Company Investment Announcements and the Market Value of the Firm

Abstract

This paper examines abnormal returns to test the stock market reaction to various categories of company investment announcements. The market-adjusted returns method is used to establish whether corporate investment announcements are relevant to market valuation. The analysis uses a data-set of 563 UK investment announcements between 1991 and 1996. Investment announcements are classified according to functional categories. Previous studies provide evidence that returns would be expected to be small and positive for most types of investment decision (Burton et al., 1999, McConnell & Muscarella, 1985, Chan, Gau & Wang, 1990, Woolridge & Snow, 1990, Al-Qudah, 1991, Chan, Martin & Kesinger, 1995). The analysis is consistent with earlier studies finding the abnormal return to be on average small and positive. The distribution is skewed towards positive reactions but the data contains many negative reactions as well. Abnormal returns vary according to the type of capital investment. The market reaction also varies with firm size; large companies tend to experience smaller responses to announcements. Cross-sectional analysis of abnormal returns against corporate growth opportunities, firm size, project size, interest rates, recent corporate performance and dummy variables for project types and joint ventures results in low explanatory power but some significant coefficients. Chung et al. (1999) reported that the quality of a company's investment opportunities is the primary determinant of market reactions to capital expenditure decisions. Our findings lend some support to a role for investment opportunities in market valuations. We report that the value of corporate growth opportunities and project size exhibit high levels of cross-sectional significance with abnormal returns. Project size returns positive coefficients for categories of investment which 'create' investment opportunities and negative for announcements of decisions to 'exercise' investment opportunities. The value of growth opportunities is calculated using the Kester (1984) and Brealey and Myers (1999) method. The growth opportunities variable is found to have an inverse relationship with abnormal returns. The negative relationship stems from the large number of capital expenditure decisions in the data-set which may not create new investment opportunities and may in fact be reducing the company stock of opportunities. The dummy variables for the project categories are also significant determinants of cross-sectional variation. The results presented increase our understanding of the way in which UK stock market participants value different types of company investment.