Bestraft die Börse EU-Skepsis?

On 26 May 2021, the Federal Council decided to end negotiations with the European Union (EU) about an institutional agreement that would replace the Bilateral Agreements I and II.  Some have deplored the Federal Council’s decision and expressed their concerns regarding its implications for Switzerland’s well-being; others have applauded it and argued that any cost to Switzerland would be small.

Can the stock market help us determine which side is right?  Yes, but only partially!  Stock price reaction to an announcement measures investors’ assessment of the implications of that announcement for listed firms’ value, thereby conveying information about investors’ view of the consequences of the announcement for the economic prospects of these firms and, indirectly, those of the country in which the firms are based.

Investors can be wrong, changes in value, or lack thereof, must be interpreted, and information that pertains to the profits of the generally large firms that are listed on stock markets does not necessarily extend to these firms’ smaller counterparts, to employees, and to overall economic well-being.  Yet, in a country such as Switzerland at least, firms, employees, and the country itself tend to prosper together and to suffer together.    

In a recently submitted Master Thesis at the University of Zurich, Master of Banking and Finance student Umberto Bernardo attempts to obtain an estimate of the economic importance of the agreements that govern Switzerland’s relation with the EU.

Specifically, Mr. Bernardo examines the Swiss stock market’s reaction to two referendums relating to that relation – the 1992 referendum on Switzerland joining the European Economic Area (EEA) and the 2014 referendum on the initiative “Against Mass Immigration.”

Mr. Bernardo does not analyze stock price reaction to the Federal Council’s 26 May decision because the topic of his thesis was chosen well before that decision.  Still, as we shall see below, his work does have some bearing on the consequences of that decision.

The decision to join the EEA was intended considerably to improve Switzerland’s access to EU markets. It would extend the 1972 Free Trade Agreement with the then European Economic Community from industrial goods to services and capital and would eliminate technical barriers to trade such as differing product requirements.  It was rejected by Swiss voters in December 1992.

Despite the decision not to join the EEA, Switzerland was able to become part of the European Single Market through a series of agreements known as Bilateral Agreements I and II. Unlike the Bilateral II agreements, the seven Bilateral I agreements are tied, in the sense that ending one agreement will automatically end the other six.

Swiss voters’ acceptance of the initiative Against Mass Immigration threatened the Bilateral I agreement on the free movement of persons, thereby threatening all Bilateral I agreements such as those on research, public procurement, and civil aviation.

Switzerland was able partially to reconcile the acceptance of the initiative with the requirements of the agreement on the free movement of persons by introducing a number of agreement-compatible requirements on Swiss employers to give precedence to local labor.

There were of course other referendums related to Switzerland’s relation with the EU during the last three decades.  What makes the two referendums considered by Mr. Bernado of particular interest is that the results in both cases were extremely close, and thus very unlikely to have been predicted by stock market participants.  Stock price reaction to the announcement of the referendums’ results therefore can be used to obtain an estimate of the importance of the referendums’ objects – access to the EEA and the Bilateral I agreements potentially endangered by the imposition of constraints on the free movement of labor – to Swiss firms and, by extension, the Swiss economy.

Mr. Bernado uses an event study methodology to obtain such estimate.  The idea is to examine how stock prices reacted to the announcement of referendum results, compare these reactions to what may be described as the normal stock price variation, and compute what is called a stock or an index’s abnormal return.  Positive, statistically significant abnormal returns indicate positive appraisal by investors; negative returns indicate the opposite. 

Mr. Bernado finds that both the Swiss Market Index (SMI), an index of the 20 largest Swiss companies, and the Swiss Performance Index (SPI) of all quoted Swiss companies experienced a positive abnormal return following the announcement of the result of the EEA referendum.  Investors deemed Switzerland’s rejection of the EEA beneficial to quoted Swiss companies.  Adjusting for the concurrent rise of the Swiss Franc against the Deutsche Mark, the SMI for example increased by 6.4%, as compared to what would have been its normal variation absent the announcement of the referendum result.  This increase was over a period of 11 days, centered on the first trading day after the Sunday on which the voting took place. 

There are, as always, many possible interpretations of this finding.  The most natural one may be that investors valued Switzerland’s regulatory autonomy, which they may have viewed as possibly compromised by membership of the EEA and eventual membership of the EU.  It is also possible that investors foresaw the possibility of alternative arrangements such as the bilateral agreements, and viewed these as preferable to membership of the EEA.

In contrast, there was little overall reaction to the announcement of the acceptance of the Against Mass Immigration initiative: both the SMI and the SPI experienced positive but statistically insignificant results.  Considering that the ending of the free movement of persons agreement would jeopardize all Bilateral I agreements, this finding is surprising.  At the risk of attributing more prescience to investors than they may have had, perhaps they were confident that Switzerland would devise an arrangement compatible with the free movement of persons agreement, which is in fact what happened.

That there was no overall reaction does not mean that all firms were left unaffected.  Mr. Bernardo finds a small but statistically significant 0.7% decline in the value of a portfolio of Swiss machine tool and electronics manufacturers.  Investors presumably feared that that the possible reappearance of technical barriers to trade would increase these firms’ cost of doing business in the EU.  Mr. Bernardo also finds a larger 3.3% decline in the value of engineering and technology giant ABB, which he contrasts with the lack of any significant response in the share price of telecom operator Swisscom.

Adjusting for CHF/Euro exchange rate movements slightly lowers these numbers and transforms the increase in the two indices from statistically insignificant to statistically significant.  It does not however change the overall pattern: the stock market as a whole very moderately increased, the value of machine tool and electronics manufacturers very moderately decreased, but ABB suffered a material decline in value.  The market value of the equity of ABB on the Friday that preceded the referendum amounted to around CHF 43 billion; 3% of 43 is about CHF 1.3 billion.  If one assumes that the same percentage applied to the wages paid to ABB’s employees and supplies sourced in Switzerland, then it is clear that the amounts at stake were not negligible, at least not for ABB shareholders, employees, and suppliers.

As noted above, Mr. Bernado’s analysis was initiated before Switzerland decided to end negotiations with the EU about an institutional agreement that would replace the Bilateral Agreements I and II.  Do his results tell us anything about the value of such an agreement?

To answer this question is not simple.  One may surmise from Mr. Bernardo’s results that (i) Switzerland, or at least the majority of quoted Swiss firms and their employees, would suffer little from an end to the bilateral agreements; indeed, that (ii) they would materially suffer if Switzerland’s regulatory autonomy were severely curtailed.  Proposition (ii) is probably true.  Proposition (i) may well be true, but it neglects the fact that the very reason the results of the referendums had little impact on firm values, with the exception of a large internationally active technology firm such as ABB, may be that investors expected Switzerland and the EU to devise alternative arrangements, which the parties did indeed.  If Proposition (i) is correct, then one may be justified in being sanguine about the end of the negotiations between Switzerland and the EU.  If it is not, then it is to be wished that, once more, Switzerland and the EU will be able to devise the necessary alternative arrangements.