Negative Price Reaction Research Articles

Market reactions to the disclosure of internal control weaknesses and to the characteristics of those weaknesses under section 302 of the Sarbanes Oxley Act of 2002

We examine the stock price reaction to management’s disclosure of internal control weaknesses under §302 of the Sarbanes Oxley Act and to the characteristics of these weaknesses, controlling for other material announcements in the event window. We find that some characteristics of the weaknesses—their severity, management’s conclusion regarding the effectiveness of the controls, their auditability, and the vagueness of the disclosures—are informative. We also find that the information content of internal control weakness disclosures depends on the severity of the internal control weakness. Moreover, in a sub-sample uncontaminated by other announcements in the event window, we find negative price reactions to the disclosure of internal control weaknesses and material weaknesses.

Suppressed Negative Information and Future Underperformance

We present evidence of inefficient information processing in equity markets by documenting that negative information withheld by securities analysts is reflected in stock prices with a significant delay. We estimate the extent of the withheld negative information based on the proportion of analysts who stop revising their annual earnings forecasts. This measure predicts negative earnings surprises and negative price reaction around earnings announcements. It could also be used to generate profitable trading strategies. We show that institutions tend to sell their stock holdings as our measure of unreported negative news increases, thus ameliorating the mispricing.

Stockholder and Bondholder Wealth Effects of CEO Incentive Grants

We examine stock and bond price reactions to first time grants of equity compensation to CEOs. For firms granting options and/or restricted stock to their CEOs for the first time during the period 1992 to 2004, we find large positive stock price reactions and large negative bond price reactions. The negative bondholder reactions are significantly larger when the CEO has little or no prior equity ownership and significantly smaller for firms with weak shareholder rights (greater managerial power). We establish links between the stock and bond price reactions and the incentive characteristics of the grants. We find that stock price reactions decrease in CEO pay-performance sensitivity (delta) and increase in the sensitivity of CEO wealth to stock volatility (vega). In contrast, we find that bondholder reactions increase in delta and decrease in vega when the CEO has little or no equity ownership prior to the grant.

Terrorism and the Stock Market

This paper examines the stock price impact of terrorist attacks. Using an official list of terrorism-related incidents compiled by the Counterterrorism Office of the U.S. Department of State, we identify 75 attacks between 1995 and 2002 in which publicly traded firms are targets. An event-study analysis around the day of the attacks uncovers evidence of a statistically significant negative stock price reaction of -0.83%, which corresponds to an average loss per firm per attack of $401 million in firm market capitalization. A cross sectional analysis of the abnormal returns indicates that the impact of terrorist attacks differs according to the home country of the target firm and the country in which the incident occurred. Attacks in countries that are wealthier and more democratic are associated with larger negative share price reactions. Most interestingly, we find that human capital losses, such as kidnappings of company executives, are associated with larger negative stock price reactions than physical losses, such as bombings of facilities or buildings. We discuss the implications of these findings for existing research on terrorism and for current policy debates regarding terrorism re-insurance programs.

Discrimination, Legal Costs and Reputational Costs

This study seeks to answer three related questions about costs of the mis-management of diversity: 1. What are the outcomes of lawsuits when firms are accused of racial or gender discrimination, including the legal costs when found guilty? 2. What are firms' stock price reactions to racial and gender discrimination lawsuits? 3. Do firms sued for racial or gender discrimination experience reputational losses; that is, do firms lose market value over and above the expected legal costs of the lawsuit? First, we analyze 1,240 racial or gender discrimination lawsuits and find that the damages paid by firms found liable in these lawsuits averaged $293,000 in the 10 years before the Civil Rights Act of 1991 (CRA91), and $1.0 million in the 10 years after CRA91. Gender discrimination lawsuits have a higher plaintiff verdict success rate than racial discrimination lawsuits. Regressions indicate that after controlling for other independent variables, the damages paid by firms in discrimination lawsuits are positively associated with size of firm, gender lawsuit (compared to race), and post-CRA91. Second, we find statistically significant negative price reactions to the announcement of gender discrimination lawsuits and private class action lawsuits, but not for racial discrimination lawsuits and EEOC lawsuits. Third, we estimate reputational costs of the lawsuit: the loss in the market value of the firm's equity when the lawsuit is announced less the predicted legal costs of the lawsuit. Our results imply that at least for publicly traded companies, discrimination charges can lead to both reputational and legal costs; and thus managers should be concerned with minimizing both. In addition, optimal public policy includes considering these nonlegal costs as part of the penalty to defendant firms in discrimination lawsuits.

Short Sale Constraints, Overvaluation, and the Introduction of Options

We investigate whether the existence of traded options represents an economically important relaxation of short sale constraints. Our analysis has three prongs. First, to the extent that option listing relaxes a binding constraint, we would expect to see investors taking synthetic short positions in the newly-listed options. Contrary to this hypothesis, we find that the volume of newly-listed options tends to be very low, and, if anything, signed volume is more bullish that bearish during the first week of trading. Moreover, we find no significant relation between signed option volume and abnormal stock returns surrounding option listing. Second, if options help relax binding short-sale constraints, we might expect bearish option volume to be positively related to proxies for short sale constraints, divergence of opinion, and/or overvaluation. We examine nine different proxies and combinations of proxies, and in each case find either no relation, or a significant negative relation. Third, we demonstrate that prior results in the literature reporting a negative price reaction surrounding option listing are not robust to alternative methodological assumptions. All our evidence suggests that options do not reduce short sale constraints in an economically meaningful way.

The Circumstances and Legal Consequences of Non‐GAAP Reporting: Evidence from Restatements*

AbstractOur study examines the circumstances of non‐GAAP financial reporting by 492 U.S. companies that announced restatements from 1995 to 1999. We focus on income statements to analyze the occurrence and resolution of litigation over restatements and explore the role of accounting items in bringing and resolving this litigation. We provide evidence on the pervasiveness of accounting misstatements, describe their nature, and show how, if at all, they affect litigation. We assess the nature of restatements by determining whether regular, recurring earnings from primary operations (core) or other components of earnings (noncore) are misstated, and we assess their pervasiveness by estimating the number of primary accounts misstated. In our sample, companies with core restatements have higher frequencies of intentional misstatements (fraud) and subsequent bankruptcy or delisting. Likewise, these companies have, on average, more material misstatements, more negative security price reactions to restatement announcements, and more negative security price changes over the six months preceding and following restatement announcements. However, controlling for these and other factors, we find a significant association between accounting items and litigation, whether occurrences or resolutions. Specifically, core restatements — driven primarily by misstatements of revenue, a component of core earnings — and more pervasive restatements each play a role, while misstatements of noncore earnings alone do not.

Shareholder Wealth Effects of European Domestic and Cross‐border Takeover Bids

Abstract This paper analyses the short‐term wealth effects of large intra‐European takeover bids. We find announcement effects of 9% for the target firms compared to a statistically significant announcement effect of only 0.7% for the bidders. The type of takeover bid has a large impact on the short‐term wealth effects with hostile takeovers triggering substantially larger price reactions than friendly operations. When a UK firm is involved, the abnormal returns are higher than those of bids involving both a Continental European target and bidder. There is strong evidence that the means of payment in an offer has an impact on the share price. A high market‐to‐book ratio of the target leads to a higher bid premium, but triggers a negative price reaction for the bidding firm. We also investigate whether the predominant reason for takeovers is synergies, agency problems or managerial hubris. Our results suggest that synergies are the prime motivation for bids and that targets and bidders share the wealth gains.

Why Do Managers Explain Their Earnings Forecasts?

ABSTRACTManagers often explain their earnings forecasts by linking forecasted performance to their internal actions and the actions of parties external to the firm. These attributions potentially aid investors in the interpretation of management forecasts by confirming known relationships between attributions and profitability or by identifying additional causes that investors should consider when forecasting earnings. We investigate why managers choose to provide attributions with their forecasts and whether the attributions are related to security price reactions to management earnings forecasts. Using a sample of 951 management earnings forecasts issued from 1993 to 1996, we find that attributions are more likely for larger firms, less likely for firms in regulated industries, less likely for forecasts issued over longer horizons, more likely for bad news forecasts, and more likely for forecasts that are maximum type. Furthermore, attributions are associated with greater absolute price reactions to management forecasts, more negative price reactions to management forecasts (forecast news held constant), and a greater price reaction per dollar of unexpected earnings. Our findings hold after control for the aforementioned determinants of attributions and after control for other firm‐ and forecast‐specific variables that are often associated with security prices.

Price Pressure around Mergers

ABSTRACTThis paper examines the trading behavior of professional investors around 2,130 mergers announced between 1994 and 2000. We find considerable support for the existence of price pressure around mergers caused by uninformed shifts in excess demand, but that these effects are short‐lived, consistent with the notion that short‐run demand curves for stocks are not perfectly elastic. We estimate that nearly half of the negative announcement period stock price reaction for acquirers in stock‐financed mergers reflects downward price pressure caused by merger arbitrage short selling, suggesting that previous estimates of merger wealth effects are biased downward.

Why Do Managers Explain Their Earnings Forecasts?

Managers often explain their earnings forecasts by linking forecasted performance to their internal actions and the actions of parties external to the firm. These attributions potentially aid investors in the interpretation of management forecasts by confirming known relationships between attributions and profitability or by identifying additional causes that investors should consider when forecasting earnings. We investigate why managers choose to provide attributions with their forecasts and whether the attributions are related to security price reactions to management earnings forecasts. Using a sample of 951 management earnings forecasts issued from 1993 to 1996, we find that attributions are more likely for larger firms, less likely for firms in regulated industries, less likely for forecasts issued over longer horizons, more likely for bad news forecasts, and more likely for forecasts that are maximum type. Furthermore, attributions are associated with greater absolute price reactions to management forecasts, more negative price reactions to management forecasts (forecast news held constant), and a greater price reaction per dollar of unexpected earnings. Our findings hold after control for the aforementioned determinants of attributions and after control for other firm- and forecast-specific variables that are often associated with security prices.

Equity Rights Issues in Spain: Flotation Costs and Wealth Effects

This paper analyses the flotation costs and the share price reaction of equity offerings in Spain. The results report a positive relationship between relative flotation costs and the underwriting of an issue, and a negative relationship between such costs and ownership concentration. Fixed flotation costs and a negative relationship with the gross offer proceeds are also observed. On average, there is a negative share price reaction on the date of the ‘previous communication’ to the Comisión Nacional del Mercado de Valores. The different sub‐samples analysed according to the underwriting of the issue and the discount offered reveal no statistical differences.

Shareholder Wealth Effects of European Domestic and Cross-Border Takeover Bids

In this paper, we analyse the short-term wealth effects of large (intra)European takeover bids. We find large announcement effects of 9% for target firms and a cumulative abnormal return that includes the price run-up over the two-month period prior to the announcement date of 23%. However, the share price of the bidding firms reacts positively with a statistically significant announcement effect of only 0.7%. We also show that the status of a takeover bid has a large impact on the short-term wealth effects of target's and bidder's shareholders, with hostile acquisitions triggering substantially larger price reactions than friendly mergers and acquisitions. We also find strong evidence that cash offers trigger much larger share price reactions than all-equity offers or combined bids consisting of cash, equity and loan notes. A high market-to-book ratio of the target leads to a higher bid premium, but triggers a negative price reaction for the bidding firm. Also, our results suggest that bidding firms should not diversify by acquiring target firms that do not match their core business. Surprisingly, domestic bids create larger short-term wealth effects than cross-border mergers and acquisitions. The country dummies we use proxy for institutional differences, such as different corporate governance regimes (ownership concentration, takeover regulation, protection of shareholder rights, and informational transparency). In addition, we investigate whether the predominant reason for mergers and acquisitions is synergies, agency problems or managerial hubris and find that synergies are the prime motivation for bids and that targets and bidders tend to share the resulting wealth gains.

Resource Allocation Effects of Price Reactions to Disclosures*

AbstractCapital market participants collectively may possess information about the valuation implications of a firm's change in strategy not known by the management of the firm proposing the change. We ask whether a firm's management can exploit the capital market's information in deciding either whether to proceed with a contemplated strategy change or whether to continue with a previously initiated strategy change. In the case of a proposed strategy change, we show that managers can extract the capital market's information by announcing a potential new strategy, and then conditioning the decision to implement the new strategy on the size of the market's price reaction to the announcement. Under this arrangement, we show that a necessary condition to implement all and only positive net present value strategy changes is that managers proceed to implement some strategies that garner negative price reactions upon their announcement. In the case of deciding whether to continue with a previously implemented strategy change, we show that it may be optimal for the firm to predicate its abandonment/continuation decision on the magnitude of the costs it has already incurred. Thus, what looks like “sunk‐cost” behavior may in fact be optimal. Both demonstrations show that, in addition to performing their usual role of anticipating future cash flows generated by a manager's actions, capital market prices can also be used to direct a manager's actions. It follows that, in contrast to the usual depiction of the information flows between capital markets and firms as being one way — from firms to the capital markets — information also flows from capital markets to firms.

Price Pressure Around Mergers

This paper examines the trading behavior of professional investors around 2,130 mergers announced between 1994 and 2000. We find considerable support for the existence of price pressure around mergers caused by uniformed shifts in excess demand, but that these effects are fairly short-lived, consistent with the notion that short-run demand curves for stocks are not perfectly elastic. We estimate that roughly one half of the negative announcement period stock price reaction for acquirers in stock-financed mergers reflects downward price pressure caused by merger arbitrage short selling.

Shareholder Wealth Effects of Large European Takeover Bids

In this paper, we analyse the short-term wealth effects of large (intra) European takeover bids. We find large announcement effects of 9% for target firms, but the cumulative abnormal return that includes the price run-up over the two-week period prior to the event rises to 20%. The share price of the bidding firms reacts positively with a statistically significant announcement effect of only 0.7%. We also show that the type of takeover bid has a large impact on the short term-wealth effects of target and bidder shareholders with hostile takeovers triggering substantially larger price reactions than friendly mergers and acquisitions. When a UK target or bidder is involved, the abnormal returns outperform those of Continental European bids. We also find strong evidence that the means of payment in an offer has a large impact on the share price reactions. High market-to-book ratio of the target lead to a higher bid premium combined but trigger a negative price reaction for the bidding firm. Bidding firms should not further diversify by acquiring target firms that do not match the bidder's core business. We also investigate whether the predominant reason for takeovers is synergies, agency problems or managerial hubris. We find a significant positive correlation between target shareholder gains and total gains for the merged entity as well as between target gains and bidder gains. This suggests that synergies are the prime motivation for bids and that targets and bidders tend to share the resulting wealth gains.

When Unions “Mattered”: The Impact of Strikes on Financial Markets, 1925–1937

This examination of the Stock Market's responsiveness to strikes looks specifically at strike actions that labor historians generally view as the major ones occurring in the United States in the years 1925–37. The authors find that strikes had large, negative effects on industry stock value. Longer strikes, violent strikes, strikes in which unions “won,” industry-wide strikes, strikes that led to union recognition, and strikes that led to large wage increases were associated with larger negative share price reactions than were other strikes. Much of the “news” generated by the typical strike seems to have been registered by the Stock Market very early in the strike. However, there were also some fairly large stock price reactions to news that could be fully revealed only at the end of a strike.

Is the Market Surprised by Poor Earnings Realizations Following Seasoned Equity Offerings?

We examine the stock price reaction to earnings announcements in the five years following seasoned equity offerings (SEOs). On average, post-SEO earnings announcements are met with a significantly negative abnormal stock price reaction. Although this negative reaction accounts for a disproportionately large portion of long-run post-SEO abnormal stock returns, on average, abnormal stock price reactions to post-seo earnings announcements are reliably negative only within the smallest quartile of equity issuers. For small firms, therefore, these findings are broadly consistent with the hypothesis that firms issue equity when the market overestimates the firm's future earnings perfomance.

Debt-reducing exchange offers

Announcements of debt-reducing exchange offers are associated with a negative average stock price reaction. We address two questions: Why do firms undertake debt-reducing exchange offers? And, what is the information conveyed by such offers? The answers are interrelated: Debt-reducing exchange offers are undertaken by financially weak firms in an effort to stave off further financial distress and, thereby, preserve value for shareholders. A successfully completed exchange offer significantly reduces the likelihood that a firm will enter Chapter 11. Announcements of debt-reducing exchange offers apparently contain two pieces of information: (1) the firm is financially weaker than would have been apparent from other publicly available information, and (2) management is attempting to preserve value for shareholders.

Capital Structure Theory: Evidence from European Property Companies' Capital Offerings

This study examines the stock price reactions on announcements of both equity and debt offerings by European property companies. The unique setting in which corporate tax rates vary between different countries enables us to test established theories in the field of capital structure. In accordance with theory, we find a negative price reaction on equity offering announcements, which is less severe for low‐tax countries and positive price reactions on the announcements of debt offerings. Besides tax arguments, we also test alternative explanations by analyzing variations in stock reactions based on differences in the relative size of the issue, the pre‐offer leverage, the underlying property types, and operational performance. The results show that corporate taxation, issue size, and operational performance are significant explanatory factors in the negative price reactions.