In the social sciences, there are instances where it is necessary to statistically assess the impact of an event on the value of the firm. In this instance, event studies are a viable tool to quantitatively assess the effectiveness of an "announced event" on the stock returns of firms. The announced event is an unanticipated event, which may have political, economic, legal, or historical implications for select firms. The stock returns of the firm are often referred to as shareholder wealth or the welfare of the firm; and assuming efficient markets, the market reaction to an announced event will be immediately reflected in the security prices (or share returns) of the firm.
DESCRIPTION OF AN EVENT STUDY
To construct an event study, a specific event and the date of the announced event, called the event date, must be identified. The event date may be found in prominent media outlets such as the New York Times, Wall Street Journal, the Associated Press, or other media outlets. Thereafter, the event window must be constructed, which is typically the event date. The event window may be extended to include the day before and the day after the actual announcement, as some announcements may occur when the stock market has closed and/or the information was leaked the day before. Alternatively, an anticipatory window may be constructed that includes days before the actual announcement to account for potential leakages prior to the actual announcement.
After the event window is constructed, the stock returns of the firm must be collected to construct an estimation window, which represents the stock returns under "normal" conditions (no confounding events have occurred such as annual report announcements, restructuring announcements, etc.). The estimation window is typically before the event window, and therefore does not include days in the event window to avoid influencing the estimation of returns under normal conditions. A selection criterion must also be determined for the inclusion of firms in the event study such as industry membership and/or data availability. Further, any potential biases during the firm selection must be disclosed.
To determine the market reaction to a specific event, the abnormal returns are constructed, which determines, on average, if the firm observed above or below average returns in response to an announced event. Specifically, assuming efficient markets, abnormal returns represent the market’s valuation of the change in the firm’s current and future expected profitability due to an announced event.
APPLICATIONS OF EVENT STUDIES IN THE SOCIAL SCIENCES
There have been many applications of event studies in the social sciences. Event studies have been used to determine the impact of presidential elections on the stock market. Srinivas Nippani and Bobby Medlin examined the impact of the delay in the declaration of a winner in the 2000 U.S. presidential election on the performance of the stock market and found a negative reaction to the delay in election results. Nippani and Augustine Arize also found evidence that the delay in the U.S. election results impacted the stock markets in other countries like Mexico and Canada. Sara Ellison and Wallace Mullin analyzed President Bill Clinton’s 1990s health care reform proposal on pharmaceutical stock prices and found that investors reacted negatively to health care reform, estimating that shareholder wealth fell by approximately 52 percent.
Event studies are also used to determine the impact of trade policy announcements on the value of the firm. John Hughes, Stefanie Lenway, and Judy Rayburn examined the stock price reactions for the semiconductor producers and downstream consumers (electronic and computer firms) affected by a subset of events starting with the filing of a Section 301 petition by the U.S. semiconductor industry alleging unfair practices by the Japanese and culminating in the 1986 Trade Agreement. Empirical evidence suggests that U.S. semiconductor producers and consumers benefited from the trade agreement. In previous trade studies, statistical results have shown that U.S. firms observed positive abnormal returns in response to the announcement of U.S. trade protection. Bruce Blonigen, Wesley Wilson, and Kasaundra Tomlin note that the studies of trade policy on the welfare of the firm ignore the possibility that foreign firms can use foreign direct investment to mitigate the positive gains to domestic producers, also known as "tariff-jumping." Using event study methodology, the statistical results suggest that affirmative U.S. antidumping decisions yield positive abnormal returns; moreover tariff-jumping in the form of new plants or plant expansions by foreign firms has a negative impact on the welfare of U.S. domestic firms that previously received trade protection.
Issues related to human resources and human rights have also been evaluated using event study methodology. Michelle Arthur and Alison Cook examined the share price reactions to 231 work-family human resource policies adopted by Fortune 500 companies, which were announced in the Wall Street Journal from 1971 to 1996. The results suggest that firm announcements of work-family initiatives positively affected the shareholder wealth of firms that implemented them. With respect to human rights issues, Judith Posnikoff analyzed the effects of announcing disinvestment or withdrawal of U.S. firms from South Africa during the 1980s on those firms’ shareholder wealth and found a significant positive announcement effect.
STRENGTHS AND LIMITATIONS
Event studies are a valuable tool, in that across many disciplines in the social sciences one can assess the effects of new information on the shareholder wealth of specific firms; and in some cases perform industry-level analysis. There are some limitations in the methodology. For example, it is difficult to identify the exact date of a specific event. In addition, there are some estimation issues, which Craig MacKinlay discussed in a 1997 survey article on event studies that outlines the issues and remedies. In sum, assuming efficient markets, event study methodology is a valuable statistical tool to evaluate issues in the social sciences.
