Negative Market Reaction Research Articles

Employee stock option plans and stock market reaction: evidence from Finland

This paper examines whether the adoption of stock option plans results in changes in shareholders’ wealth, and whether the stock market reactions to ESOP announcements could be explained by the target group of ESOP and the dilution effect. Short-horizon test methods are applied for this purpose. The sample consists of ESOP announcements of Finnish publicly quoted companies on the Helsinki Stock Exchange during the time period 1988–1998. The event study results show a slightly positive market reaction to announcements of ESOPs targeted to management and a negative market reaction in the case of ESOPs targeted to all employees. The results of regression analysis show that the ESOPs with limited dilution convey positive information to the stock market and the dilution effect has a negative impact on stock returns, especially in the case of ESOPs targeted to all employees.

Evidence on the pernicious effect of financial report environmental disclosure

Unlike previous US environmental regulations, the Toxics Release Inventory (TRI), passed into law in 1986, focused on using information as a tool for reducing pollution. As noted by Konar and Cohen [Journal of Environmental Economics and Management 32 (1997) 109], if investors cared enough about the pollution performance information required under the enactment to punish bad performers, firms would have a market-based incentive to reduce toxic emissions. However, legitimacy theorists suggest that corporations may use largely voluntary financial report environmental disclosures to offset or mitigate the negative aspects of other information or actions. Accordingly, these disclosures could reduce the market effect of the TRI program. This study examines the market reaction to the unexpected proposal by President George Bush in June of 1989 for revisions in the Clean Air Act to identify whether TRI information and 10-K report environmental disclosures had an impact. Based on a sample of 112 firms, we find that companies with worse pollution performance (higher levels of size-adjusted toxic releases into the air) suffered more negative market reactions than companies with better performance. However, companies with less extensive environmental disclosures in their 10-K reports suffered more negative market reactions than companies with more extensive disclosure. These results suggest that, while the TRI information may be inducing market effects that could in turn work as a quasi-regulatory device, financial report environmental disclosure reduces its impact. If concern about the environment is important, therefore, it appears that environmental disclosure under a largely voluntary regime is inadequate.

The Information Content and Timeliness of Fair Value Accounting: An Examination of Goodwill Write-offs Before, During and After Implementation of SFAS 142*

As U.S. accounting standard setters increasingly favor a fair value based regime, critics claim that the abandonment of a historical cost based system may produce unintended consequences, such as increased bias and manipulation in financial reports. In this paper, we present exploratory evidence on the tensions between relevance and reliability that are at the heart of the fair value debate. More specifically, we examine whether certain changes to fair value accounting embedded in Statement of Financial Accounting Standards No. 142: Goodwill and Other Intangibles Assets (SFAS 142) alter the information content and timeliness of goodwill write-offs. In general, we document a negative and significant stock market reaction to the announcement of goodwill write-offs, however the results are driven by large firms and single segment firms. Further, we find that the application of SFAS 142 does not change the information content of these write-offs. Additionally, we find that write-offs of goodwill and other intangible assets were recorded on a timely basis before the adoption of SFAS 142, and remain so after its adoption. However, these results are driven by large firms. Finally, managers appear to have acted strategically during the initial adoption period as they wrote off goodwill and other intangible assets that were not yet impaired as a cumulative effect of an accounting change to both insure against future operating losses and present a more conservative balance sheet.

Sub-Optimal Acquisition Decisions under a Majority Shareholder System

The high separation of ownership from control achieved through the concurrent use of non-voting shares and stock pyramiding could favor acquisitions made to increase private benefits of the controlling shareholders rather than all shareholders’ wealth. A standard event study methodology is carried out on three different samples of Italian acquisitions during the 1989–1996 period in order to test this hypothesis. We find evidence that a worse market reaction characterizes acquiring firms with a higher separation of ownership from control, while more value-enhancing transactions are undertaken by those smaller in size and with higher prior-performance. An entrenchment effect seems to determine a significant U-shaped relationship between the market reaction and the ultimate shareholder ownership. When the sample is restricted to acquiring firms with a dual class equity structure we find that non-voting shares report significantly negative excess returns in contrast to significantly higher positive returns for voting shares. Such evidence seems to indicate that the average acquisition has been overpaid, as suggested by the negative market reaction of the non-voting shares, while it was expected to lead to higher private benefits to the majority shareholders, as suggested by the revaluation of the voting shares. Finally, the market reaction to acquisitions made within pyramidal groups seems to indicate that the price is set so as to transfer wealth towards the companies located at the upper levels, where majority shareholders own greater fractions of the companies’ cash flows.

Was Arthur Andersen Different? An Empirical Examination of Major Accounting Firms' Audits of Large Clients

Enron and other corporate financial scandals focused attention on the accounting industry in general and on Arthur Andersen in particular. Part of the policy response to Enron, the criminal prosecution of Andersen, eliminated one of the few major audit firms capable of auditing many large, public corporations. This article explores whether Andersen's performance, as measured by frequency of financial restatements, measurably differed from that of other large auditors. Financial restatements trigger significant negative market reactions and their frequency can be viewed as a measure of accounting performance. We analyze the financial restatement activity of approximately 1,000 large, public firms from 1997 through 2001. After controlling for client size, region, time, and industry, we find no evidence that Andersen's performance significantly differed from that of other large accounting firms.

The effect of supply chain glitches on shareholder wealth

This paper estimates the shareholder wealth affects of supply chain glitches that resulted in production or shipment delays. The results are based on a sample of 519 glitches announcements made during 1989–2000. Shareholder wealth affects are estimated by computing the abnormal stock returns (actual returns adjusted for industry and market-wide influences) around the date when information about glitches is publicly announced. Supply chain glitch announcements are associated with an abnormal decrease in shareholder value of 10.28%. Regression analysis is used to identify factors that influence the direction and magnitude of the change in the stock market’s reaction to glitches. We find that larger firms experience a less negative market reaction, and firms with higher growth prospects experience a more negative reaction. There is no difference between the stock market’s reaction to pre-1995 and post-1995 glitches, suggesting that the market has always viewed glitches unfavorably. Capital structure (debt–equity ratio) has little impact on the stock market’s reaction to glitches. We also provide descriptive results on how sources of responsibility and reasons for glitches affect shareholder wealth.

The Usefulness of the Supervisory Board Report in China

Chinese listed companies adopt a two‐tier board structure, a Board of Directors (BoD) and a Supervisory Board. They are also required to provide in their annual reports a supervisory board report (SBR). However, Congquin, a listed company, failed to issue a SBR in its 1998 annual report. This study specifically investigates the usefulness of the SBR by examining the stock market reaction to Congquin's SBR omission. The study also examines the Supervisory Board's reporting process and users’ perceived usefulness of the SBR through interviews with directors, supervisory board members and senior executives of 16 listed companies. Discussions were also held with financial analysts, regulatory officials and academics. Our event study suggests that the absence of the SBR in Congquin's 1998 annual report caused a negative market reaction suggesting that investors had considered the SBR and the Supervisory Board important and were discouraged by the problems manifested by the absence of the SBR. Our interviews reveal that the usefulness of the SBR depends on the role that the Supervisory Board plays in corporate governance. If the Supervisory Board is an honoured guest, a friendly advisor, or a censored watchdog, it is unlikely that the SBR will convey much useful information. By contrast, if the Supervisory Board acts as an independent watchdog, then the SBR would be useful. Given the fact that the Supervisory Board in most of the companies that participated in the interviews fell into the first three categories, there remains a strong need to improve the usefulness of the SBR and strengthen the functioning of the Supervisory Board.

The economic cost of publicly announced information security breaches: empirical evidence from the stock market*

This study examines the economic effect of information security breaches reported in newspapers or publicly traded US corporations. We find limited evidence of an overall negative stock market reaction to public announcements of information security breaches. However, further investigation reveals that the nature of the breach affects this result. We find a highly significant negative market reaction for information security breaches involving unauthorized access to confidential data, but no significant reaction when the breach does not involve confidential information. Thus, stock market participants appear to discriminate across types of breaches when assessing their economic impact on affected firms. These findings are consistent with the argument that the economic consequences of information security breaches vary according to the nature of the underlying assets affected by the breach.

Unsolicited Credit Ratings: Theory and Empirical Evidence

Unsolicited ratings are credit ratings of firms that have not requested rating evaluation and therefore do not pay fees. Accordingly, unsolicited ratings are issued solely by the discretion of rating agencies based on public information. Given the controversy surrounding unsolicited ratings raised by Japanese firms and some studies, we examine whether the market extracts any new information from unsolicited ratings. We find that unsolicited ratings typically are of speculative grade rather than investment grade; induce significant announcement period abnormal returns for downgrades; and have greater impact for speculative-grade ratings than investment-grade ratings. Keiretsu affiliation of Japanese firms does not mitigate the negative market reaction to unsolicited rating downgrades. Our results suggest that high-quality firms signal through solicited ratings while low-quality firms are revealed through unsolicited ratings.

Diversification, Ownership and Control of Swedish Corporations

We study the short- and long-term valuation effects of Swedish takeovers. Using a sample of 93 bidding firms that acquired 101 targets between 1980 and 1995, we find that diversifying acquisitions lead to a negative market reaction and deterioration of the operating performance of the bidder. Announcement and performance gains in each of the three years following the acquisition occur only when bidders expand their core rather than their peripheral lines of business. Our findings suggest that focused acquisitions lead to greater synergies and operating efficiencies than diversifying acquisitions. Intra-group acquisitions, however, show that bidders do not realise significant gains whether they adopt diversifying or focusing investment strategies by purchasing firms controlled by the Wallenberg and SHB conglomerate groups. Intra-group targets realize significant gains regardless bidder's investment strategy. Finally, the evidence does not support the view that intra-conglomerate acquisitions are associated with expropriation of minority shareholders. However, they appear to enhance the control rights of large shareholders of the bidding firm.

The Effect of 10K Restatements on Firm Value, Information Asymmetries, and Investors' Reliance on Earnings

Restating 10-Ks has become an increasingly common phenomenon in financial reporting. Restatements clearly signal that the firm's prior financial statements were not credible and were of relatively lower quality. In this study, we examine the effect of restatements on investors' and dealers' perceptions of the firm. First, we examine the market returns and the bid-ask spread effects at the announcement of the accounting problem that leads to restatement. We find negative market returns for accounting problem announcements, and we find that the negative reaction is most pronounced for firms with revenue recognition issues. We also find an increase in spreads surrounding the announcement of revenue recognition problems. Second we examine returns and spreads from the announcement of the restatement to the filing of the restated financial statements. We find a significant negative market reaction and a larger negative reaction for firms with revenue recognition problems. We find no change in spreads from before the announcement of the accounting problem to after the restatement is filed. Finally, we examine the effect of the restatement on earnings response coefficients, and find that the market reacts less to earnings after a restatement than to earnings prior to a restatement. In general, these results indicate that investors and dealers react negatively to restatements and are more concerned with revenue recognition problems than with other financial reporting errors.

Diversification, Ownership and Control of Swedish Corporations

We study the short‐ and long‐term valuation effects of Swedish takeovers. Using a sample of 93 bidding firms that acquired 101 targets between 1980 and 1995, we find that diversifying acquisitions lead to a negative market reaction and deterioration of the operating performance of the bidder. Announcement and performance gains in each of the three years following the acquisition occur only when bidders expand their core rather than their peripheral lines of business. Our findings suggest that focused acquisitions lead to greater synergies and operating efficiencies than diversifying acquisitions. Intra‐group acquisitions, however, show that bidders do not realise significant gains whether they adopt diversifying or focusing investment strategies by purchasing firms controlled by the Wallenberg and SHB conglomerate groups. Intra‐group targets realize significant gains regardless bidder’s investment strategy. Finally, the evidence does not support the view that intra‐conglomerate acquisitions are associated with expropriation of minority shareholders. However, they appear to enhance the control rights of large shareholders of the bidding firm.

Shredded Reputation: The Cost of Audit Failure

In this article we investigate the impact of the Enron audit failure on auditor reputation. Specifically, we examine Arthur Andersen’s clients’ stock market impact surrounding various dates on which Andersen’s audit procedures and independence were under severe scrutiny. On the three days following Andersen’s admission that a significant number of documents had been shredded, we find that Andersen’s other clients experienced a statistically negative market reaction, suggesting that investors downgraded the quality of the audits performed by Andersen. We also find that audits performed by Andersen’s Houston office suffered a more severe decline in abnormal returns on this date. We are not able to show that Andersen’s independence was questioned by the amount of non–audit fees charged to its clients.

Shareholder Wealth Effects of Rights Offerings in an Emerging European Market: The Istanbul Stock Exchange

This research investigates the market reaction to both unsweetened (plain) and sweetened (with simultaneous distribution of bonus issues) rights offerings during the announcement and subscription periods. Three hypotheses, namely the signaling, the issue price irrelevance and the price pressure hypotheses, are tested within the unique institutional settings of the Istanbul Stock Exchange (ISE). Similar in direction to the research results in the U.S., but greater in magnitude, a negative market reaction is empirically detected on the announcement day for unsweetened rights offerings. However, for sweetened rights offerings, a positive market reaction is detected supporting the sweetener effect of bonus issues. Positive market reactions are also found during the subscription periods of both unsweetened and sweetened rights offerings. The cross-sectional analyses of the observed market reactions provide evidence supporting the three hypotheses.

Are stock dividends (MUSHOs) melons or lemons in Japan?

Whether stock dividends are favorable or unfavorable has been a topic of debate for many years. With real transaction costs involved and without a real effect on the firms' value, stock dividends are often described as “lemons”. When the announcements of stock dividends are associated with increases in future cash dividends, they are perceived favorably as “melons”. Given the dividend payout practice in Japan, the market, on average, reacts positively to Musho-koufu (MUSHO) announcements. Moreover, the market reaction is greater for MUSHOs with higher distribution ratios. Further analysis indicates that MUSHOs of higher distribution ratios are associated with greater increase in dividend payments in the future years than MUSHOs of smaller ratios. However, MUSHOs may not be as good as they appear on average. The three-day cumulative abnormal returns around announcement day range from −12.90% to 28.37%. In addition, among all the MUSHO announcements, about 38.6% incur a negative market reaction. Obviously, some MUSHOs are not perceived favorably by the market. In general, we offer some clues as to which stock dividends are more likely to be favorably or unfavorably perceived. MUSHOs with a higher distribution ratio and an increase in investment are more favorably perceived by the market. MUSHOs by firms that belong to keiretsu groups are also regarded favorably.

Are Initial Return and IPO Discount the Same Thing? A Comparison of Direct Public Offerings and Underwritten IPOs

The major difference between this study and the literature is in the estimation of the true IPO discount. We point out that initial return consists of two parts: the true discount of the offer price as well as the market reaction on the listing. By comparing the true discounts in traditional underwritten IPOs and the emerging direct public offerings(DPOs), we find that DPOs have both lower initial returns and lower discounts than IPOs, furthermore, DPOs have positive market reaction(overreaction) while IPOs have negative market reaction(underreaction) in the first month. The reason for the smaller discount of DPOs is not due to underwriting mechanism or firm characteristics, but that DPOs investors have less information asymmetry problem than their counterpart in IPOs. However, the DPO investors may be overconfident on their private information, which leads to market overreaction in the first month. Key words: DPO, IPO discount, initial return, overconfidence, information asymmetry

Mergers and Acquisitions in the Telecommunications Industry:Myths and Reality

This paper investigates how market participants react to mergers and acquisitions (M&As) involving telecommunications companies. The empirical evidence suggests that such activities convey bad news to the market. This is consistent with the synergy trap hypothesis and extant empirical findings of value-reducing diversification strategies in recent literature. The evidence also indicates that a cross-border, rather than a domestic M&A deal, is the main driver of the negative market reaction. Further, our evidence of negative impacts on the bidder's business after an M&A reinforces our main finding that market participants, on average, perceive M&A activities to be detrimental to shareholder value. This suggests that value creation or synergy through an M&A deal is not warranted even though it can generate an increase in size of the firm.

Why Do US Firms Choose Global Equity Offerings?

This study examines the economic motivation for global seasoned equity offerings made by US firms. We find that firms announcing global offerings have significantly less negative market reactions than had they limited the issues to domestic only. The extent of the reduced price drop at issue announcement is found to be negatively associated with pre-announcement price run-up, firm size, and market-to-book equity, but positively associated with unsystematic risk. We also find that global issuingfirms outperform their domestic counterparts for up to three years following the offerings. As an increasing number of foreign companies have raised equity capital in the US capital market, many US companies are seeking global dissemination of their new equity through a procedure that commonly sets aside a proportion of the total shares for targeted foreign investors (global tranche) with simultaneous issue of the remaining shares in standard registered form in the US domestic market (domestic tranche). Although the two tranches are marketed separately by two syndicates of underwriters, the global tranche is usually led by the overseas affiliates of the lead US underwriters of the domestic tranche to ensure tight control over the allocation of shares. The offer price is the same to all investors, regardless of nationality, because the Rules of Fair Practice of the National Association of Securities Dealers (NASD) do not allow price discrimination. Since there is generally no obstacle to foreign investors purchasing shares directly in the US market, one might wonder about the motivations for and potential benefits of global issues. We develop three hypotheses regarding the motivations of global offerings. The name recognition and accessibility hypothesis suggests that global issues enhance investor recognition and participation in both the primary and the secondary markets. The alleviation of asymmetric information hypothesis posits that the ability to issue global shares may serve to validate firm quality, reducing the information asymmetry between insiders and investors. The window of opportunity hypothesis postulates that firms may switch to global offerings when domestic demand for their new shares is weak. We examine the economic effect of global issues by comparing a sample of global seasoned equity offerings made by US industrial companies from 1985 through 1995 and a domestic control sample that includes all purely domestic offerings during the same period.

Employee Downsizing Strategies: Market Reaction and Post Announcement Financial Performance

Empirical studies have generally reported insignificant market reactions to employee downsizing. In an effort to reconcile ongoing layoffs with inconclusive empirical results, we segregated our sample by downsizing strategy and examined employee layoff announcements made by Fortune 500 firms during the 1993–1995 period. Unlike previous studies, we find a positive market reaction for layoff announcements related to revenue refocusing. Market reaction with respect to layoff announcements involving cost cutting was insignificant while weak evidence was found for a negative market reaction to layoffs related to plant closings. Consistent with the market reaction, post announcement analysis revealed that downsizing in conjunction with revenue refocusing (plant closing) improved (reduced) firm financial performance and that revenue refocusing firms significantly outperformed cost cutting and plant closing firms over the three–year post announcement period.

Inferring Accounting Information from Corporate Financing Choices: An Examination of Security Issuances in the Banking Industry*

AbstractThis study examines the impact of regulatory capital and several of its determinants (i.e., earnings, loan loss provisions, charge‐offs and growth) on bank managers' financing decisions and investors' interpretations of those decisions. The analysis is related to two streams of research. We add to the corporate finance literature that seeks to explain the market's reaction to security issuances by developing and testing a refined set of predictions of the demand for debt and equity capital using a sample of capital‐regulated firms (banks). We extend the accounting literature that links regulatory capital‐management decisions with bank performance by examining whether investors infer that performance.We find that bank managers' financing choices reflect their private information regarding the levels of regulatory capital, earnings, and charge‐offs in the issuance year. We document a negative market reaction to capital‐increasing issuances and a positive reaction to capital‐decreasing issuances. A cross‐sectional analysis of that market reaction indicates that investors infer managers' expectations of earnings in the issuance year.