Patterns in Corporate Events

Patterns in Corporate Events

(Editor’s Note: This post comes to us from Raghavendra Rau of Purdue University and Aris Stouraitis of the City University of Hong Kong..)

It has been extensively documented that corporate events occur in waves. However, existing empirical studies have examined individual types of waves separately. In our paper, Patterns in the timing of corporate event waves, which was recently accepted for publication in the Journal of Financial and Quantitative Analysis, we investigate whether a relation exists between the different types of corporate events. Our analysis focuses on the timing of five different types of corporate events (new issues – both IPOs and SEOs, mergers – both stock and cash-financed, and share repurchases) using a comprehensive dataset of corporate transactions over the 25-year period 1980-2004.

The starting point in our analysis is the observation that most corporate events are combinations of two activities that have been central to corporate finance: financing decisions and investment decisions. The academic literature has traditionally argued that financing and investment decisions are driven by one of two hypotheses: (1) The neoclassical efficiency hypothesis which suggests that managers undertake corporate transactions for efficiency reasons, issuing equity or buying targets to take advantage of growth opportunities or to invest in positive NPV projects, and (2) the market misvaluation hypothesis which suggests that rational managers take advantage of irrational market misvaluations by issuing stock in exchange for cash or other firms.

What distinguishes the events we study is the extent to which they involve either the financing decision or the investment decision. Theories that describe why firms choose investment or financing decisions imply that related corporate events should be affected by the same factors. If we consider pure financing decisions for example, SEOs, IPOs, and stock repurchases are related, in that the former two both involve firms issuing equity while the last involves buying back equity.

The first part of our analysis consists of three tests that explore the correlation structure of event activity, that is, how activity in one type of event correlates with activity in other events. First, we find strong positive correlations at the industry level in contemporaneous activity within stock issuance events of different types (SEOs, IPOs, stock-financed M&A), and negative correlations between all three stock issuance events and stock repurchases. Second, we find that lagged SEO volume predicts future IPO volume, and that lagged SEO and IPO volume both predict future stock-financed M&A volume. Third, we show that waves of events follow the same pattern. We find, therefore, a previously undocumented pattern in the timing of corporate events.

The second part of our analysis involves regressions where we explain the likelihood of different types of waves using explanatory variables that proxy for neoclassical efficiency or misvaluation factors. Our analysis suggests that waves are driven by both neoclassical and misvaluation factors and the relative importance of these factors changes in different periods, leading to differing conclusions in the different studies that look at this issue.

The full paper is available for download here. [link to full paper on SSRN]