Understanding the Distress Puzzle: Surprises in the Pre-Delisting Period

77 Pages Posted: 16 Mar 2012

See all articles by Tze Chuan 'Chewie' Ang

Tze Chuan 'Chewie' Ang

Deakin University - Department of Finance; Financial Research Network (FIRN)

Multiple version iconThere are 4 versions of this paper

Date Written: March 12, 2012

Abstract

In this study, I decompose realized returns into ex ante expected returns (as proxied by the implied cost of capital) and unexpected returns. I show that the negative cross-sectional relation between distress risk and stock returns documented in previous studies is driven by the increasingly low ex post unexpected returns and the increasingly high distress risk in the pre-delisting period – the two-year period prior to a firm’s delisting due to financial distress. After controlling for the firm-months in the pre-delisting period, which constitutes only 0.3% of total market capitalization or 3%-5% of NYSE/AMEX/Nasdaq firm-months, distress risk is positively related to ex post realized returns. The finding is robust to a range of distress risk measures, size, book-to-market ratio, momentum, leverage, and short-term reversal. Ex ante, investors expect high earnings per share (EPS) and stock returns in firms with high distress risk, but they are surprised by the lower-than-expected EPS and returns (ex post) in the pre-delisting period. The negative surprises concentrate around earnings announcements and the delisting month when investors correct their valuation errors about distressed firms’ future prospect. Overall, realized returns are similar to ex ante expected returns, except in the pre-delisting period. This divergence has implications in asset-pricing tests.

Keywords: Distress risk, delisting, bankruptcy, expected return, implied cost of capital, asset pricing anomaly, earnings announcement

JEL Classification: G12, G14, G33

Suggested Citation

Ang, Tze Chuan, Understanding the Distress Puzzle: Surprises in the Pre-Delisting Period (March 12, 2012). Available at SSRN: https://ssrn.com/abstract=2023185 or http://dx.doi.org/10.2139/ssrn.2023185

Tze Chuan Ang (Contact Author)

Deakin University - Department of Finance ( email )

221 Burwood Highway
Burwood, Victoria 3125
Australia
+61 3 9244 6626 (Phone)

HOME PAGE: http://www.deakin.edu.au/profiles/tze-ang

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia,
Brisbane, Queensland 4071
Australia

HOME PAGE: http://www.firn.org.au

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