Joint Meeting of the Mid-Atlantic and Northeast Regions

Announcements of Strategic Alternatives and Stock Price Reversal: Risk, Limits to Arbitrage, and Mispricing

• In Event: Doctoral/Student Faculty Interchange I

Abstract

We document a stock price reversal around companies’ announcements of strategic alternatives
(SA), where the announcement return of +5.4 percent is followed by -9.1 percent in the subsequent
six months. First, we document this return pattern across years and industries, and show it is
incremental to other corporate events and firm fundamentals known to predict stock returns.
Second, we investigate risk and transaction cost explanations. We estimate a monthly alpha around
-1% and find that SA firms’ returns covary with market and size factors, and covary inversely with
momentum, underreaction, and behavioral factors. We find that when transaction costs are high,
the announcement return (post-event return) is attenuated (exacerbated). Third, we attempt to
explain the cross-section of announcement and future returns with investor and manager
characteristics and find evidence suggesting that: (i) investor sophistication mitigates future return
predictability; (ii) short-sellers exploit the negative post-event returns; and (iii) investors react less
positively to announcements made by overconfident and inaccurate managers. Fourth, we show
that the negative future return is driven by negative future earnings announcement surprises and
firms that are not eventually acquired.

Authors

• Hyun Jung Rim, George Washington University

• Jenny Zha Giedt, George Washington University