Information asymmetry and self-selection bias in bank loan announcement studies

Event-study driven research has produced a consensus that loans are unique relative to other financial contracts. But these studies assume that small samples of loan announcements adequately represent the loan population. We find that loan announcements are rare and driven by factors such as information asymmetry and perceived materiality. We show that the sample used by Billett, Flannery, and Garfinkel (1995) fails to represent the loan universe and that significant abnormal announcement returns are confined to their smallest firms. Our sample, which better represents the loan population, produces an abnormal return insignificantly different from zero. The findings suggest that self-selection bias affects extant loan announcement research and do not support the views that loans are a special form of finance or that private and public debt differ in significant ways. Were all loans to be announced, the average abnormal return would likely be insignificant.     

Why are convertible bond announcements associated with increasingly negative issuer stock returns? An arbitrage-based explanation

While convertible offerings announced between 1984 and 1999 induce average abnormal stock returns of −1.69%, convertible announcement effects over the period 2000–2008 are more than twice as negative (−4.59%). We hypothesize that this evolution is attributable to a shift in the convertible bond investor base from long-only investors towards convertible arbitrage funds. These funds buy convertibles and short the underlying stocks, causing downward price pressure. Consistent with this hypothesis, we find that the differences in announcement returns between the Traditional Investor period (1984–1999) and the Arbitrage period (2000–September 2008) disappear when controlling for arbitrage-induced short selling associated with a range of hedging strategies. Post-issuance stock returns are also in line with the arbitrage explanation. Average announcement effects of convertibles issued during the Global Financial Crisis are even more negative (−9.12%), due to a combination of short-selling price pressure and issuer, issue, and macroeconomic characteristics associated with these offerings.     

Information,uncertainty, and behavioral effects: Evidence from abnormal returns around real estate investment trust earnings announcements

In this study, we examine the influence of real estate market sentiment, market-level uncertainty, and REIT-level uncertainty on cumulative abnormal earnings announcement returns over the 1995–2009 time period. We first document the relative coverage of analysts' earnings forecasts on U.S. REITs, as well as REITs from several countries (i.e., Australia, Belgium, Canada, France, Hong Kong, Japan, the Netherlands, and UK). We show that coverage outside of the U.S. is limited, and we consequently focus our analysis on U.S. REITs. We find strong evidence that earnings announcements contain pricing relevant information, with positive (negative) earnings surprises relative to analysts' forecasts resulting in significantly positive (negative) abnormal returns around the announcement date. Consistent with the findings from the broader equity market literature, we find limited evidence of a pre-announcement drift in the cumulative abnormal returns. However, in sharp contrast to the existing equity literature, we find no evidence of a post-earnings announcement drift in our aggregate sample or when the sample is restricted to the largest negative surprises. We find evidence of a post-earnings announcement drift for only the largest positive earnings surprises. These results are consistent with REIT returns more quickly impounding information relative to the broader equity market, in part because of the parallel private real estate market and because of the U.S. REIT structure and information environment. Finally, in our conditional regression analysis of cumulative abnormal returns, we find that real estate investor sentiment, market-wide uncertainty, and firm-level uncertainty significantly affect the magnitude of abnormal announcement returns and also influence the effect of unexpected earnings on abnormal returns.     

Another look at the role of the industrial structure of markets for international diversification strategies

This paper re-examines the extent to which gains from international diversification are due to differences in industrial structure across countries. Recent papers by Roll (1992), Journal of Finance 47, 3–42 and Heston and Rouwenhorst (1994), Journal of Financial Economics 36, 3–27 investigate this issue and find conflicting evidence. Using a new database, the Dow Jones World Stock Index, with coverage in 25 countries and over 66 industry classifications, we decompose comprehensively both country and industrial sources of variation. We confirm that little of the variation in country index returns can be explained by their industrial composition. We also uncover differences in the proportion of variation in industry index returns that is captured by country and industry factors and discuss the implications for global diversification strategies.     

STOCK REPURCHASES AND SECURITYHOLDER RETURNS: A CASE STUDY OF TELEDYNE

This study examines securityholder returns around nine major repurchase announcements and 10 other repurchase-related announcements by the Teledyne Corporation between 1972 and 1984. Statistically significant positive excess returns to common stock and convertible preferred stockholders are documented. Contrary to prior research that investigated the average response to repurchase announcements, however, there is a wealth transfer from bondholders to stockholders. Bondholder returns around the repurchase announcements are significantly negative. These returns are examined for each announcement and each bond issue.     

New evidence on the announcement effect of convertible and exchangeable bonds

This study investigates the announcement and issuance effects of offering convertible bonds and exchangeable bonds using data for the Swiss and German markets during January 1996 and May 2003. The analysis suggests that announcement effects of convertible bonds and exchangeable bonds are associated with significantly negative abnormal returns. German firms exhibit a stronger reaction than Swiss firms, possibly for institutional reasons. We also investigate the effect of the market return of the announcement effect and find that the negative abnormal returns are significantly more pronounced when previous market returns have been negative. Furthermore, we analyze the relation between the announcement effects and equity components by controlling for the equity signal sent to the market. We find the size of the equity component of an issue to have a strong influence on the announcement effect for convertible but not for exchangeable securities and offer an explanation for this difference.     

Wealth effects of convertible bond and convertible preference share issues: An empirical analysis of the UK market

We examine the wealth effects of the announcement of issues of different types of convertible securities by UK firms and find significant negative effects on shareholder wealth. We however, also find that when the sample is partitioned by method of issue, privately placed convertible bonds, in contrast to previous research, exhibit a negative impact on firm wealth. Further, we also find negative wealth effects for firms that issue convertible securities to refinance previous debt or finance specific acquisitions. However announcements of convertible bond issues, for the purpose of financing capital expenditure schemes, show significant positive wealth effects. Finally, we find mixed support for testable predictions of the main theoretical models relating cross-sectional firm characteristics of convertible bond issuers to abnormal returns.     

Is M&A different during a crisis? Evidence from the European banking sector

The financial crisis has affected the landscape of the banking sector around the world. We use a sample of transactions carried out by European acquirers in 2007–2010 to study the acquirer’s stock price market reaction to both announcements and completions of acquisitions. At the aggregate level, we find that there are no significant abnormal returns around the announcement of an acquisition while there are positive abnormal returns at completions. We study the cross-sectional determinants of abnormal returns and find that announcement returns are mainly explained by the acquirer bank characteristics, while completion returns mainly depend on opacity of the target and on the drop in idiosyncratic volatility associated with a reduction of uncertainty.     

THE VALUATION EFFECTS OF OUT-OF-THE-MONEY CALLS OF CONVERTIBLE SECURITIES

We examine the valuation effects of out-of-the-money calls of convertible securities. In general, out-of-the-money calls generate positive abnormal stock returns. These returns are higher when the call price exceeds the market value of the called securities (positive premium calls), compared with when the market value exceeds the call price (negative premium calls). Furthermore, Value Line Investment Survey net operating income forecasts are significantly higher after call announcements for positive premium calls, while the revision is insignificant for negative premium calls. The results are consistent with the hypothesis that positive premium calls signal positive information.     

The Effects of Stock Repurchases on Rival Firms

This paper investigates the stock price behavior of rival firms in the same industry as firms announcing stock repurchase tender offers. Using a sample of 134 repurchase announcements, I find that rival firms on average realize insignificant announcement period abnormal returns. Negative rival stock price performance is detected over longer intervals surrounding the announcement period and for a subset of announcements which ex ante were identified as most likely to affect rivals. This evidence, however, is statistically weak and does little to alter the overall conclusion that the information in repurchase announcements is primarily firm-specific.     

Do Capital Structure Adjustments by Takeover Targets Influence Acquisition Gains?

We link debt issuances by target companies around takeover announcements to enhanced target bargaining power in negotiations with bidders over merger synergy gains in completed takeovers. Announcements of debt issuances by targets—especially new bank loans—are associated with more positive target equity returns relative to those made by nontargets, particularly for debt issuances immediately surrounding the takeover announcement. At least some of these gains to targets come at the expense of bidder shareholders, as bidder equity abnormal returns at target debt issuance are negative. We further show that targets issuing debt are primarily those with relatively low acquisition abnormal returns, consistent with initially poor target bargaining power. Subsequent debt issuances by targets increase the likelihood of positive adjustments to acquisition premiums offered by acquirers.     

How important are semi-annual earnings announcements? An information event perspective

Using a method that avoids the need to specify earnings expectations, we demonstrate that the period surrounding the semi-annual announcement of Australian firms' earnings is, on average, an important source of information. Although there is substantial year-to-year variation, we observe no evidence of any significant time trend, and also conclude that a shift from Australian domestic generally accepted accounting principle to International Financial Reporting Standards did not impact the association between earnings announcement windows and stock returns. We also find no evidence that the informativeness of earnings announcements varies systematically with firm size, analyst following or economic news (i.e., positive vs. negative stock returns, profits vs. losses), although we do observe significant variation across industries. Our conclusion is further supported by contrasting the earnings release date with the days immediately prior to release, or high information days other than earnings announcement windows. Using a more precise event window relative to prior studies (i.e., 3 h vs. 3 days), we confirm that earnings announcements contain significant new information about fundamentals.     

The information content of a convertible debt offer announcement

We develop a model of convertible debt financing that combines issue and call decisions into a common framework. The model suggests a role for refinancing costs in a manager's efforts to signal firm productivity to investors by an appropriate choice of debt issue terms. A cross section of convertible debt offers can be divided into two groups: a high conversion ratio group and a low conversion ratio group. The model predicts that high conversion ratios are negatively correlated with offer announcement stock returns and low conversion ratios are uncorrelated with offer announcement stock returns. The model is tested on a sample of 124 convertible debt offer announcements. Test results support model accuracy.     

The information content of a convertible debt offer announcement

We develop a model of convertible debt financing that combines issue and call decisions into a common framework. The model suggests a role for refinancing costs in a manager's efforts to signal firm productivity to investors by an appropriate choice of debt issue terms. A cross section of convertible debt offers can be divided into two groups: a high conversion ratio group and a low conversion ratio group. The model predicts that high conversion ratios are negatively correlated with offer announcement stock returns and low conversion ratios are uncorrelated with offer announcement stock returns. The model is tested on a sample of 124 convertible debt offer announcements. Test results support model accuracy.     

The source of abnormal returns from strategic alliance announcements

This study links together theoretical models of strategic alliances with an empirical examination of stock returns on the announcement of strategic alliances. Using a sample of 123 strategic alliance announcements, the results find strong support for the hypothesis that strategic alliance announcements generate significant positive abnormal returns on the announcement day. Although strategic alliances are more prevalent in the higher technology industries, the source of the abnormal stock returns is a subsample of firms with the lowest market to book values. This is found to be supportive of the hypothesis that the announcement of a strategic alliance is additional information for firms with low growth. There is no empirical support for the knowledge, flexibility and the hubris hypotheses.     

Informed Options Trading Prior to Dividend Change Announcements

This paper investigates the information content of options trading prior to dividend change announcements. I find a positive (negative) relation between pre‐announcement abnormal implied volatility (IV) spread (abnormal IV skew) and cumulative abnormal stock returns around dividend change announcements. The predictive power of informed options trading is stronger for announcements of dividend reduction and when the options market is more liquid relative to the stock market and weaker when information has already been incorporated in the stock market. The predictability of informed options trading is robust to a placebo test and alternative measures of informed options trading. Overall results suggest that informed options trading predicts dividend change announcement returns.     

The impact of rights issues of convertible debt in Australian markets

Australian convertible debt issues are rights issues of non-callable securities and are issued in a market characterised by thin trading, significant institutional investor participation rates and a high number of resource firms. However, this study documents a significant negative announcement effect for rights issues of convertible debt, similar to international evidence. An analysis of the determinants of the announcement effect supports variants of the information asymmetry and agency cost hypotheses. The results do not support the convertible debt models of Kim [Kim, Y., 1990. Informative conversion ratios, a signalling approach. Journal of Financial and Quantitative Analysis 25, 229–243], Brennan and Kraus [Brennan, M., Kraus, A., 1987. Efficient financing under asymmetric information. Journal of Finance 42, 1225–1243], Green [Green, R.C., 1984. Investment incentives, debt and warrants. Journal of Financial Economics 13, 115–136] but some support is found for Stein's [Stein, J., 1992. Convertible bonds as backdoor equity financing. Journal of Financial Economics 32, 3–22], convertible debt model and Mayers [Mayers, D., 1998. Why firms issue convertible bonds: the matching of financial and real investment options. Journal of Financial Economics 47, 83–102], sequential financing model. However, support is found for Brous and Kini [Brous, P.A., Kini, O., 1994. The valuation effects of equity issues and the level of institutional ownership: evidence from analysts’ earnings forecasts. Financial Management 23, 33–46], equity issue based external monitoring model and Eckbo and Masulis [Eckbo, B., Masulis, R., 1992. Adverse selection and the rights offer paradox. Journal of Financial Economics 32, 292–332], rights issue adverse selection model.     

Recapitalization of one class of common stock into dual-class: Growth and long-run stock returns

We study a sample of 178 firms that changed from a one-share one-vote into a dual-class common stock structure during 1979–1998. We find that dual-class recapitalizations are shareholder value enhancing corporate initiatives. Using accounting data, Lehn et al. (1990) [Lehn, K., Netter, J., Poulsen, A., 1990. Consolidating corporate control: dual-class recapitalizations versus leveraged buyouts. Journal of Financial Economics 27, 557–580] provide evidence that dual-class recapitalizing firms grow faster than firms in a control group and undertake secondary equity offerings (SEOs) to finance growth. We show that growth is indeed beneficial to the shareholders. The stockholders, on average, earn significant positive abnormal returns of 23.11% in a period of 4 years following the announcement month. Furthermore, abnormal returns are even larger (52.61%) for the dual-class firms that issue equity. This evidence is especially supportive of the value enhancing hypothesis as it is contrary to the prevailing result that SEOs are generally followed by large negative returns. We do not find any evidence of managerial entrenchment.     

The 1994–1995 Mexican Currency Crisis and U.S. Bank Stock Returns

We investigate the impact of the 1994–1995 Mexican currency crisis on U.S. bank stock returns. We use a jump-diffusion model rather than a pure diffusion model to describe daily stock returns, because the public release of unexpected information generally is associated with discrete jumps in prices. Traditional event study models pool both announcement effects and trading effects and may lead to inefficient estimators. The jump-diffusion model can separate the impact of informed trading from unanticipated public announcements. Our results indicate that the variance of the jumps is large and increases with bank size and portion of loans to Mexico.     

Stock reaction to dividend savings of convertible preferred calls: Free cash flow or price pressure effects?

Calls of in-the-money convertible preferred stock typically induce dividend savings for the firm, since preferred dividends exceed common stock dividends. Prior research finds that these savings are negatively related to stock returns at call announcement and argues that the market expects managers to abuse the increased free cash flow. This paper finds that dividend savings are closely related to call size, suggesting other explanations. Larger calls experience a more negative announcement reaction. Consistent with temporary liquidity effects, there is a price reversal during the conversion period, which is greater for larger calls.