Towards a Democratic New Normal? Investor Reactions to Interim‐Regime Dominance during Violent Events

• DOI: http://doi.org/10.1111/joms.12553
• Author: Arjen Slangen,Marc Essen,J. (Hans) Oosterhout,Omar El Nayal
• Date: 01 May 2020
• Published date: 01 May 2020

© 2020 Society for the Advancement of Management Studies and John Wiley & Sons, Ltd.

Towards a Democratic New Normal? Investor

Reactions to Interim-Regime Dominance during

Violent Events

Omar El Nayala, Arjen Slangenb, J. (Hans) van Oosterhoutc

and Marc van Essend

aUniversidade Católica Portuguesa; bKU Leuven; cErasmus University; dUniversity of South Carolina

ABSTRACT Although interim regimes in former autocracies are generally tasked with initiating

a democratic ‘new normal’, they may privately intend to become their country’s new autocratic

rulers. We argue that, to cope with the uncertainty stemming from this possibility, investors infer

an interim regime’s intentions from the dominance displayed by the regime during government-

related violence, as reflected in the share of civilian fatalities. Specifically, we propose that inves-

tors interpret higher interim-regime dominance as a signal of weaker democratic intentions and

associate such weaker intentions with a gloomier political outlook for local firms. We therefore

hypothesize that investors react more negatively to violent events characterized by higher

interim-regime dominance. We also hypothesize a less negative effect of such dominance for

firms with larger foreign footprints, lower indebtedness, or more concentrated ownership, since

investors will likely consider such firms more resilient to political deterioration. Applying event

study methodology to 94 spells of violence in Egypt during the Arab Spring, we find substantial

support for our hypotheses, thus contributing to management research on investor decision-

making, violence, and political uncertainty.

Keywords: event study, government-related violence, interim-regime dominance, new normal,

political uncertainty, signals

The fall of long-standing despots (…) is a necessary part of any transition to democracy. But it can

also start a civil war, or lead to a new dictatorship as the next strongman builds his own networks of

power

The Economist (2019, p. 54) in response to the fall of Sudan’s autocratic leader Omar

al-Bashir on 11 April.

Journal of Man agement Studi es 57:3 May 2020

doi:10. 1111/j om s.1 25 53

Address for reprints: Marc van Essen, Darla Moore School of Business, University of South Carolina, 1014

Greene St, Columbia, SC 29208 (marc.vanessen@moore.sc.edu)

506 O. El Nayal et al.

© 2020 Society for the Advancement of Management Studies and John Wiley & Sons, Ltd.

INTRODUCTION

Many management studies have explored how firms are affected by the actions and poli-

cies of national governments (e.g., Malik and Kotabe, 2009; Sun et al., 2015). In general,

these studies focused either implicitly or explicitly on conventional types of governments

in the form of democracies and autocracies (Alvarez et al., 1996). However, over the past

70 years more than 40 countries have at some point had a different type of regime –

namely, an ‘interim’ one (Geddes et al., 2014; Guttieri and Piombo, 2007).

Interim regimes are especially common in countries that have just experienced a col-

lapse of autocratic rule. In such countries, interim regimes are generally tasked with

initiating a transition to a so-called ‘new normal’, broadly defined as economic, political,

or social conditions that are fundamentally different from the traditional state of the

environment (Ahlstrom et al., 2017; Hitt et al., 2016). More specifically, interim regimes

in former autocracies are typically tasked with initiating a new normal of democratic

governance by organizing free and fair elections and handing over power to the elected

officials shortly afterwards (Geddes et al., 2014; Seely, 2009).

Although interim regimes in former autocracies often claim to be committed to their

task of initiating a democratic new normal, they may privately intend to become their

country’s new autocratic rulers (Pevehouse, 2005). Examples of countries that have

had such untrustworthy interim regimes include Algeria, Brazil, Chile, Cuba, Ethiopia,

Nicaragua, Nigeria, and Yemen. The interim regimes of these and other countries at

some point during their tenure announced that they had decided to prolong their rule,

often under the pretence of ‘national interest’ (Shain and Linz, 1995). Since interim re-

gimes may develop the private intention to become autocratic rulers at any point during

their tenure, potential and actual investors in local firms face substantial political uncer-

tainty during interim periods. To cope with this uncertainty, investors will likely attempt

to obtain information on an interim regime’s political intentions throughout its tenure,

but how exactly they do so has remained unclear.

In this study, we combine insights from the behavioural perspective on investor deci-

sion-making (e.g., Schijven and Hitt, 2012) with political science research on regimes’

use of violence (e.g., Davenport, 1999, 2007) to propose that investors infer an interim

regime’s political intentions during its tenure from crude pieces of public information, or

‘signals’. Specifically, we argue that investors infer these intentions from the share of civil-

ian fatalities in the total death toll resulting from events of government-related violence

in the country, a share that we refer to as the ‘dominance’ shown by the interim regime.

We argue that investors interpret higher interim-regime dominance during a given vio-

lent event as a signal that the regime has weaker democratic intentions at that time, and

that investors associate such weaker intentions with a more adverse political outlook for

local firms. We therefore hypothesize that violent events characterized by higher inter-

im-regime dominance are received more negatively by the local stock market.

Furthermore, we argue that investors use pieces of information on individual fir ms as

signals of a firm’s resilience to the adverse political developments that may result from

high interim-regime dominance. Specifically, we contend that investors consider this re-

silience to be higher among firms with larger foreign footprints, lower indebtedness, or

more concentrated ownership structures. For such firms we therefore hypothesize the

Towards a Democratic New Normal? 507

© 2020 Society for the Advancement of Management Studies and John Wiley & Sons, Ltd.

negative relationship between an interim regime’s dominance during a violent event and

the stock market’s reaction to that event to be weaker.

We find support for most of our hypotheses in an event study of 94 spells of deadly

violence that occurred under the two interim regimes that ruled Egypt during the Arab

Spring. Our study thereby contributes to three streams of management research. First,

it contributes to the behavioural perspective of investor decision-making, which has pro-

posed that investors tend to infer the intentions of managers from signals (Connelly et al.,

2011), given that these intentions may be self-serving and are unlikely to be made public

(Schijven and Hitt, 2012). Our findings enrich this perspective by showing that investors

also use signals to develop insight into the private intentions of external actor s, in our

case the political intentions of interim governments in former autocracies. In addition,

our findings suggest that investors use firm-specific characteristics in the form of a firm’s

foreign footprint and ownership structure as signals of its resilience to adverse politi-

cal developments, given that this resilience is generally also hard to ascertain otherwise

(DesJardine et al., 2019).

Second, our study contributes to research on how firms are affected by violence.

Specifically, whereas prior studies explored how firms are affected by the severity and

spatial attributes of violence (Dai et al., 2013, 2017; Witte et al., 2017), our study focuses

attention on the distribution of the fatalities across the parties involved and shows the

relevance of this distribution for fir ms’ market value.

Finally, our study contributes to management research on political uncertainty by fo-

cusing on a hitherto unexplored source of such uncertainty, namely the private nature

of a regime’s political intentions. Most prior management studies of political uncertainty

conceptualized such uncertainty as originating from a lack of checks and balances in a

country’s political system (e.g., Hendriks et al., 2018; Henisz, 2000).

BACKGROUND: INTERIM REGIMES AND THEIR INTENTIONS

When an autocratic country experiences a coup, revolution, or foreign invasion that

causes its regime to collapse, an interim government is typically installed to initiate a

transition to a democratic new normal (Guttieri and Piombo, 2007). Such a government

differs from a conventional government in at least two important ways. First, whereas a

conventional government tends to develop and implement a wide variety of policies, an

interim government usually has a very narrow mandate. In a former autocracy, an in-

terim government’s primary policy task is usually to organize free and fair elections that

are meant to mark the beginning of a democratic new nor mal for the country and its

populace (Seely, 2009). Second, interim governments are supposed to rule for a shorter

period than their conventional counterparts. Specifically, they are expected to hand over

power to a group of elected representatives within a reasonable timeframe, typically re-

garded to be two years (Shain and Linz, 1995).

Although interim regimes in former autocracies are supposed to organize democratic

elections and hand over power to elected representatives soon afterwards, they may not

necessarily intend to do so (Derpanopoulos et al., 2016; Pevehouse, 2005). At any time

during their tenure, such regimes may privately intend to become their country’s new

autocratic rulers, as they may develop an obsession for political power and a taste for