Do Firms Manipulate Their Stock Prices? Causal Evidence from M&A

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Wednesday February 29, 2012 at 9:29 am
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Editor’s Note: The following post comes to us from Kenneth Ahern and Denis Sosyura, both of the Department of Finance at the University of Michigan.

In the paper, Who Writes the News? Corporate Press Releases During Merger Negotiations, which was recently made publicly available on SSRN, we show that firms manipulate their stock prices during merger negotiations in order to affect the terms of the transaction. We argue that this strategy is made possible by the loose regulation of corporate disclosure. In particular, U.S. federal laws generally do not require firms to publicly disclose all material corporate events when they occur. Instead, firms have significant flexibility with respect to the content and timing of their press releases. We show that firms strategically exploit the flexibility afforded by the law to influence their stock prices precisely when they benefit the most from short-term manipulation.

To identify firms with incentives to manage their stock prices, we focus on stock acquisitions, a setting where a short-term change in firms’ stock prices has a long-term effect on merger outcomes. If an acquirer in a stock acquisition can temporarily raise its stock price during a short time window when the stock exchange ratio is determined (usually several weeks), it can issue fewer of its shares for each target share and reduce the true cost of the takeover. To establish causal evidence of price manipulation, we exploit the difference in the time period when the terms of the merger are determined in fixed-exchange ratio vs. floating-exchange ratio stock acquisitions. These two groups of transactions are very similar along firm and deal characteristics, but have a clear dichotomy in the timing of media management incentives.

Using one of the largest media datasets in finance research, with over 600,000 daily news articles, we find that firms issue more press releases with positive news and selectively withhold negative news during merger negotiations. This strategy, which we label media management, enables a firm to raise its stock price by approximately 5 percent, controlling for other factors, precisely during the period when the stock exchange ratio is set. The media management strategy has a significant real effect on the outcome of the merger. We estimate that a one standard deviation increase in an acquirer’s press release issuance leads to an 11 percent increase in the acquirer’s gain relative to the target’s gain.

Overall, we provide some of the first evidence that the fundamental relation between information and stock prices can be distorted by a firm’s strategic incentives to control its news coverage. In contrast to the typical assumption of exogenous media coverage, our results show that firms actively use the media to manipulate their stock prices and realize long-lasting real effects. Our findings also provide new explanations for one of the main puzzles in merger research: the run-up in bidders’ stock prices followed by a correction at the merger announcement. In contrast to assumptions of exogenous misvaluation, our paper provides evidence that the run-up is driven, in part, by firms’ strategic timing of news releases. Further, in contrast to the typical assumptions of managers’ irrationality or poor governance proposed to justify negative announcement returns, our results suggest that merger returns reflect a rational discounting of selectively-released news.

The full paper is available for download here.

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