In our paper, Merger Negotiations with Stock Market Feedback, forthcoming in the Journal of Finance, we investigate whether pre-bid target stock price runups increase bidder takeover costs—an issue of first-order importance for the efficiency of the takeover mechanism. We base our predictions on a simple model with rational market participants and synergistic takeovers. Takeover signals (rumors) received by the market cause market anticipation of deal synergies that drive stock price runups. The model delivers the equilibrium pricing relation between the runup and the subsequent offer price markup (the surprise effect of the bid announcement) that should exist in a sample of observed bids.
Posts Tagged ‘Market reaction’
Recent events suggest that shareholders pay attention to matters involving the personal lives of CEOs and take this information into account when making investment decisions. In our paper, Separation Anxiety: The Impact of CEO Divorce on Shareholders, which was recently made publicly available on SSRN, we examine the impact that CEO divorce can have on a corporation.
There are at least three potential ways in which a CEO divorce might impact a corporation and its shareholders. The first is loss of control or influence. A CEO with a significant ownership stake in a company might be forced to sell or transfer a portion of this stake to satisfy the terms of a divorce settlement. This can reduce the influence that he or she has over the organization and impact decisions regarding corporate strategy, asset ownership, and board composition. Shareholder reaction to loss of control will vary, depending on the view that investors have of CEO performance and governance quality. If they view performance and governance quality favorably, they will react negatively to the news; if they view management as entrenched or a poor steward of assets, they will react positively. Shareholder reaction will also depend in part on what happens to divested shares, including whether they are transferred to the spouse, sold in a block to a third-party, or dispersed in the general market. Each of these can shape the future governance of a firm.
An issue of considerable interest to accounting researchers is the association between shareholders and firms’ financial reporting quality (FRQ). In our paper, Blockholder Heterogeneity and Financial Reporting Quality, which was recently made publicly available on SSRN, we examine a specific type of shareholder, blockholders, because (1) they offer a sample of shareholders that are expected to have a significant impact on firms’ financial reporting decisions and (2) we are able to track individual blockholders and their association with FRQ. As discussed in more detail below, these two sample design features allow us to provide a test of the extent to which (large) shareholders influence FRQ. Blockholders also provide an interesting and economically important sample because of their large presence in U.S. capital markets in recent years.
In our paper, When Blockholders Leave Feet First: Do Ownership and Control Affect Firm Value?, which was recently made publicly available on SSRN, we investigate the effect of ownership and control on firm value, a longstanding question in finance, by employing the sudden death of large individual shareholders as a natural experiment. Our analysis focuses on stock price reactions to the deaths of individual blockholders who hold 5% or more in a U.S. listed firm. The main advantage of this approach is that sudden deaths are exogenous events that allow us to identify the impact of ownership and control on firm value. We analyze the value of inside and outside blockholders. Outside blockholders differ from insiders in that they are not actively involved in day-to-day management. We compare the magnitude of stock price reactions between inside and outside blockholders and note that any effect of ownership transition on firm value due to liquidity or anticipated takeover activity is likely to cancel out. The difference in the stock price reactions between inside and outside blockholders is therefore informative about the value of ownership and control.
Our study is the first to evaluate the effect of blockholders on firm value through the use of sudden deaths. In a related paper Slovin and Sushka (1993) analyze the event of death of blockholders. We draw a distinction between sudden and non-sudden deaths because entrenched blockholders are likely to hold onto their ownership until their deaths. Our concerns about entrenchment appears to be relevant as our findings show that stock price reactions are systematically more positive for non-sudden deaths than for sudden deaths. Using sudden death as opposed to non-sudden death is thus important for the interpretation of the effect of blockholders on firm value.
In Rollover Risk: Ideating a U.S. Debt Default, forthcoming in the Boston College Law Review, I systematically examine how a U.S. debt default might occur, how it could be avoided, its potential consequences if not avoided, and how those consequences could be mitigated. The impending debt-ceiling showdown between Congress and the President makes these questions especially topical. The Republican majority in Congress is conditioning any raise in the federal debt ceiling on spending cuts and reforms. Yet without raising the debt ceiling, the government may end up defaulting, perhaps as early as mid-October.
Even without that showdown, however, these questions are important. As the article explains, certain types of U.S. debt defaults, due to rollover risk, are actually quite realistic. This is the risk that the government will be temporarily unable to borrow sufficient funds to repay—sometimes termed, to refinance—its maturing debt.
Because rollover risk is such a concern, one might ask why governments, including the United States, routinely depend on borrowing new money to repay their maturing debt. The answer is cost: using short-term debt to fund long-term projects is attractive because, if managed to avoid a default, it tends to lower the cost of borrowing. The interest rate on short-term debt is usually lower than that on long-term debt because, other things being equal, it is easier to assess a borrower’s ability to repay in the short term than in the long term, and long-term debt carries greater interest-rate risk. But this cost-saving does not come free of charge: it increases the threat of default.
In our paper, Seasoned Equity Offerings, Corporate Governance, and Investments, forthcoming in the Review of Finance, we assess how the strength of governance affects investor confidence about management’s intended uses of the proceeds from SEOs. Our primary tests are conducted using difference-in-differences approaches using the staggered enactments of business combination statutes (BCS) as an exogenous shock weakening external pressure for good governance from the market for corporate control.
These tests are supplemented by two additional analyses, one relying on shareholder-value-reducing acquisitions as an ex post proxy for weak governance; the other relying on top management’s firm-related wealth sensitivity to shareholder value as a proxy for the strength of internal governance. These empirical analyses cover different sample periods spanning 1982 through 2006. Investor reaction to SEOs is positively and significantly related to the strength of governance regardless of which empirical strategy we use and which time period we examine.
The economic magnitudes of governance impacts are surprisingly large, explaining much of the negative stock price reactions to the announcement of SEOs. Absent secondary offerings, investors’ main concern with SEOs is whether management will use the proceeds productively or wastefully. Good governance enhances investor confidence, helping firms raise external equity at lower costs.
There is a long-standing debate across law, economics and finance regarding the justifications for a mandatory disclosure regime of the type exemplified by US securities law, and a related literature on the empirical question of whether mandatory securities regulation increases the value of firms (i.e. whether the benefits of regulation exceed the compliance costs). In our working paper The Costs and Benefits of Mandatory Securities Regulation: Evidence from Market Reactions to the JOBS Act of 2012 recently made publicly available on SSRN, we use a recent securities law reform to shed new light on this old question.
The Jumpstart Our Business Startups (“JOBS”) Act was passed by Congress in March 2012, and signed by the President on April 5, 2012. It relaxed disclosure and compliance obligations for a new category of firms defined by the Act, known as “emerging growth companies” (EGCs), that satisfied certain criteria (including, most prominently, generating less than $1 billion of revenue in its most recently completed fiscal year). The Act relaxed existing requirements for EGCs conducting initial public offerings (IPOs) on US equity markets, and also relaxed EGCs’ post-IPO disclosure and compliance obligations for a 5-year period. Perhaps most importantly, EGCs were permitted an exemption from auditor attestation of internal controls under Section 404(b) of the Sarbanes-Oxley Act of 2002, as well as exemption from certain future changes to accounting rules.
In an open capital market economy, guided by market signals, firms (and their managers) play an important role in the allocation of capital. Zingales (2000) proposes that the media may also play a role, perhaps positive, perhaps negative, in guiding firms (and their managers) in making capital allocation decisions. Dyck and Zingales (2002) develop this idea more fully. Given that the media collect, aggregate, disseminate, and amplify information, and to the extent that this information affects managers’ reputations, they propose that managers are sensitive to the way in which the media report and comment upon their decisions. Managers may even be sensitive to whether the media reports on their decisions at all. After all, a bad decision that goes unnoticed may be no worse than a good decision that goes equally unnoticed.
In our paper, The Role of the Media in Corporate Governance: Do the Media Influence Managers’ Capital Allocation Decisions?, forthcoming in the Journal of Financial Economics, we investigate whether, and to what extent, managers of publicly-traded U.S. corporations are sensitive to public news media in making one specific type of capital allocation decision. To wit: the decision of whether to complete or abandon a large proposed corporate acquisition that is accompanied by a negative stock market reaction at the announcement (“value-reducing acquisition attempt”). More specifically, we investigate whether the likelihood that a value-reducing acquisition attempt is abandoned is related to the level of media attention given to the attempt and to the tone of media coverage regarding the acquirer’s attempt at the time of the acquisition announcement.
How should firms communicate with the capital market in advance of corporate events? If firm insiders receive some private information that their firm may perform poorly in the near future, should they inform investors about this adverse information as soon as possible, or should they wait to release this information? Further, is the manner of communication by firms related to their performance in the short or the long run?
A concrete example of the above situation is that of a firm contemplating a dividend cut in the future. Firm insiders may have received some private information about a potential decline in future earnings, or that the current level of dividends is unsustainable for some other reasons (e.g., a change in the competitive environment requiring it to retain more cash within the firm). Under these circumstances, should insiders release a statement to the market that they are reviewing the firm’s dividend policy, and indicating that there is a possibility of a dividend cut (in other words, “prepare” the market)? Or should they wait till they in fact decide to cut their firm’s dividends before making any announcement?
While there have been several theoretical as well as empirical analyses of dividend signaling (see, e.g., Bhattacharya (1979), John and Williams (1985), and Miller and Rock (1985) for theoretical models), unfortunately, there has been no systematic empirical analysis so far in the literature that provides guidance to decision makers regarding the right way to communicate adverse private information to the equity market. The objective of this paper is to fill this gap in the literature by providing the first empirical analysis of a firm’s choice between preparing and not preparing the market before a dividend cut and the consequences of market preparation.
Companies that fail to file a 10-K or 10-Q on time are required by SEC Rule 12b-25 to file a Form NT (NT for non-timely), which provides a narrative explanation for the late filing. No analogous rule exists for earnings announcements, which often precede 10-K or 10-Q filings. For companies that are unable to report earnings by their expected date, therefore, managers face a decision – to keep silent or announce the delay. The SEC has also manifested interest in earnings delays: it recently announced a quantitative model that is expected to supply potential leads to its Division of Enforcement and lists earnings delays as a signal of earnings management.
In our paper, How Do Investors Interpret Announcements of Earnings Delays?, which was recently accepted for publication in the Journal of Applied Corporate Finance, we show that announcements of a delay in the reporting of earnings produce an average one-day abnormal stock return of approximately -6%. So, although announcements of a delay in the reporting of earnings are infrequent, they tend to be associated with a considerable reduction in firm value. In addition, delays precipitated by accounting issues or lacking an explanation result in more negative market reactions than delays related to business events, implementation of new accounting standards, or non-business reasons such as bad weather.