Event study

An Event study is a statistical method to assess the impact of an event on the value of a firm. For example, the announcement of a merger between two business entities can be analyzed to see whether investors believe the merger will create or destroy value. The basic idea is to find the abnormal return attributable to the event being studied by adjusting for the return that stems from the price fluctuation of the market as a whole.

Event studies have been used in a large variety of studies, including mergers and acquisitions, earnings announcements, debt or equity issues, corporate reorganisations, investment decisions and corporate social responsibility (MacKinlay 1997; McWilliams & Siegel, 1997).

Motivation

The logic behind the event study methodology (within the specific context of mergers) is explained in Warren-Boulton and Dalkir (2001):

Investors in financial markets bet their dollars on whether a merger will raise or lower prices. A merger that raises market prices will benefit both the merging parties and their rivals and thus raise the prices for all their shares. Conversely, the financial community may expect the efficiencies from the merger to be sufficiently large to drive down prices. In this case, the share values of the merging firms’ rivals fall as the probability of the merger goes up. Thus, evidence from financial markets can be used to predict market price effects when significant merger-related events have taken place.

Methodologies

The general event study methodology is explained in, for example, MacKinlay (1997) or Mitchell and Netter (1994).

Warren-Boulton and Dalkir use an event-probability methodology originally developed by McGuckin et al. (1992) to be applied to merger analysis. Their specific methodology involves ex-ante calculation of the financial markets' assessment of the probability that the merger will indeed take place in the future.

It is important to note that short-horizon event studies are more reliable than long-horizon event studies as the latter have many limitations. However, Kothari and Warner (2005) (S.P. Kothari and Jerold Warner) were able to refine long-horizon methodologies in order to improve the design and reliability of the studies over longer periods.

Application to merger analysis

Warren-Boulton and Dalkir (2001) apply their event-probability methodology to the proposed merger between Staples, Inc. and Office Depot (1996), which was challenged by the Federal Trade Commission and eventually withdrawn.

Empirical methods

Warren-Boulton and Dalkir (2001) run a time-series regression. In addition, they also look at the effect of the merger in specific event windows.

Findings

Warren-Boulton and Dalkir (2001) find highly significant returns to the only rival firm in the relevant market. Based on these returns, they are able to estimate the price effect of the merger in the product market which is highly consistent with the estimates of the likely price increase from other independent sources.

See also

• Post earnings announcement drift, an anomaly found in event studies of earnings announcements

• CRSP, database commonly used in event studies

References

• Mitchell, Mark L. and Jeffry M. Netter. "The Role of Financial Economics in Securities Fraud Cases: Applications at the Securities and Exchange Commission." The Business Lawyer February 1994
• MacKinlay, A. C. “Event Studies in Economics and Finance,” Journal of Economic Literature Vol. XXXV, Issue 1 (March 1997).
• McGuckin, R. H., F. R. Warren-Boulton, and P. Waldstein. “The Use of Stock Market Returns in Antitrust Analysis of Mergers,” Review of Industrial Organization Vol. 7 (1992).
• McWilliams, A. and Siegel, D. "Event studies in management research: Theoretical and empirical issues" Academy of Management Journal, Vol. 40, No. 3, (1997)
• Warren-Boulton, F. and S. Dalkir. “Staples and Office Depot: An Event-Probability Case Study,” Review of Industrial Organization, Vol. 19, No. 4, (2001).
• Kothari, S.P., and Jerold B. Warner, 2005, "Econometrics of Event Studies", Tuck School of Business at Dartmouth, working paper. Econometrics of Event Studies [dead link]
• Kothari, S.P., and Jerold B. Warner, 200[4!], "Econometrics of Event Studies" http://papers.ssrn.com/sol3/papers.cfm?abstract_id=608601