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An event study is a
statistical Statistics (from German: ''Statistik'', "description of a state, a country") is the discipline that concerns the collection, organization, analysis, interpretation, and presentation of data. In applying statistics to a scientific, industria ...
method to assess the impact of an event on the value of a firm. For example, the announcement of a
merger Mergers and acquisitions (M&A) are business transactions in which the ownership of companies, other business organizations, or their operating units are transferred to or consolidated with another company or business organization. As an aspect ...
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 In finance, an abnormal return is the difference between the actual return of a security and the expected return. Abnormal returns are sometimes triggered by "events." Events can include mergers, dividend announcements, company earning announcements ...
attributable to the event being studied by adjusting for the return that stems from the price fluctuation of the market as a whole. The event study was invented by Ball and Brown (1968). As the event methodology can be used to elicit the effects of any type of event on the direction and magnitude of stock price changes, it is very versatile. Event studies are thus common to various research areas, such as accounting and finance, management, economics, marketing, information technology, law, political science, operations and supply chain management. One aspect often used to structure the overall body of event studies is the breadth of the studied event types. On the one hand, there is research investigating the stock market responses to economy-wide events (i.e., market shocks, such as regulatory changes, or catastrophic events). On the other hand, event studies are used to investigate the stock market responses to corporate events, such as mergers and acquisitions, earnings announcements,
debt Debt is an obligation that requires one party, the debtor, to pay money or other agreed-upon value to another party, the creditor. Debt is a deferred payment, or series of payments, which differentiates it from an immediate purchase. The ...
or
equity Equity may refer to: Finance, accounting and ownership * Equity (finance), ownership of assets that have liabilities attached to them ** Stock, equity based on original contributions of cash or other value to a business ** Home equity, the dif ...
issues, corporate reorganisations, investment decisions and
corporate social responsibility Corporate social responsibility (CSR) is a form of international private business self-regulation which aims to contribute to societal goals of a philanthropic, activist, or charitable nature by engaging in or supporting volunteering or ethicall ...
(MacKinlay 1997;MacKinlay, A. C. “Event Studies in Economics and Finance,” ''Journal of Economic Literature'' Vol. XXXV, Issue 1 (March 1997). Available at:https://www.jstor.org/stable/2729691 McWilliams & Siegel, 1997).


Methodology

The general event study methodology is explained in, for example, MacKinlay (1997) or Mitchell and Netter (1994). In MacKinlay (1997), this is done "using financial market data" to "measure the impact of a specific event on the value of a firm". He argues that "given rationality in the marketplace, the effects of an event will be reflected immediately in security prices. Thus a measure of the event's economic impact can be constructed using security prices observed over a relatively short time period". It is important to note that short-horizon event studies are more reliable than long-horizon event studiesChen, M.Y., 'I Just Did 400 Million Event Studies' – A Study of Market Model Robustness and Deterioration in Times of Crisis (2014). Available at: https://ssrn.com/abstract=2534446 as the latter have many limitations. However, Kothari and
Warner Warner can refer to: People * Warner (writer) * Warner (given name) * Warner (surname) Fictional characters * Yakko, Wakko, and Dot Warner, stars of the animated television series ''Animaniacs'' * Aaron Warner, a character in ''Shatter Me s ...
(2005) were able to refine long-horizon methodologies in order to improve the design and reliability of the studies over longer periods.


Empirical Methods

Methodologically, event studies imply the following: Based on an estimation window prior to the analyzed event, the method estimates what the normal stock returns of the affected firm(s) should be at the day of the event and several days prior and after the event (i.e., during the event window). Thereafter, the method deducts this 'normal returns' from the 'actual returns' to receive 'abnormal returns' attributed to the event. Event studies, however, may differ with respect to their specification of normal returns. The most common model for normal returns is the 'market model' (MacKinlay 1997). Following this model, the analysis implies to use an estimation window (typically sized 120 days) prior to the event to derive the typical relationship between the firm's stock and a reference index through a
regression analysis In statistical modeling, regression analysis is a set of statistical processes for estimating the relationships between a dependent variable (often called the 'outcome' or 'response' variable, or a 'label' in machine learning parlance) and one ...
. Based on the regression coefficients, the normal returns are then projected and used to calculate the abnormal returns. Alternative models for the normal returns include the
CAPM CAPM may refer to: * Capital asset pricing model, a fundamental model in finance * Certified Associate in Project Management, an entry-level credential for project managers {{Disambig ...
model, or more simplistic approaches such as mean returns (see MacKinlay 1997 for an overview).


Calculation of abnormal returns

Depending on the model chosen for the 'normal return', conducting event studies requires the researcher to implement a distinct sequence of steps. For the most common model, the 'market model', the steps are as follows: # Retrieve and match time series of financial returns of the focal firm's stock and its reference index. # For each event, identify the sequences of firm and market returns that need to be included in the estimation window. # Using regression analysis, calculate the alpha, beta and sigma coefficients that explicate the typical relationship between the stock and the reference index. # With these three parameters, predict the 'normal returns' for all days of the event window. # Deducting these 'normal returns' from the 'actual returns' gives you the 'abnormal returns' which are the metrics of interest.


Significance of abnormal returns

To specify if individual abnormal returns differ from zero with some statistical validity, test statistics need to be applied. Various test statistics at the different levels of analysis (i.e., AR-, CAR-, AAR- and CAAR-level) exist for this purpose. The most common test, the
t-test A ''t''-test is any statistical hypothesis testing, statistical hypothesis test in which the test statistic follows a Student's t-distribution, Student's ''t''-distribution under the null hypothesis. It is most commonly applied when the test stati ...
, divides the abnormal returns through the root mean square error of the regression. Resulting t-values need then to be compared with the critical values of the
Student's t-distribution In probability and statistics, Student's ''t''-distribution (or simply the ''t''-distribution) is any member of a family of continuous probability distributions that arise when estimating the mean of a normally distributed population in sit ...
. There is some evidence that during times of high volatility (e.g.
financial crisis of 2007–2008 Finance is the study and discipline of money, currency and capital assets. It is related to, but not synonymous with economics, the study of production, distribution, and consumption of money, assets, goods and services (the discipline of fi ...
), too many companies tend to show significantly abnormal returns using the
t-test A ''t''-test is any statistical hypothesis testing, statistical hypothesis test in which the test statistic follows a Student's t-distribution, Student's ''t''-distribution under the null hypothesis. It is most commonly applied when the test stati ...
, which makes it more difficult to determine which returns are truly "abnormal".


Software for conducting event studies

Event studies can be implemented with various different tools. Single event studies can easily be implemented with MS Excel, event studies covering multiple events need to be built using statistical software packages (e.g.,
STATA Stata (, , alternatively , occasionally stylized as STATA) is a general-purpose statistical software package developed by StataCorp for data manipulation, visualization, statistics, and automated reporting. It is used by researchers in many fie ...
,
Matlab MATLAB (an abbreviation of "MATrix LABoratory") is a proprietary multi-paradigm programming language and numeric computing environment developed by MathWorks. MATLAB allows matrix manipulations, plotting of functions and data, implementation ...
). Besides of these multi-use tools, there are solutions tailored to conducting event study analyses (e.g.
Eventus

EventStudyTools
.


Application to merger analysis

The logic behind the event study methodology (within the specific context of
merger Mergers and acquisitions (M&A) are business transactions in which the ownership of companies, other business organizations, or their operating units are transferred to or consolidated with another company or business organization. As an aspect ...
s) is explained in Warren-Boulton and Dalkir (2001):Warren-Boulton, F. and S. Dalkir. “Staples and Office Depot: An Event-Probability Case Study,” Review of Industrial Organization, Vol. 19, No. 4, (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. Warren-Boulton and Dalkir (2001) apply their event-probability methodology to the proposed merger between ''
Staples, Inc. Staples Inc. is an American retail company headquartered in Framingham, Massachusetts, that offers products and services designed to support working and learning. The company opened its first store in Brighton, Massachusetts on May 1, 1986. By ...
'' and ''
Office Depot The ODP Corporation is an American office supply holding company headquartered in Boca Raton, Florida. The company has combined annual sales of approximately $11 billion, and employs about 38,000 associates with businesses in the United States. ...
'' (1996), which was challenged by the
Federal Trade Commission The Federal Trade Commission (FTC) is an independent agency of the United States government whose principal mission is the enforcement of civil (non-criminal) antitrust law and the promotion of consumer protection. The FTC shares jurisdiction ov ...
and eventually withdrawn.


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.


Application in litigation

The results of event studies have been accepted as evidence in litigation in US, in the quantification of damages in cases relating to securities fraud.


See also

*
Post earnings announcement drift Post or POST commonly refers to: *Mail, the postal system, especially in Commonwealth of Nations countries **An Post, the Irish national postal service **Canada Post, Canadian postal service **Deutsche Post, German postal service **Iraqi Post, Ira ...
, an anomaly found in event studies of earnings announcements * CRSP, database commonly used in event studies


References

*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). https://www.jstor.org/stable/41798368 *McWilliams, A. and Siegel, D. "Event studies in management research: Theoretical and empirical issues" Academy of Management Journal, Vol. 40, No. 3, (1997) https://www.jstor.org/stable/257056 {{DEFAULTSORT:Event Study Valuation (finance)