Event Studies in Securities Litigation: Low Power, Confounding Effects, and Bias

Posted: 21 Mar 2015 Last revised: 22 Nov 2020

See all articles by Alon Brav

Alon Brav

Duke University - Fuqua School of Business; European Corporate Governance Institute (ECGI); National Bureau of Economic Research (NBER)

J.B. Heaton

One Hat Research LLC

Date Written: March 19, 2015

Abstract

Are event studies in securities litigation reliable? Basic’s fraud-on-the-market presumption sparked the wide use of event studies in securities litigation, and the Supreme Court’s 2014 decision in Halliburton will make event studies even more important, as litigants fight over the existence of a price impact before class certification. What is interesting about the use of the event studies in securities litigation, however, is that the methodology used in court differs from the methodology long-used in academic research. With few exceptions, securities litigation event studies are single-firm event studies, while almost all academic research event studies are multi-firm event studies. Multi-firm event studies are generally accepted in financial economics research, and peer-reviewed journals contain them by the hundreds. By contrast, single-firm event studies – the mainstay of modern securities fraud litigation – are almost nonexistent in peer-reviewed journals.

Importing a methodology that economists developed for use with multiple firms into a single-firm context creates three substantial difficulties. First, single-firm event studies suffer from a severe signal-to-noise problem in that they lack statistical power to detect price impacts unless the price impacts are quite large. Inattention to statistical power lowers the deterrent effect of the securities laws by giving a “free pass” to some economically meaningful price impacts and may encourage more small- and mid-scale fraud on markets than is socially optimal given the costs of litigation. Second, single-firm event studies do not average away confounding effects. While this problem is well known, some courts have unrealistic expectations of litigants’ ability to quantitatively decompose observed price impacts into those caused by alleged fraud and those unrelated to alleged fraud. Third, low statistical power and confounding effects combine to generate sizeable upward bias in detected price impacts and therefore in damages. To improve the accuracy of adjudication in securities litigation, we suggest that litigants report the statistical power of their event studies, that courts allow litigants flexibility to deal with the problem of confounding effects, and that courts and litigants consider the possibility of upward bias in the detection of price impacts and the estimation of damages.

Keywords: event studies, securities litigation

JEL Classification: G30, K22, K41

Suggested Citation

Brav, Alon and Heaton, J.B., Event Studies in Securities Litigation: Low Power, Confounding Effects, and Bias (March 19, 2015). Washington University Law Review, Vol. 93, No. 2, 2015, Available at SSRN: https://ssrn.com/abstract=2581202 or http://dx.doi.org/10.2139/ssrn.2581202

Alon Brav

Duke University - Fuqua School of Business ( email )

100 Fuqua Drive
Durham, NC 27708-0120
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European Corporate Governance Institute (ECGI) ( email )

c/o the Royal Academies of Belgium
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1000 Brussels
Belgium

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

J.B. Heaton (Contact Author)

One Hat Research LLC ( email )

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7th Floor
Chicago, IL 60610
United States

HOME PAGE: http://www.onehatr.com/

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