Investor Reaction to Corporate Event Announcements: Under-Reaction or Over-Reaction?

Abstract

Two conflicting behavioral models, under-reaction and over-reaction, have been proposed as explanations for the long-run abnormal return patterns following a variety of corporate events. We test hypotheses that distinguish between these two behavioral models for four corporate events, seasoned equity offerings, share repurchases, stock-financed acquisitions and cash-financed acquisitions. The evidence is consistent with the hypothesis that long-run abnormal returns are attributable to the investor under-reaction model. Investors under-react to short-term information available prior to the event and subsequently under-react to information conveyed by the corporate event. Long-run abnormal returns reflect the net effect of investor under-reaction to these two pieces of information. We find no evidence to support the over-reaction model. We also find no evidence to support a more complicated behavioral model that postulates investor under-reaction to short-term information and over-reaction to long-term trends.

Note: Previous title: It's All Under-Reaction

Keywords: Anomalies, over-reaction, under-reaction, behavioral finance, long-horizon stock performance

JEL Classification: G14, G34