[Status: Revise & Resubmit] Companies’ strategic alternatives announcements cause a +5% 3-day announcement return followed by -10% (market-adjusted) in the ensuing 6 months. We first investigate whether an anomaly exists and demonstrate that the anomaly is significant, pervasive across years, industries, firm size, and information environments, and is not driven by confounding variables nor risk. We then investigate why investors misprice the announcements and find that investors appear overly optimistic about a potential merger or acquisition and do not fully incorporate the negative fundamental news conveyed by the announcement. Meanwhile, short sellers exploit the mispricing. We also evaluate market frictions as limits to arbitrage. This study’s contributions are: (i) evaluating mispricing and risk explanations for an event that causes extreme stock returns, (ii) challenging investors’ widely held belief that such announcements reflect good news, and (iii) warning investors and analysts about a behavioral bias they might unknowingly adopt. 

When a company seeks to sell itself in the M&A market, managers and directors must decide whether to publicly disclose the evaluation of strategic alternatives. Yet, little is known about the costs and benefits to the firm of publicly revealing this news. The benefits: The announcement leads to greater investor attention and a more robust M&A sales process, and ultimately, a valuation premium if a transaction is consumated. The costs: A public process consumes more resources, and the public news alienates stakeholders such as customers and employees, who withdraw their support from the company, leading to worse operating performance and lower employee growth. The disclosure's valuation benefit to shareholders is conditional on a subsequent takeover while the valuation penalty is unconditional, i.e., it impacts all disclosing firms.

This study provides a analytical and numerical assessment of the most commonly-used measures of accruals quality. An ideal empirical measure of AQ would not be associated with underlying economic parameters of a firm's earnings; moreover, it would also be monotonically increasing or decreasing in the presence of various types of accruals errors and have significant test power to detect lower AQ in the treatment versus control firms. While none of the 5 extant or 2 new measures we analyze provide a panacea, they vary in how close they come to achieving the ideal characteristics. Our results should be useful to researchers in choosing which combination of accrual quality proxies to use and in interpreting research findings.

In the value-relevance literature, tests of the relation between an asset's value on the financial statements and the asset's market value are typically plagued by measurement issues, from imputing the asset's market value, and model misspecification issues, from imperfectly controlling for the company's other assets and liabilities. Oil and gas royalty trusts, however, provide a cleaner setting to conduct a value-relevance test because the primary assets of these trusts are mature oil and gas reserves, their other assets and liabilities are negligible, and the asset's estimated value is clearly disclosed in 10-Ks. We find that managerial DCF estimates of oil and gas reserves are priced by investors, yet investors may buoyantly overlook the finite nature of these reserves until media converage prompts the stock price to coverge with the DCF estimate.

Whether to make the news public is a key decision that can have significant consequences affecting investor reactions, the subsequent sale process (should one occur), firm operations, employees, and ultimately firm value.