Event Studies in Economics and Finance STOR A.Craig MacKinlay Journal of Economic Literature,Volume 35,Issue 1 (Mar.,1997),13-39. Stable URL: http://links.istor.org/sici?sici=0022-0515%28199703%2935%3A1%3C13%3AESIEAF3E2.0.CO%3B2-W Your use of the JSTOR archive indicates your acceptance of JSTOR's Terms and Conditions of Use,available at http://www.jstor.org/about/terms.html.JSTOR's Terms and Conditions of Use provides,in part,that unless you have obtained prior permission,you may not download an entire issue of a journal or multiple copies of articles,and you may use content in the JSTOR archive only for your personal,non-commercial use. Each copy of any part of a JSTOR transmission must contain the same copyright notice that appears on the screen or printed page of such transmission. Journal of Economic Literature is published by American Economic Association.Please contact the publisher for further permissions regarding the use of this work.Publisher contact information may be obtained at http://www.jstor.org/journals/aca.html. Journal of Economic Literature 1997 American Economic Association JSTOR and the JSTOR logo are trademarks of JSTOR,and are Registered in the U.S.Patent and Trademark Office. For more information on JSTOR contact jstor-info@umich.edu. ©2003 JSTOR http://www.jstor.org/ Sun Feb1608:14:172003
Journal of Economic Literature Vol.XXXV (March 1997),pp.13-39 Event Studies in Economics and Finance A.CRAIG MACKINLAY The Wharton School,University of Pennsylvania Thanks to John Campbell.Bruce Grundy.Andrew Lo.and two anonymous referees for helpful comments and discussion.Research support from the Rodney L.White Center for Financial Research is gratefully acknowledged. 1.Introduction deficit.I However,applications in other fields are also abundant.For example, the ee omm event studies are used in the field of law event on the value of firms.On the sur- and economics to measure the impact on face this seems like a difficult task,but a the value of a firm of a change in the measure can be constructed easily using regulatory environment (see G.William an event study.Using financial market Schwert 1981)and in legal liability cases data,an event study measures the impact event studies are used to assess damages of a specific event on the value of a firm. (see Mark Mitchell and Jeffry Netter The usefulness of such a study comes 1994).In the majority of applications, from the fact that,given rationality in the focus is the effect of an event on the the marketplace,the effects of an event price of a particular class of securities of will be reflected immediately in security the firm,most often common equity.In prices.Thus a measure of the event's this paper the methodology is discussed economic impact can be constructed in terms of applications that use common using security prices observed over a equity.However,event studies can be relatively short time period.In contrast, applied using debt securities with little direct productivity related measures may modification. require many months or even years of Event studies have a long history.Per- observation. haps the first published study is James The event study has many applica- Dolley (1933).In this work,he examines tions.In accounting and finance re- the price effects of stock splits,studying search,event studies have been applied mominal price changes at the time of the to a variety of firm specific and economy split.Using a sample of 95 splits from wide events.Some examples include 1921 to 1931,he finds that the price in- mergers and acquisitions,earnings an- mouncements,issues of new debt or eq- 1The first three examples will be discussed later uity,and announcements of macro- in the paper.Grant McQueen and Vance Roley (1993)provide an illustration of the fourth using economic variables such as the trade macroeconomic news announcements. 13
14 Journal of Economic Literature,Vol.XXXV (March 1997) creased in 57 of the cases and the price with the necessary tools for calculating declined in only 26 instances.Over the an abnormal return,making statistical in- decades from the early 1930s until the ferences about these returns,and aggre- late 1960s the level of sophistication of gating over many event observations. event studies increased.John H.Myers The null hypothesis that the event has no and Archie Bakay (1948),C.Austin impact on the distribution of returns is Barker (1956,1957,1958),and John maintained in Sections 4 and 5.Section 6 Ashley (1962)are examples of studies discusses modifying this null hypothesis during this time period.The improve- to focus only on the mean of the return ments included removing general stock distribution.Section 7 presents analysis market price movements and separating of the power of an event study.Section 8 out confounding events.In the late presents nonparametric approaches to 1960s seminal studies by Ray Ball and event studies which eliminate the need Philip Brown (1968)and Eugene Fama for parametric structure.In some cases et al.(1969)introduced the methodology theory provides hypotheses concerning that is essentially the same as that which the relation between the magnitude of is in use today.Ball and Brown consid- the event abnormal return and firm char- ered the information content of earn- acteristics.Section 9 presents a cross- ings,and Fama et al.studied the effects sectional regression approach that is use- of stock splits after removing the effects ful to investigate such hypotheses. of simultaneous dividend increases. Section 10 considers some further issues In the years since these pioneering relating event study design and the pa- studies,a number of modifications have per closes with the concluding discussion been developed.These modifications re- in Section 11. late to complications arising from viola- tions of the statistical assumptions used 2.Procedure for an Event Study in the early work and relate to adjust- ments in the design to accommodate At the outset it is useful to briefly dis- more specific hypotheses.Useful papers cuss the structure of an event study.This which deal with the practical importance will provide a basis for the discussion of of many of the complications and adjust- details later.While there is no unique ments are the work by Stephen Brown structure,there is a general flow of and Jerold Warner published in 1980 and analysis.This flow is discussed in this 1985.The 1980 paper considers imple- section. mentation issues for data sampled at a The initial task of conducting an event monthly interval and the 1985 paper study is to define the event of interest deals with issues for daily data. and identify the period over which the In this paper,event study methods are security prices of the firms involved in reviewed and summarized.The paper this event will be examined-the event begins with discussion of one possible window.For example,if one is looking at procedure for conducting an event study the information content of an earnings in Section 2.Section 3 sets up a sample with daily data,the event will be the event study which will be used to illus- earnings announcement and the event trate the methodology.Central to an window will include the one day of the event study is the measurement of an ab- announcement.It is customary to define normal stock return.Section 4 details the event window to be larger than the the first step-measuring the normal specific period of interest.This permits performance-and Section 5 follows examination of periods surrounding the
MacKinlay:Event Studies in Economics and Finance 15 event.In practice,the period of interest choices for modeling the normal re- is often expanded to multiple days,in- turn-the constant mean return model cluding at least the day of the an- where Xt is a constant,and the market mouncement and the day after the an- model where Xt is the market return. nouncement.This captures the price The constant mean return model,as the effects of announcements which occur name implies,assumes that the mean after the stock market closes on the an- return of a given security is constant nouncement day.The periods prior to through time.The market model as- and after the event may also be of inter- sumes a stable linear relation between est.For example,in the earnings an- the market return and the security re- nouncement case,the market may ac- turn. quire information about the earnings Given the selection of a normal perfor- prior to the actual announcement and mance model,the estimation window one can investigate this possibility by ex- needs to be defined.The most common amining pre-event returns. choice,when feasible,is using the period After identifying the event,it is neces- prior to the event window for the estima- sary to determine the selection criteria tion window.For example,in an event for the inclusion of a given firm in the study using daily data and the market study.The criteria may involve restric- model,the market model parameters tions imposed by data availability such as could be estimated over the 120 days listing on the New York Stock Exchange prior to the event.Generally the event or the American Stock Exchange or may period itself is not included in the esti- involve restrictions such as membership mation period to prevent the event from in a specific industry.At this stage it is influencing the normal performance useful to summarize some sample char- model parameter estimates. acteristics (e.g.,firm market capitaliza- With the parameter estimates for the tion,industry representation,distri- normal performance model,the abnor- bution of events through time)and note mal returns can be calculated.Next any potential biases which may have comes the design of the testing frame- been introduced through the sample se- work for the abnormal returns.Impor- lection. tant considerations are defining the null Appraisal of the event's impact re- hypothesis and determining the tech- quires a measure of the abnormal return. niques for aggregating the individual The abnormal return is the actual ex post firm abnormal returns. return of the security over the event win- The presentation of the empirical re- dow minus the normal return of the firm sults follows the formulation of the over the event window.The normal re- econometric design.In addition to pre- turn is defined as the expected return senting the basic empirical results,the without conditioning on the event taking presentation of diagnostics can be fruit- place.For firm i and event date t the ful.Occasionally,especially in studies abnormal return is with a limited number of event observa- ARit=Rit-E(RitXt) (1) tions,the empirical results can be heav- ily influenced by one or two firms. where ARt,Rit,and E(RitX:)are the ab- Knowledge of this is important for gaug- normal,actual,and normal returns re- ing the importance of the results. spectively for time period t.Xt is the Ideally the empirical results will lead conditioning information for the normal to insights relating to understanding the return model.There are two common sources and causes of the effects (or lack
16 Journal of Economic Literature,Vol.XXXV (March 1997) of effects)of the event under study.Ad- is Datastream,and the source of the ac- ditional analysis may be included to dis- tual earnings is Compustat. tinguish between competing explana- If earnings announcements convey in- tions.Concluding comments complete formation to investors,one would expect the study. the announcement impact on the mar- ket's valuation of the firm's equity to de- 3.An Example of an Event Study pend on the magnitude of the unex- pected component of the announcement. The Financial Accounting Standards Thus a measure of the deviation of the Board (FASB)and the Securities Ex- actual announced earnings from the mar- change Commission strive to set report- ket's prior expectation is required.For ing regulations so that financial state- constructing such a measure,the mean ments and related information releases quarterly earnings forecast reported by are informative about the value of the the Institutional Brokers Estimate Sys- firm.In setting standards,the informa- tem (I/B/E/S)is used to proxy for the tion content of the financial disclosures market's expectation of earnings.I/B/E/S is of interest.Event studies provide an compiles forecasts from analysts for a ideal tool for examining the information large number of companies and reports content of the disclosures. summary statistics each month.The In this section the description of an mean forecast is taken from the last example selected to illustrate event month of the quarter.For example,the study methodology is presented.One mean third quarter forecast from Sep- particular type of disclosure-quarterly tember 1990 is used as the measure of earnings announcements-is considered. expected earnings for the third quarter The objective is to investigate the infor- of1990. mation content of these announce- To facilitate the examination of the ments.In other words,the goal is to see impact of the earnings announcement on if the release of accounting information the value of the firm's equity,it is essen- provides information to the marketplace. tial to posit the relation between the in- If so there should be a correlation be- formation release and the change in tween the observed change of the mar- value of the equity.In this example the ket value of the company and the infor- task is straightforward.If the earnings mation. disclosures have information content, The example will focus on the quar- higher than expected earnings should be terly earnings announcements for the 30 associated with increases in value of the firms in the Dow Jones Industrial Index equity and lower than expected earnings over the five-year period from January with decreases.To capture this associa- 1989 to December 1993.These an- tion,each announcement is assigned to nouncements correspond to the quar- one of three categories:good news,no terly earnings for the last quarter of 1988 news,or bad news.Each announcement through the third quarter of 1993.The is categorized using the deviation of the five years of data for 30 firms provide a actual earnings from the expected earn- total sample of 600 announcements.For ings.If the actual exceeds expected by each firm and quarter,three pieces of in- more than 2.5 percent the announce- formation are compiled:the date of the ment is designated as good news,and if announcement,the actual earnings,and the actual is more than 2.5 percent less a measure of the expected earnings.The than expected the announcement is des- source of the date of the announcement ignated as bad news.Those announce-