0.10% 0.20% 0.30% t-5 t-4 t-3 t-2 t-1 t t+1 t+2 t+3 t+4 t+5

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24 Table I

Descriptive Statistics on FDI Announcements & Key Variables

This table presents descriptive information on FDI announcements and key variables. It shows the number of FDI announcements per year, sector, economic climate (without the years 2014-2015) and for the time periods before and after Israel became an OECD member. There are 9 projects with an investment size larger than the mean investment, and 14 projects with an amount of jobs created larger than the mean amount of jobs created.

Total Number January 2003 – December 2015 72

Year 2003 3 2004 6 2005 5 2006 11 2007 5 2008 12 2009 2 2010 3 2011 9 2012 1 2013 5 2014 4 2015 6 _____________________________________________________________________ Sector Construction 1 Consumer Goods 1 Creative Industries 3 Energy 2 Environmental Technology 4 Financial Services 11

Food, Beverages & Tobacco 3

ICT & Electronics 35

Life & Physical Sciences 7

Professional Services 5

Transport Equipment 2

_____________________________________________________________________

Economic Climate Rise in GDP growth 22

Decline in GDP growth 40

_____________________________________________________________________

OECD Before Joining the OECD 45

After Joining the OECD 27

_____________________________________________________________________

CAPEX Average Investment Size $91,455,000

Median Investment Size $15,650,000 _____________________________________________________________________

Jobs Average Number of Jobs Created 139

Median Number of Jobs Created 48

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25 Table II

A List of All FDI Announcements (Reduced Sample Size)

This table presents a list of all 72 FDI announcements used in this paper, thus only the ones for which I could find an exact announcement date using a Bloomberg terminal. The list includes the exact announcement dates, the name of the company and the sector. The classification for the different sectors was made by fDiMarkets.com.

Sector Company

Date

Creative Industries Texas A&M University

14/12/2015

Financial Services Barclays Bank

07/10/2015

ICT & Electronics SanDisk

31/08/2015

ICT & Electronics eBay

12/08/2015

Life sciences Gilead Sciences

27/04/2015

ICT & Electronics Apple Inc

02/03/2015

ICT & Electronics Kaspersky Lab

06/10/2014

Creative Industries Facebook

07/07/2014

ICT & Electronics Alcatel-Lucent

20/05/2014

ICT & Electronics IBM

27/01/2014

ICT & Electronics Amazon.com

15/10/2013

Environmental Technology Abengoa

20/06/2013

ICT & Electronics Apple Inc

11/02/2013

ICT & Electronics Sprint Nextel

30/01/2013

ICT & Electronics ViaEuropa

16/01/2013

Life sciences Perrigo

21/06/2012

ICT & Electronics Apple Inc 14/12/2011 Professional Services Greenberg Traurig 07/12/2011 Financial Services Citigroup 19/09/2011

ICT & Electronics Cupp Computing

28/07/2011

Life sciences General Electric (GE)

13/06/2011

ICT & Electronics Marvell Technology 23/05/2011 Financial Services Barclays Bank 14/03/2011 Financial Services Alstom 07/03/2011

ICT & Electronics Microsoft

31/01/2011

Transport Equipment General Motors (GM)

01/11/2010

ICT & Electronics AT&T

07/10/2010

Environmental Technology Siemens

17/02/2010

ICT & Electronics Hewlett-Packard (HP)

24/11/2009

Financial Services eBay

14/09/2009

ICT & Electronics Motorola Solutions 01/12/2008 Creative Industries Bloomberg 04/09/2008 Consumer Goods Haier Group 12/08/2008

ICT & Electronics SAP

10/07/2008

01/05/2008

14/04/2008

Environmental Technology Veolia Environnement

03/03/2008

02/03/2008

ICT & Electronics Google

28/02/2008

ICT & Electronics Tata Group

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ICT & Electronics Yahoo 14/01/2008 Financial Services UniCredit 13/01/2008 Life sciences Pfizer 30/10/2007

ICT & Electronics eBay 08/10/2007 Transport Equipment General Motors (GM) 13/08/2007 Financial Services Credit Suisse Group

08/08/2007

22/01/2007

Environmental Technology Intel

22/11/2006

17/10/2006

ICT & Electronics Intel

04/09/2006

21/08/2006

ICT & Electronics Marvell Technology

28/06/2006

Construction Trump

26/06/2006

ICT & Electronics Oracle 31/05/2006 Life sciences SciGen 30/05/2006 Financial Services BNP Paribas 10/04/2006

Food, Beverages & Tobacco Tate & Lyle

08/03/2006

ICT & Electronics Deutsche Telekom 06/02/2006 Financial Services Canaan Partners 14/12/2005 Financial Services WR Hambrecht 13/12/2005

ICT & Electronics Intel

15/11/2005

Financial Services BNP Paribas

10/11/2005

05/05/2005

ICT & Electronics Intransa

22/11/2004

ICT & Electronics Huawei Technologies

26/10/2004

Food, Beverages & Tobacco Nestle 29/07/2004 Physical Sciences Endiama 15/07/2004 Energy Zorlu Holding 27/05/2004 Energy British Gas Group (BG)

20/04/2004

Life sciences Serono

20/11/2003

Financial Services State Bank of India

25/09/2003

Food, Beverages & Tobacco Nestle

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27 Table III

World’s Most Admired Companies by Fortune

Table III shows the world’s 100 most admired companies made by Fortune magazine together with Korn Ferry Hay Group, a global management consulting firm. The list was used to construct the dummy variable “famous”. That is, only FDI announcements made by companies included in the list get a value of 1, otherwise they get a value of 0. For a full description of the methodology used to create the list, please see: http://fortune.com/worlds-most-admired-companies/.

Rank Company Country

_____________________________________________________________________

1 Intel United States

2 Google United States

3 Amazon.com United States

4 Berkshire Hathaway United States

5 Walt Disney United States

6 Starbucks United States

7 Southwest Airlines United States

8 FedEx United States

9 Nike United States

10 General Electric United States

11 American Express United States

12 Costco United States

13 Nordstorm United States

14 Facebook United States

15 Coca-Cola United States

16 Johnson & Johnson United States

17 Microsoft United States

18 BMW Germany

19 Netflix United States

20 JP Morgan Chase United States

21 Procter & Gamble United States

22 Boeing United States

23 Goldman Sachs Group United States

24 Whole Food Market United States

25 Wells Fargo United States

26 BlackRock United States

27 CVS Health United States

28 Toyota Motor Japan

29 Marriot International United States

30 Delta Air Lines United States

31 Home Depot United States

32 IBM United States

33 UPS United States

34 salesforce.com United States

35 Samsung Electronics South Korea

36 Accenture Ireland

37 Exxon Mobil United States

38 Nestle Switzerland

39 Target United States

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41 Unilever United Kingdom

42 Walmart United States

43 Intel United States

44 PepsiCo United States

45 Caterpillar United States

46 Deere United States

47 Visa United States

48 AT&T United States

49 Publix Super Markets United States

50 Charles Schwab United States

51 3M United States

52 ABB Switzerland

53 Abbott Laboratories United States

54 Activision Blizzard United States

55 Adidas Germany

56 Adobe Systems United States

57 AECOM United States

58 Aetna United States

59 Aflac United States

60 Air France-KLM Group France

61 Airbus Group Netherlands

62 Alcoa United States

63 Allianz Germany

64 Allstate United States

65 American Electric Power United States

66 AmerisourceBergen United States

67 Amgen United States

68 Anheuser-Busch InBev Belgium

69 Anixter International United States

70 Anthem United States

71 Applied materials United States

72 Aramark United States

73 ArcelorMittal United States

74 Archer Daniels Midland United States

75 Arrow Electronics United States

76 Asustek Computer Taiwan

77 Autodesk United States

78 Automatic Data Processing United States

79 Avnet United States

80 Ball United States

81 Bank of America United States

82 Bank of New York Mellon United States

83 Baosteel Group China

84 BASF Germany

85 Bayer Germany

86 BB&T Corp. United States

87 Bed Bath & Beyond United States

88 Best Buy United States

89 BHP Billiton Australia

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91 Boston Scientific United Kingdom

92 Bristol-Myers Squibb United States

93 Broadridge Financial Solutions United States

94 BT Group United Kingdom

95 Bunge Bermuda

96 C.H. Robinson Worldwide United States

97 CACI International United States

98 CalAtlantic Group United States

99 Canon Japan

100 Capital One Financial United States

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30 Table IV

Market Reactions to FDI Announcements

This table presents the results of the ordinary least squares estimates of the regressions of the percentage change in the Tel-Aviv 25 index on all FDI announcements, large CAPEX announcements, ‘many jobs created’ announcements, the effect of announcements by companies from different sectors and by “famous” companies. The sample consists of 3031 daily observations from 2003 to 2015 and is adjusted to the differences in trading days between the Israeli stock market and the American. In addition, the daily values of the variable ‘NASDAQ’ were converted from American Dollar to Israeli Shekel using the appropriate daily exchange rates. Heteroscedasticity and autocorrelation consistent standard errors (HAC) are reported in parentheses. *, **, *** represent statistical significance at the 10, 5, and 1 percent levels in a two-sided t-test.

____________________________________________________________________________________________

(Dependent variable: percentage change in the Tel-Aviv 25 stock market index)

(1) (2) (3) (4) (5) (6) (7) ___________________________________________________________________________________ All announcements -0.004*** (0.001) Capex -0.008** (0.003) Jobs -0.002 (0.003) Tech. companies -0.005*** (0.002) Financial companies -0.001 (0.004)

All non-tech. companies -0.003*

(0.002) “Famous” companies -0.005** (0.002) Percentage change in 0.16*** 0.16*** 0.16*** 0.16*** 0.16*** 0.16*** 0.16*** NASDAQ (0.02) (0.02) (0.02) (0.02) (0.02) (0.02) (0.02) Constant 0.00** 0.00** 0.00** 0.00** 0.00** 0.00** 0.00** (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) Adjusted 𝑅2 _0.039 _0.037 _0.036 _0.038 _0.037 _0.037 _0.037 Observations 3031 3031 3031 3031 3031 3031 3031

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31 Table V

Market Reactions to FDI Announcements (Decline in Real GDP Growth)

This table presents the results of the ordinary least squares estimates of the regressions of the percentage change in the Tel-Aviv 25 index on all FDI announcements, large CAPEX announcements, ‘many jobs created’ announcements, the effect of announcements by companies from different sectors and by “famous” companies. The sample consists of 1448 daily observations for periods of decline in real GDP growth in Israel from 2004 to 2013. It covers the periods 2004, 2007-2008, 2010-2011 and 2013. The data is adjusted to the differences in trading days between the Israeli stock market and the American. In addition, the daily values of the variable ‘NASDAQ’ were converted from American Dollar to Israeli Shekel using the appropriate daily exchange rates. Heteroscedasticity and autocorrelation consistent standard errors (HAC) are reported in parentheses. *, **, *** represent statistical significance at the 10, 5, and 1 percent levels in a two-sided t-test.

____________________________________________________________________________________________

(Dependent variable: percentage change in the Tel Aviv 25 stock market index)

(1) (2) (3) (4) (5) (6) (7) ___________________________________________________________________________________ All announcements -0.003 (0.002) Capex -0.005 (0.004) Jobs 0.001 (0.005) Tech. companies -0.006* (0.003) Financial companies 0.001 (0.006)

All non-tech. companies -0.002

(0.003) “Famous” companies -0.007** (0.003) Percentage change in 0.15*** 0.15*** 0.15*** 0.15*** 0.15*** 0.15*** 0.15*** NASDAQ (0.03) (0.03) (0.03) (0.03) (0.03) (0.03) (0.03) Constant 0.00 0.00 0.00 0.00 0.00 0.00 0.00 (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) Adjusted 𝑅2 _0.036 _0.034 _0.034 _0.037 _0.034 _0.034 _0.037 Observations 1448 1448 1448 1448 1448 1448 1448

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32 Table VI

Market Reactions to FDI Announcements (Rise in Real GDP Growth)

This table presents the results of the ordinary least squares estimates of the regressions of the percentage change in the Tel-Aviv 25 index on all FDI announcements, large CAPEX announcements, ‘many jobs created’ announcements, the effect of announcements by companies from different sectors and by “famous” companies. The sample consists of 1212 daily observations for periods of rise in real GDP growth in Israel from 2003 to 2012. It covers the periods 2003, 2005-2006, 2009 and 2012. The data is adjusted to the differences in trading days between the Israeli stock market and the American. In addition, the daily values of the variable ‘NASDAQ’ were converted from American Dollar to Israeli Shekel using the appropriate daily exchange rates. Heteroscedasticity and autocorrelation consistent standard errors (HAC) are reported in parentheses. *, **, *** represent statistical significance at the 10, 5, and 1 percent levels in a two-sided t-test.

____________________________________________________________________________________________

(1) (2) (3) (4) (5) (6) (7) ___________________________________________________________________________________ All announcements -0.007*** (0.002) Capex -0.012*** (0.003) Jobs -0.012*** (0.003) Tech. companies -0.007*** (0.002) Financial companies -0.005 (0.005)

All non-tech. companies -0.006**

(0.003) “Famous” companies -0.004 (0.003) Percentage change in 0.13*** 0.13*** 0.13*** 0.13*** 0.13*** 0.13*** 0.13*** NASDAQ (0.04) (0.04) (0.04) (0.04) (0.02) (0.02) (0.02) Constant 0.00*** 0.00*** 0.00*** 0.00*** 0.00*** 0.00*** 0.00*** (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) Adjusted 𝑅2 0.02 0.02 0.02 0.02 0.02 0.02 0.02 Observations 1212 1212 1212 1212 1212 1212 1212

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33 Table VII

Market Reactions to FDI Announcements (Before Joining the OECD)

This table presents the results of the ordinary least squares estimates of the regressions of the percentage change in the Tel-Aviv 25 index on all FDI announcements, large CAPEX announcements, ‘many jobs created’ announcements, the effect of announcements by companies from different sectors and by “famous” companies. The sample consists of 1864 daily observations for the period before Israel became an official OECD member, namely from 2003 to September 2010. The data is adjusted to the differences in trading days between the Israeli stock market and the American. In addition, the daily values of the variable ‘NASDAQ’ were converted from American Dollar to Israeli Shekel using the appropriate daily exchange rates. Heteroscedasticity and autocorrelation consistent standard errors (HAC) are reported in parentheses. *, **, *** represent statistical significance at the 10, 5, and 1 percent levels in a two-sided t-test.

____________________________________________________________________________________________

(1) (2) (3) (4) (5) (6) (7) ___________________________________________________________________________________ All announcements -0.003* (0.001) Capex -0.006* (0.003) Jobs -0.003 (0.003) Tech. companies -0.005** (0.002) Financial companies -0.000 (0.004)

All non-tech. companies -0.002

(0.002) “Famous” companies -0.004** (0.0019) Percentage change in 0.11*** 0.11*** 0.11*** 0.11*** 0.11*** 0.11*** 0.11*** NASDAQ (0.02) (0.02) (0.02) (0.02) (0.02) (0.02) (0.02) Constant 0.00** 0.00** 0.00** 0.00** 0.00** 0.00** 0.00** (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) Adjusted 𝑅2 0.019 0.018 0.018 0.019 0.017 0.018 0.018 Observations 1864 1864 1864 1864 1864 1864 1864

Stock market reaction to FDI announcements : evidence from the Israeli Stock Market

Master Thesis