Long-run Abnormal Returns Research Articles

Merger Waves, Pseudo Market Timing and Post-Merger Performance

Do managers time the market when they make merger decisions? Merger and acquisition waves seem to correspond with market tides, cresting with bull markets. A contentious debate exists over whether this trend indicates managerial market timing ability. Pseudo market timing, introduced by Schultz (2003, Journal of Finance 58, 483–517), provides an alternative hypothesis to explain abnormal performance following events even when managers cannot time the market. I find that acquiring firms which use stocks as the method of payment exhibit negative long-run abnormal returns in event-time, but not in calendar time. Simulations reveal that even when ex ante expected abnormal returns are zero (i.e. managers have no market timing ability), median ex post performance for acquirers is significantly negative when event-time is used. These findings support pseudo market timing as an explanation for acquiring firm underperformance in the context of stock mergers.

The Relevance of Information Technology Expenditures

ABSTRACT: Although information technology (hereafter, IT) expenditures represent an increasingly large investment for most corporations, firms are not required to disclose them separately in their financial statements. We hypothesize and find evidence that information about a firm’s IT expenditures helps explain its future performance as reflected in both accounting measures (residual income, earnings volatility) and market measures (stock price and long-run abnormal returns). In particular, we provide evidence of market mispricing and suggest the lack of firm-level annual IT expenditure disclosure as one potential reason for such mispricing. Altogether, the evidence presents a persuasive case that information about a firm’s IT expenditures is useful to stock market participants. The evidence we report is useful to managers and accounting policy makers contemplating the public disclosure of firm-level information about IT investments.

The Information Content of Trade Credit

During 1992–2007, suppliers financed almost 10% of the total assets of U.S. listed firms. This intensive usage of trade credit is puzzling in the light of its high (implicit) costs. By arguing that trade credit use provides valuable information to outside investors, we first derive a theoretical model that predicts a positive correlation between trade credit use and the quality of the firm’s investments. Then, using several proxies for firm’s investment quality (Z-score, return on assets, and long-run abnormal returns), we show that this prediction receives strong support from a large sample of U.S. firms.

Cause and effects of poison pill adoptions by spinoff units

We find that units are more likely to adopt poison pills at the time of a spinoff if their parents have anti-takeover provisions in place. In addition, the probability that a spinoff unit adopts a poison pill is negatively related to outside block ownership, but positively related to the size of the unit, institutional ownership, industry takeover activities, and relative industry market-to-book ratio. Units that adopted poison pills elicit a strong negative market response at the time of the spinoff, which implies that investors may believe the pills could prevent the units from being acquired. Despite the initial negative market response, abnormal long-run returns are higher among units that implement poison pills before the spinoff is executed than among units that do not. Moreover, we find that the units’ adoption of poison pills does not reduce their likelihood of being acquired, which suggests that the pills may be intended to increase bargaining power rather than prevent takeovers, and could explain the more favorable long-run abnormal returns.

Speculation and e-commerce: The long and the short of IT

Over the past 25 years, the development of electronic commerce (e-commerce) has challenged and threatened firms to adapt their business models and processes. Successful adaptation can lead to improved efficiencies, growth in market share, expansion into new markets, or simply survival in competitive markets. Short-window event studies provide evidence that the market places significant value on investments in e-commerce. However, if the market misunderstands how these projects add value, value measurement based on short-run returns could be misleading. We address this possibility by examining the market reaction to e-commerce investment announcements by a sample of mining companies. We argue that this group of companies represents a sample for which, a priori, there is no expected value added to the firm from the type of investment they announce. We find strong evidence that the market reacts positively to these announcements in the days surrounding the information release. However, we find that in the three-year period subsequent to the announcement the firms realize long-run negative abnormal returns. Significant share-price rises leading up to and immediately subsequent to the announcement dates were completely reversed over the subsequent three years. We interpret this result as being consistent with the market not always understanding when e-commerce adds value. While our result is only applicable to equity investments in small, speculative ventures, it suggests some caution in the use of short-run market value changes as a measure of the value added to firms by an e-commerce investment.

The stock market reaction to criticism of corporate governance practices of companies listed on the JSE

ABSTRACTThis paper investigates a key aspect of possible reputational damage to a company: the publication of criticism of corporate governance practice in the financial press. To understand the valuation effect associated with such criticism, long-run abnormal returns following the publication date are examined. In addition to the initial negative reaction on publication, the companies in the sample experienced further significant risk-adjusted returns of -15,15% and -22,94% respectively over the next one and two years. A decline in future operating performance appears to be an important reason for the poor stock market performance of the companies. These results underscore the importance of investors fully understanding the disclosure of a company's corporate governance practice.

Performance and Characteristics of Acquiring Firms in the Chinese Stock Markets

We investigate the performance and characteristics of acquiring firms on 1148 M&A on the two Chinese stock markets from 1998 to 2003. Using the market model, the CAPM model and the buy-and-hold methods, we find significantly positive abnormal returns before (6 months) and upon M&A announcements, while the long-run abnormal returns (6 months) after M&A are insignificant. Within our sample, cash is the dominant payment method and the competition during M&A is low. The cross-sectional analysis on acquirers' market performance upon announcements shows that the political advantages of acquiring firms have a significantly positive impact on the acquirers' performance, while the economic advantages do not. Cross-provincial M&A and better corporate governance create value to acquiring firms. Finally, cash payment impacts positively and regulation development impacts negatively the performance of acquiring firms during M&A.

Comment on ‘earnings management around UK open offers’

This note discusses the result of Iqbal, A., S. Espenlaub, and N. Strong. 2008. Earnings management around UK open offers. European Journal of Finance, this issue, regarding long-run abnormal returns following open offers and announcement abnormal returns, compared with differing results in two previous studies based on similar samples. A survivorship bias explains some of the differences in the reported long-run abnormal returns. The difference in the announcement abnormal returns could be due to use of different data sources.

Investor Horizon and CEO Horizon Incentives

We examine the relation between shareholder investment horizon and CEO horizon incentives derived from compensation contracts. We find that influential incumbent shareholders provide managers with short-horizon incentives to maximize current firm value when these shareholders plan to sell their stock. Specifically, we use the IPO setting in which venture capitalists represent short-horizon, controlling investors with strong selling incentives after the IPO. We predict and find that VC’s short-term incentives influence CEO’s annual horizon incentives following the IPO. At the same time, institutional monitoring limits the influence of VCs on annual, short-horizon incentives. To preempt this disciplining by market participants, VCs grant equity prior to the IPO that correspond with their short-horizons and result in shorter portfolio horizon incentives for the CEO after the IPO. We also document a positive relation between long-run abnormal stock returns and horizon incentives, consistent with horizon incentives influencing management actions.

Do Privatization IPOs Outperform in the Long-Run?

This paper investigates the long-run stock returns of privatization initial public offering (IPO) firms using a sample of 241 privatization IPOs from 42 countries during the period 1981-2003. We compare one-, three-, and five-year holding period returns of privatization IPOs to those of the domestic stock market indices and to those of size and size-and-book-to-market equity ratio (BM)-matched firms from the same countries. Consistent with previous studies, we find that privatization IPOs significantly outperform their domestic stock markets in the long-run. However, they show less consistent abnormal long-term stock performance relative to their size- or size-and-BM-matched benchmark firms. These results confirm the problems inherent in estimating long-run abnormal returns. Additionally, the market values privatization IPOs without much systematic bias after the IPO, in contrast to private companies' IPOs. This is consistent with privatization IPOs having less information asymmetry than private IPOs

Cycles in the IPO market

We develop a model in which time-varying real investment opportunities lead to time-varying adverse selection in the market for IPOs. The model is consistent with several stylized facts known about the IPO market: economic expansions are associated with a dramatic increase in the number of firms going public, which is in turn positively correlated with underpricing. Adverse selection is procyclical in the sense that dispersion in unobservable quality across firms should be more pronounced during booms. Taking the premise that uncertainty is resolved (and thus private information revealed) over time, we test this hypothesis by looking at long-run abnormal returns and delisting rates. Consistent with the model, we find (a) greater cross-sectional return variance, and (b) higher incidence of delisting for hot-market IPOs.

A Dynamic Model of Corporate Financing with Market Timing

In this paper, I build a dynamic trade-off model of financing with difference in beliefs between the manager and investors. In the model, investors update more readily on earnings announcements than the manager does. The model offers a parsimonious treatment of endogenous financing, payout, and cash policies. The model generates a broad set of well-documented empirical facts that are difficult to explain using standard theories. In particular, the model predicts: 1) high stock returns predicting equity issuance, 2) the low debt ratios of firms in cross-section, 3) the substantial presence of firms with no debt or negative net debt and the fact that zero-debt firms are more profitable, pay larger dividends, and keep higher cash balances than other firms, and 4) the negative relationship between profitability and both book and market leverage ratios. If investors overextrapolate trends in earnings growth, the model also predicts the negative/positive long-run abnormal returns following stock issuances/repurchases.

Would various benchmark measurements affect abnormal return performances of IPO? Evidence from Taiwan's IPO market

This paper tries to answer the question: would the initial/long-run returns IPO significantly differ when various alternative measurements of market portfolio are adopted? Briefly, this study states that various methodologies for market returns might correspond to different magnitudes of abnormal returns of IPO. The aforementioned hypothesis is tested in Taiwan's high-tech IPO market. Our empirical findings are consistent with the following notions. Firstly, various methodologies of market portfolio benchmark perform significant effects on the magnitudes of the long-run abnormal returns of IPO, but not for the initial abnormal returns of IPO. Secondly, by using the purging and value-weighted market-adjusted returns as a standard, the use of non-purging (equally weighted) benchmark will underestimate (overestimate) the poor long-run IPO's return.

Long-run performance following quality management certification

Public firms that seek and successfully receive certification of quality management, type ISO 9000, seem to experience different post-announcement share-price drifts depending on their size. This result is not consistent with the notion that companies seeking to implement a quality management system may be reducing agency problems between managers and shareholders, which are among corporate governance and control goals of any well management company. Otherwise, we should have observed material and positive abnormal share-price changes, following ISO 9000 registration announcements, independently of company size. Our results show that only stocks of large-size firms, experience positive average significantly abnormal returns over the post-announcement 1-, 2-, and 3-year horizons. On the other hand, stocks of small-size firms experience negative average significantly abnormal returns, and stocks of mid-size firms do not show any material gain over the same horizons. Although there is a rich finance literature that has studied the long-run abnormal stock-price returns following several major corporate events, this study seems to be the only one that have examined the potential long-run impact of this certification-event, despite the fact that those standards have been around since the middle 1980s.

Cycles in the IPO Market

We develop a model in which time-varying real investment opportunities lead to time-varying adverse selection in the market for initial public offerings. The model is consistent with several stylized facts known about the IPO market: economic expansions are associated with a dramatic increase in the number of firms going public, which is in turn positively correlated with underpricing. The model also makes new predictions regarding long-run IPO returns. Adverse selection is shown to be of procyclical severity in the sense that dispersion in unobservable quality across firms should be more pronounced during booms. Taking the premise that uncertainty will only be resolved (and thus private information revealed) over time, we test this hypothesis by looking at long-run abnormal returns and delisting rates. Consistent with the model, we find a) greater cross-sectional return variance and b) higher incidence of delisting during hot IPO markets.

Positive Performance and Private Equity Placements: Outside Monitoring or Inside Expertise?

Executive Summary. This paper examines the performance of real estate investment trusts (REITs) making equity private placements. Since REITs are frequent issuers of equity, we can control for the market’s reaction to underinvestment versus monitoring. Like previous studies of REIT public offerings, we find a significant negative abnormal return associated with the announcement of an equity private placement, positive long-run abnormal returns, and improved operating performance. The long-run abnormal returns are not associated with the presence of an external monitor. It does appear, however, that REIT managers are able to time equity issues to correspond with stock market performance and investment opportunities in the real estate market.

Investor awareness and the long-term impact of FTSE 100 index redefinitions

This study finds an asymmetric long-run abnormal return performance following stocks’ inclusion in or deletion from the FTSE 100 Index. This asymmetry suggests that investors’ awareness of stocks is influenced by index changes. These results extend those documented by Chen et al . (2004) for the S&P 500.

Market Misvaluation and Merger Activity: What Do Managers' Insider Trades Tell Us?

This paper explores the link between stock market overvaluation and merger activity. I examine how managers recently traded in own company stock in their personal portfolios to infer whether they view their firm as overvalued or undervalued. I find that firms whose managers sold more recently are more likely to acquire other firms for stock and the subsequent mergers have negative and lower short-run and long-run abnormal returns. I also find that acquirer firm managers abnormally increase their selling of company stock before stock mergers but not before cash mergers. To the extent that managerial trading reflects overvaluation, my results can be interpreted as supporting the empirical predictions of models of misvaluation driven mergers.

Major Investments, Firm Financing Decisions, and Long-Run Performance

We assemble a sample of 1,558 large investments made by 1,185 firms over the period 1989-1999, and study two main issues: How do firms pay for these large investments? And how does the stock market subsequently evaluate them? We find that major investments are mostly externally financed. The pecking order and market timing effects on capital structure are transitory. Firms move toward target leverage ratios. Long-run abnormal stock returns are not generally consistent with the hypothesis that managers tend to overinvest with internal funds. Only firms financing large projects with (newly-raised) external funds exhibit reliably negative abnormal returns over the subsequent 1 – 3 years.

Valuation Effects of Institutional Ownership: the Case of Corporate Takeovers

We examine the relation between institutional ownership in acquiring firms and their post takeover stock performance. We find that negative long-run abnormal returns appear to decline (in economic and statistical terms) as the extent and persistence of institutional ownership increase, after accounting for the size, book-to- market and method of payment effects. Given the unusually high uncertainty surrounding takeovers, such evidence implies that the degree of short sale constraints serves as an important determinant of acquiring firms’ short-run overpricing (Miller, 1977). It appears that the presence of institutions mitigates and in most cases eliminates, through effective arbitrage, any short-run overpricing that may be responsible for the long-run underperformance of acquirers, preserving in this way efficiency in the takeover markets.