Materiality and Magnitude: Event Studies in the Courtroom

Abstract

Since the Supreme Court's Daubert ruling, there has been an increased scrutiny of expert testimony in the courtroom. This has given rise to the need for analyses that, to the extent possible, are testable, supported by published literature, have a known or potential rate of error, and follow procedures that derive from objective standards rather than from an expert's own potentially subjective opinions or beliefs. An event study of a security's price, typically the measurement of a stock price's movement in response to a specific event or announcement, is an empirical technique that can be screened for admissibility with straightforward application of the Daubert factors. We argue that a properly conducted event study is an underutilized tool in litigation outside the field of securities law, and that event studies are often applied in an inexact or unscientific manner within securities litigation. To examine the usefulness of event studies, this paper discusses how they can be used to measure the impact of two different types of events: disclosure of an alleged securities fraud, and allegations illegal actions causing lost profits to a publicly traded defendant firm. We also compare the event study to other methodologies for determining the importance and size of an outside event on a company, and examine the conditions under which properly conducted event studies provide more objective and accurate measurements of the effects of these events on the company. We conclude that where an event study can be performed in a manner that provides reliable results, the event study is generally superior to other techniques because it provides estimates of statistical significance (materiality), confidence intervals around results, and reduces and clearly delineates the assumptions made by the analyst.