Characteristic-Based Expected Returns and Corporate Events

Abstract

We propose that expected returns estimated from the broad stock market based on firm characteristics provide a useful benchmark for assessing whether returns to certain stocks are abnormal. To illustrate, we document that the apparently abnormal returns after eight important events, including credit rating and analyst recommendation downgrades, initial and seasoned public equity offerings, mergers and acquisitions, dividend initiations, share repurchases and stock splits, are substantially reduced or eliminated when event stock returns are compared to characteristic-based expected returns. A simple five-characteristic specification using firm size, book-to-market ratio, profitability, asset growth, and return momentum performs well for most examined events.