Liberalisation and capital market performance: lessons from the Enron affair
| Published date | 01 September 2005 |
| Pages | 229-253 |
| Date | 01 September 2005 |
| DOI | https://doi.org/10.1108/13581980510622090 |
| Author | Rui T. Dias,M. Isabel Soares,Giuseppe Tardivo |
| Subject Matter | Accounting & Finance,Financial risk/company failure,Financial compliance/regulation |
Liberalisation and capital market
performance: lessons from the Enron affair
Rui T. Dias
a
, M. Isabel Soares
b
and Giuseppe Tardivo
c
Received: April, 2005
a
Ph.D. Student of Business Administration, Universita
`degli Studi di Torino, Italy — e-mail:
dias@econ.unito.it
b
Full Professor, University of Porto, Faculty of Economics, Portugal — e-mail: isoares@fep.up.pt
c
Professor of Business Management and Director of the Ph.D programme in Business
Administration, Universita
`degli Studi di Torino, Italy — e-mail: tardivo@econ.unito.it
Rui T. Dias is a Ph.D. Student of Business
Administration at the Universita
`degli
Studi di Torino, Italy — e-mail: dias@
econ.unito.it
M. Isabel Soares is a Full Professor at the
University of Porto, Faculty of Economics,
Portugal — e-mail: isoares@fep.up.pt
Giuseppe Tardivo is a Professor of Busi-
ness Management and Director of the
Ph.D programme in Business Administra-
tion at the Universita
`degli Studi di Torino,
Italy — e-mail: tardivo@econ.unito.it
ABSTRACT
JEL Classification: K23, K22, G32;
KEYWORDS: Financial Regulation, Utility
Industries, Economic Liberalisation;
We discuss the consequences of liberalization on
capital market performance. Greater autonomy
is expected to bring efficiency, profit and aug-
mented welfare. In some cases, this higher
autonomy has also been connected to episodes of
fraud. We discuss the role a regulatory activity
can play into such a scenario. In order to do it,
we focus on factors such as volatility and perfor-
mance of capital markets, and we analyze the
hypothesis that the capital markets’ functioning
is conditioned by the regulatory activity. We
analyze firms’ strategies by studying the specific
case of Enron. This analysis allowed us to
relate firms’ behaviour, motivation and strate-
gies with the necessity of a regulatory process
on capital markets, in order to achieve an envir-
onment of confidence where the market can
fulfil its objectives.
Our results point out for the existence of a
positive relationship between our proxy of the
regulatory activity and the level of stock market
index. Our results also pointed out for the exis-
tence of a negative relationship between the con-
ditional volatility modelled by GARCH
models and the growth rate of that regulatory
index. The use of autoregressive process had the
objective to include in the model the expecta-
tions formed in the capital market in previous
periods.
INTRODUCTION
The objective of our article is to discuss
the consequences of liberalization on
market performance, especially in the case
of the capital market. We debate what
kind of changes a scenario of liberalization
brings to firms and to investors. The
reason we find this theme relevant is that
we have been witnessing a liberalization
trend that has created a wave of world-
wide consensus regarding the necessity of
giving firms more liberty to do business.
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Journal of Financial Regulation and Compliance Volume 13 Number 3
Journal of Financial Regulation
and Compliance, Vol. 13, No. 3,
2005, pp. 229–253
#Emerald Group Publishing
Limited, 1358–1988
According to these voices, this greater
autonomy brings efficiency, profit and
augmented welfare. Nevertheless, we have
also witnessed some cases in which very
important firms (in terms of dimension,
for example ENRON) have allied to that
autonomy strategies of fraud and investor
deception. We discuss the impact that such
strategies have on the business environ-
ment, specifically on the capital market
performance, and the role a regulatory
structure can play in establishing a frame-
work that prevents or attenuates situations
like these.
A study like this is important since Capi-
tal markets have become, around the
world, one of the most important ways for
firms to gather funds. A debate on this
problematic seems therefore to have wide-
spread relevance. Another important aspect
is that the object of our study is on the big-
gest world capital market. Since we have
been witnessing cases of greater liberaliza-
tion it is also interesting to note that there’s
a higher level of market interdependence
worldwide, so any important subject that
relates the biggest market is relevant to all
other markets. We have also chosen this
subject in order to debate how strategies of
some big firms (in a scenario of greater lib-
eralization) can have an impact in the
market and consequently originate distor-
tions on the markets where other firms
compete for funds. The use of those strate-
gies transforms competitiveness in an illegi-
timate game, where firms that behave
accordingly to the rules and ethics lose
access to funding. In such a scenario the
objective of regulation should be the one
of preserving the market stability but also
to save the access to funds for firms that
are able to deliver what was previously
shown to investors.
The structure of this article is as follows:
section 1 discusses capital markets, volati-
lity and regulation; section 2 discusses the
case of ENRON as an example of a firm
that profited from liberalization to show
itself as a preferable investment asset
towards investors; section 3 develops an
empirical research relatively to USA stock
market, its volatility and regulatory activ-
ity in order to find a relationship between
regulatory activity, market confidence,
market stock index evolution and volati-
lity; and section 4 points out the most
important conclusions, limitations and pos-
sibilities for future research.
This structure allows us to verify our
hypothesis of research. We discuss volati-
lity and performance of capital markets
considering the possibility of capital mar-
kets’ functioning being conditioned by the
regulatory process. We analyze firms’
behaviour and we discuss it by giving a
deep insight of the concrete case of Enron.
This analysis allowed us to relate firms’
behaviour, motivation and strategies with
the necessity of a regulatory process on
capital markets.
CAPITAL MARKETS: VOLATILITY AND
REGULATION
Capital markets: introduction
Capital markets play an important role in
the economy by making possible the trans-
fer of funds from savers (investors) to pro-
ject developers (firms). Firms give back to
investors a part of propriety along with the
correspondent part on the results. In the
case of deferred transactions, confidence
amongst players is a fundamental element.
The uncertainty regarding the possibility
of fulfilling all pre-determined conditions
of the transaction, and the uncertainty
regarding the characteristics of the object
of the transaction can undermine the confi-
dence between both parts. Information
asymmetry increases uncertainty, therefore
the necessity of confidence.
Firms represent a complex environment
where it is developed contemporaneously a
set of projects. When investors try to have
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Liberalisation and capital market performance
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