Mistaking Bad News for Good News: Mispricing of Strategic Alternatives Announcements

Abstract

Companies’ strategic alternatives announcements lead to negative future stock returns. We first investigate whether an anomaly exists and demonstrate that the anomaly is significant, pervasive across years, industries, firm size, and information environments, and 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.

Keywords: Corporate disclosure, stock returns, mergers and acquisitions, investor fixation, earnings announcements

JEL Classification: G12, G14, G34, G41, M41