The Impact of Financial Sanctions: The Case of Iran 2011-2016

Excerpt

Financial sanctions are fast becoming a potent and widely used foreign policy tool and an alternative to military power projection. They have become progressively more sophisticated, and, thanks to rising interconnection of the global financial system, increasingly effective in targeting specific goals. In recent years, the United States has imposed financial sanctions against individuals and corporate entities in Russia, Myanmar, Nicaragua, Venezuela, and Iran, among others. The economic impact of financial sanction policies, however, is an understudied subject in the literature. In this paper, we provide the a comprehensive documentation of how financial sanctions affect publicly traded firms in a target country. We study the sequence of sanctions, their impact on stock returns of targeted firms and industries, as well as changes to the capital structure and profitability of those firms affected by sanctions. To this end, we focus on a combination of sanctions imposed on Iranian corporations listed in the Tehran Stock Exchange (henceforth, TSE) in the 2011–2016 period. During this time, Iran faced comprehensive and far-reaching economic and financial sanctions in response to its nuclear program.

The reasons for our focus on Iran are fourfold. First, these sanctions delivered their intended goal: The Islamic Republic of Iran suspended much of its nuclear enrichment efforts and resumed negotiation with the United States and five other world powers about its nuclear program.¹ Second, for an emerging or frontier economy, Iran has a relatively large stock market, and share holding features prominently in financial decisions of the better-off Iranians. As a result, financial sanctions  have significant impact in Iran’s case. In addition, the sanctions regime against Iran was unique because of its length, intensity, and diversity; furnishing us with a natural experiment to observe the full impact of modern financial sanctions on a country. Third, we have access to a unique data set that provides detailed financial information about the universe of publicly traded firms listed in the TSE. Access to these data allows us to carefully measure the impact of sanctions on Iranian firms. Our data set includes both imposition and removal of sanctions. Finally, U.S.-Iran relations and sanctions against Iran are again in the policy-related headlines. Ours is thus a timely study to document and analyze the impact of the previous (successful) round of sanctions. We expect that the lessons from this study contribute to relevant research and policy debates.

This paper presents comprehensive empirical analysis on how different players in the market react to various types of sanctions, and how these sanctions affect a firm’s performance and financing decisions. We find that sanctions affect politically connected firms more than ordinary firms, and that they have lasting negative effects that appear in long-term stock returns and profitability ratios. Our results confirm the predictions of financial economic theory in the sense that, not surprisingly, firm management and shareholders facing an episode of well-coordinated and well executed sanctions act as the theory predicts they should. Targeted firms decrease their leverage and increase their cash holding to manage their perceived increased risk. Our results are robust to both imposition and removal of sanctions. Curiously, we find that while removing sanctions lead to positive returns, the magnitude of these positive abnormal returns are smaller for politically connected firms. In other words, politically connected firms demonstrate a smaller bounce back in returns.

1. The so-called P5+1 countries are the United States, the United Kingdom, France, Russia, Peoples Republic of China, and Germany.