Wyatt DuBois, Penn State
UNIVERSITY PARK – Announcing a merger on a Friday may not be the best idea if you want people to pay attention. Research by two Penn State accounting professors suggests that investor inattention results in lower trading reactions to Friday merger announcements.
In a forthcoming issue of Management Science, Henock Louis, associate professor of accounting at the Penn State Smeal College of Business, and Amy Sun, assistant professor of accounting at Smeal, detail the impact of this inattentiveness on acquirers’ trading volumes and returns around merger announcements.
“If people were not distracted on Fridays, we would not observe any difference in the trading volume between transactions announced on Fridays and those announced on other weekdays, but we do see a huge difference,” said Sun.
When a major corporate event such as a merger occurs, stocks usually react to that news, with the fullness of the reaction depending on how much attention investors’ pay to the event announcement. Suppose, Sun suggested, that bad news about a particular stock is released to the market and the news should cause the stock price to decrease by 10 percent. If people are fully attentive and react completely, then one should observe a 10 percent drop in the stock price on the days surrounding the news announcement. If people are not attentive, then one would observe less than a 10 percent drop.
The market reaction to stock-for-stock merger announcements generally depends on the public status of the acquired company. If the acquired company is privately held, then the reaction is usually positive, meaning the stock price increases. If the acquired company is a publicly held company, then the reaction is usually negative and the stock price decreases.
“This contrast offers us a natural setting to test whether, on average, the stock market reacts completely to Friday merger announcements,” said Sun.
The researchers found that for acquisitions involving privately held targets, on average, investor inattentiveness results in a less positive reaction to the Friday announcements than to the non-Friday announcements. Similarly, for acquisitions involving publicly traded targets, on average, investor inattentiveness results in a less negative reaction to the Friday announcements than to the non-Friday announcements.
The researchers controlled for factors that may have a differential impact on the market reaction and trading volume, such as the size of the transaction or the size of the firm that makes the announcement.
Louis and Sun observed that about 26 percent of the announcements are made on Monday. The percentage of announcements slowly declines throughout the week, resulting in a mere 14 percent on Friday.
“We think managers believe Monday is the best time to make their announcements,” said Sun. “The numbers show us that managers believe timing does matter.”
The researchers said investors should be aware of their own behavior bias and the inadequate adjustment of stock prices for transactions made on Friday.
“Investors should be aware of these differences when they are trying to purchase or sell stocks related to a merger announcement,” Sun said. “They should take into consideration the inattentiveness and the related completeness of the reaction.”
People also could try to take advantage of market inefficiencies as a result of this phenomenon. If one knows that the market does not react fully to an announcement and it does not, one could take advantage of this.
“If you know that a stock price will continue to decrease, you can short sell,” Sun noted. “Similarly, if you know that the stock price will continue to increase, then you could purchase the stock.”
Prior research shows that such is the case for smaller events like earnings announcements, but Louis and Sun are the first to document that people do not pay full attention to major corporate events like merger announcements.
Louis and Sun next plan to explore why a company would announce a merger on a Friday knowing that investors are inattentive.