Stock Market Reaction to Acquisition Announcements Using an

Stock Market Reaction to Acquisition Announcements using an Event Study Approach

Isfandiyar Shaheen Department of Economics ECO490 Submitted May 5, 2006, in partial completion of the requirements for departmental honors. Expected date of graduation: May 13, 2006. Abstract This paper uses an event study methodology to empirically examine stock market reaction to acquisition announcements. The results indicate that target firms experience significant positive abnormal returns surrounding an acquisition announcement. In case of hostile transactions, the abnormal returns are maximized one after event day as opposed to event day for target firms. Acquiring firms experience negative abnormal returns on announcement day for stock financed acquisitions. We observed abnormal returns on event day (Day 0) and the following day (Day 1). Based on this observation a linear regression model is developed to use publicly available information in predicting abnormal returns.

1. Introduction Mergers and acquisitions represent a prevalent strategy in expanding distribution channels, or entering new markets across most industries. A popular belief is that mergers and acquisitions strengthen businesses by making their operations more synergetic. Announcements of mergers and acquisitions immediately impact a target company’s stock price, as induced reaction in the stock market cause investors to revise expectations about the company’s future profitability (Panayides and Gong, 2002). According to the Efficient Markets Hypothesis, “prices reflect all publicly available information on an underlying asset” (Fama, 1970). Event studies are frequently used to test market efficiency (Brown and Warner, 1980). An event study is a statistical method used to gauge the impact of a corporate event, such as stock splits, earnings announcements and acquisition announcements. The Synergy Trap Hypothesis posits that immediately before and after an acquisition announcement, the acquiring firm’s stock...