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Corporate Investment and Asset Price Dynamics: Implications for SEO Event Studies and Long‐Run Performance

Murray Carlson, Adlai Fisher and Ron Giammarino

Journal of Finance, 2006, vol. 61, issue 3, 1009-1034

Abstract: We present a rational theory of SEOs that explains a pre‐issuance price run‐up, a negative announcement effect, and long‐run post‐issuance underperformance. When SEOs finance investment in a real options framework, expected returns decrease endogenously because growth options are converted into assets in place. Regardless of their risk, the new assets are less risky than the options they replace. Although both size and book‐to‐market effects are present, standard matching procedures fail to fully capture the dynamics of risk and expected return. We calibrate the model and show that it closely matches the primary features of SEO return dynamics.

Date: 2006
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Handle: RePEc:bla:jfinan:v:61:y:2006:i:3:p:1009-1034