Announcement-period Stock Returns Research Articles

Firm social networks, trust, and security issuances

We observe that public firms are more likely to issue seasoned stocks rather than bonds when theirs boards are more socially-connected. These connected issuers experience better announcement-period stock returns and attract more institutional investors. This social-connection effect is stronger for firms with severe information asymmetry, higher risk of being undersubscribed, and more visible to investors. Our conjecture is this social-network effect is driven by trust in issuing firms. Given stocks are more sensitive to trust, these trusted firms are more likely to issue stocks than bonds. Trustworthiness plays an important role in firms’ security issuances in capital markets.

A Structural Model of Analyst Forecasts: Applications to Forecast Informativeness and Dispersion

We modify Morris and Shin (2002) to develop a structural model of analyst earnings forecasts. The model allows for analysts to herd due to informational effects and non-informational incentives. The benefits of our model are twofold: (1) we can decompose earnings forecasts into informational and bias components, and measure the stock price response to each component, and (2) we can estimate the impact of bias on the dispersion in analyst forecasts. In a pair of empirical exercises, we find a strong relation between the informational component of analyst forecasts and announcement period stock returns. We also find that analyst biases do not have an impact on forecast dispersion.

Role of Financial Reporting and Auditing in Disciplining CEOs: Evidence from Goodwill Impairments

According to accounting and auditing standards, external auditors and management must both independently monitor goodwill balance for any impairment. Therefore, goodwill impairment may contain valuable incremental information about the CEO’s ability which the board can utilize for CEO retention decisions. Consistent with this expectation, we find goodwill impairments lead to a large jump in subsequent CEO turnover. The turnover-impairment relationship varies with CEO power, auditor quality, accounting performance, and CEO-age and the information in goodwill impairment is incremental to the announcement period stock returns. Our analyses suggest that boards utilize the negative information in goodwill impairment in one of two ways. In the more severe cases, the incumbent CEO is dismissed; in other cases, their equity compensation is reduced which suggests that retention and pay act as alternative disciplining mechanisms. Our study highlights how the intersection of financial reporting and auditing can generate valuable information in disciplining CEOs.

How Accounting Firms Compete for Financial Advisory Roles in the M&A Market

Accounting firms participating in M&A advisory teams can leverage their knowledge accumulated through assurance services to give the teams a competitive advantage in advising on transactions with hard-to-value targets. Consistently, we document that bidders are more likely to select accounting firms to advise on transactions involving such targets. Knowledge spillover aids in estimating the target’s value, which translates into higher service quality offered by accounting firms as captured by higher acquirer announcement-period stock returns and lower likelihood of overpaying for the target. The effects we document are concentrated in cases when the accounting firm is the audit-specialist in the target’s industry or target’s auditor and the target has low reporting quality. Our results help explain why Thomson Reuters ranks accounting firms among top global advisors, particularly in the mid- and low-end M&A advisory market.

Does offshoring create value for shareholders?

We study the wealth effect of offshoring by analyzing the announcement-period returns as well as the long-run operating and stock return performance of firms that offshored their activities in the period 2000–2005. Announcement-period stock returns are positive for firms that offshore activities primarily to reduce costs but are negative for firms that offshore activities for other reasons. Also, announcement-period stock returns are higher for firms with a larger size, better operating performance, lower growth potential, and a higher cost of goods sold in the year prior to the offshoring announcement. Firms that offshore activities primarily to reduce costs enjoy improved operating and stock return performance in the years following the offshoring. Overall, our findings indicate that not all firms enjoy the benefits of offshoring; rather, only those that offshore primarily to reduce costs do.

How Much Is Too Much: Are Merger Premiums Too High?

Abstract Is it too much to pay target firm shareholders a 50% premium on top of market price? Or is it too much to pay a 100% premium when pursuing mergers and acquisitions? How much is too much? In this paper, we examine how the extent of merger premiums paid impacts both the long‐run and announcement period stock returns of acquiring firms. We find no evidence that acquirers paying high premiums underperform those paying relatively low premiums in three years following mergers, and the result is robust after controlling for a variety of firm and deal characteristics. Short term cumulative abnormal returns are moreover positively correlated to the level of the premium paid by acquirers. Our evidence therefore suggests that high merger premiums paid are unlikely to be responsible for acquirers' long‐run post merger underperformance.

How Much is Too Much: Are Merger Premiums Too High?

Is it too much to pay target firm shareholders a 50% premium on top of market price? Or is it too much to pay a 100% premium when pursuing mergers and acquisitions? How much is too much? In this paper, we examine how the extent of merger premiums paid impacts both the long-run and announcement period stock returns of acquiring firms. We find no evidence that acquirers paying high premiums underperform those paying relatively low premiums in three years following mergers, and the result is robust after controlling for a variety of firm and deal characteristics. Short term cumulative abnormal returns are moreover positively correlated to the level of the premium paid by acquirers. Our evidence therefore suggests that high merger premiums paid are unlikely to be responsible for acquirers' long-run post merger underperformance.

Outside directors and corporate board decisions

Between 1993 and 2000, at least 18 countries saw publication of guidelines proposing minimum representation of outside directors on corporate boards. Underlying this movement is an apparent presumption that boards with significant outside directors will make different and, perhaps, better decisions than boards dominated by insiders. As the first-mover in this movement, the United Kingdom provides a laboratory for a “natural experiment” to examine this presumption empirically. We find that UK boards that complied with the exogenously imposed standard were more likely to appoint outside chief executive officers (CEOs). Additionally, announcement period stock returns indicate that investors appear to view appointments of outside CEOs as good news. Apparently, boards with more outside directors make different (and perhaps better) decisions.

Does Investor Misvaluation Drive the Takeover Market?

This paper tests the hypothesis that irrational market misvaluation affects firms' takeover behavior. We employ two contemporaneous proxies for market misvaluation, pre-takeover book/price ratios and pre-takeover ratios of residual income model value to price. Misvaluation of bidders and targets influences the means of payment chosen, the mode of acquisition, the premia paid, target hostility to the offer, the likelihood of offer success, and bidder and target announcement period stock returns. The evidence is broadly supportive of the misvaluation hypothesis.

Operating Performance and Free Cash Flow of Asset Buyers

We examine a sample of 552 firms that announce asset purchases. We find that the announcement period returns are negatively related to the amount of free cash flow for buyers with fewer growth opportunities. Compared to the year prior to the purchase, the mean long-run operating performance of asset buyers worsens in each of the three years following the transaction. Operating performance changes are negatively related to the amount of free cash flow, and the relationship is stronger for buyers with fewer growth opportunities. We also find that buyer firms experience a decline in the return on assets and asset turnover ratios. These findings are consistent with Jensen’s (1986) free cash flow theory. Asset sales have become increasingly common in recent years. Two recent examples are the Fuji Xerox purchase of Xerox’s Chinese operations for $550 million and the Univision Communications purchase of USA’s television stations for $1.1 billion. John and Ofek (1995) and Lang, Poulsen, and Stulz (1995) examine stock price reactions to the announcement of changes in the ownership of assets. They find that the announcement period stock returns are positive on average for the seller and positive or zero for the buyer of the asset. Most researchers concentrate on the seller’s stock price reaction to the announcement of the asset sales. We focus primarily on the buyer’s operating performance following the purchase. We examine the operating performance of the asset buyers during a seven-year period around the asset purchase, measuring performance in terms of pretax operating cash flow scaled by the book value of assets. Two other measures are an industry-adjusted measure, which adjusts raw performance by a matched portfolio based on industry, and a matched-firm-adjusted method, which is based on a portfolio matched by firm size and performance. By all three measures, compared to the year prior to the purchase, operating performance worsens during the three-year period following the asset purchase. We also find that the asset buyers experience a decline in the return on assets and asset turnover ratios during the three years following the purchase. The cross-sectional regressions show a significant relationship between the changes in operating performance and growth opportunities and free cash flow of the asset buyers. On average, operating performance changes are negatively related to free cash flow for buyers with fewer growth opportunities. Although the coefficient of free cash flow is also negative for highgrowth firms, free cash flow has lower economic and statistical significance than in the case of low-growth firms. Changes in focus or the method of payment for the purchased assets have no effect on the long-run performance of the buyers. Like several other authors, we find the average stock price reaction is positive for the asset buyers. Our univariate results show that announcement period returns are positive and significant for buyers with low free cash flow. The cross-sectional regressions control for other factors

Outside Directors and Corporate Board Decisions: A Natural Experiment

During the 1990s, the global economy appears to have suffered an outbreak of director mania - at least 18 countries have witnessed publication of guidelines that stipulate floors for the representation of outside directors on corporate boards. The apparent (largely untested) premise underlying this movement is that boards with significant outside directors will make different (and perhaps better) decisions than boards dominated by inside directors. As the first-mover in this movement, the U.K. provides a laboratory for a natural experiment to examine this presumption empirically. We investigate one key board task - the appointment of the CEO - to determine whether boards are more likely to appoint an outside CEO after they have increased the representation of outside directors to comply with the exogenously imposed standards. We find that the (coerced) increase in outside directors does alter the CEO selection decision. Additionally, announcement period stock returns indicate that the decisions are not only different, they also appear to be better.

Leverage Ratios, Industry Norms, and Stock Price Reaction: An Empirical Investigation of Stock-for-Debt Transactions

In this paper, I extend the stock-for-debt research by investigating whether stock value is influenced by how a firm changes its leverage ratio in relationship its industry leverage ratio norm. I find that announcement-period stock returns for firms moving away from industry debt-to-equity norms are significantly more negative than returns for firms moving closer to these norms. This finding is consistent with optimal capital structure theory if industry debt-to-equity norms are reasonable approximations of wealth maximizing leverage ratios.