Market e#ciency survives the challenge from the literature on long-term return anomalies. Consistent with the market e#ciency hypothesis that the anomalies are chance results, apparent overreaction to information is about as common as underreaction, and post-event continuation of pre-event abnormal returns is about as frequent as post-event reversal. Most important, consistent with the market e#ciency prediction that apparent anomalies can be due to methodology, most long-term return anomalies tend to disappear with reasonable changes in technique. # 1998 Elsevier Science S.A. All rights reserved.

A rapidly growing literature claims to reject the efficient market hypothesis by producing large estimates of long-term abnormal returns following major corporate events. The preferred methodology in this literature is to calculate average multi-year buy-and-hold abnormal returns and conduct inferences via a bootstrapping procedure. We show that this methodology is severely flawed because it assumes independence of multi-year abnormal returns for event firms, producing test statistics that are up to four times too large. After accounting for the positive cross-correlations of event firm abnormal returns we find virtually no evidence of reliable abnormal performance for our samples.

As in previous decades, merger activity clusters by industry during the 1990s. One particular kind of industry shock, deregulation, becomes a dominant factor, accounting for nearly half of the merger activity since the late 1980s. In contrast to the 1980s, mergers in the 1990s are mostly stock swaps, and hostile takeovers virtually disappear. Over our 1973 to 1998 sample period, the announcement-period stock market response to mergers is positive for the combined merging parties, suggesting that mergers create value on behalf of shareholders. Consistent with that, we find evidence of improved operating performance following mergers, relative to industry peers.

The share of equity issues in total new equity and debt issues is a strong predictor of U.S. stock market returns between 1928 and 1997. In particular, firms issue relatively more equity than debt just before periods of low market returns. The equity share in new issues has stable predictive power in both halves of the sample period and after controlling for other known predictors. We do not find support for efficient market explanations of the results. Instead, the fact that the equity share sometimes predicts significantly negative market returns suggests inefficiency and that firms time the market component of their returns when issuing securities.

We present a model of mergers and acquisitions based on stock market misvaluations of the combining firms. The model explains who acquirers whom, whether the medium of payment is cash or stock, what the valuation consequences of mergers are, and why there are merger waves. Some of the key predictions of the model are: 1) acquisitions are disproportionately for stock when market valuations are high, and for cash when they are low; 2) targets in cash acquisitions earn low returns prior to the acquisitions, whereas bidders in stock acquisitions earn high returns; 3) long run returns to bidders in stock acquisitions are likely to be negative, those to bidders in cash acquisitions are likely to be positive; 4) despite negative long run returns, acquisitions for stock serve the interest of long run shareholders of the bidder; 5) diversification strategies serve the interest of bidding shareholders even when they earn negative announcement returns; 6) such diversifying acquisitions are likely to be for stock; 7) management resistance to cash tender offers is often in the interest of shareholders; 8) acquisition targets are likely to have managers and shareholders with relatively shorter horizons than the bidders. 1 We are grateful to Robin Greenwood and Rafael La Porta for helpful comments, to Mark

We survey the evidence on the relationship between board composition and firm performance. Boards of directors of American public companies that have a majority of independent directors behave differently, in a number of ways, than boards without such a majority. Some of these differences appear to increase firm value; others may decrease firm value. Overall, within the range of board compositions present today in large public companies, there is no convincing evidence that greater board independence correlates with greater firm profitability or faster growth. In particular, there is no empirical support for current proposals that firms should have "supermajority-independent boards " with only one or two inside directors. To the contrary, there is some evidence that firms with supermajority-independent boards are less profitable than other firms. This suggests that it may be useful for firms to have a moderate number of inside directors (say three to five on an average-sized eleven member board). We offer some possible explanations for these results, based on board dynamics, the informational advantages possessed by inside (and, often, affiliated) directors, and the value of interaction between different types of directors who bring different strengths to the board. published in

Kyle, Jeremy Stein, and Jeff Wurgler, for useful discussions and ideas. We also thank workshop participants Merger intensity spikes in times of high market valuations (i.e., when average M/B ratios are at their highest). This is especially true for stock-based mergers, supporting recent theories by Rhodes-Kropf and Viswanathan (2002) and Shleifer and Vishny (2003). To explore whether this is the result of correlated valuation errors or behavioral mispricing we decompose M/B into three components: firm-specific deviation from short-run industry valuations; short-run industry deviations from long-run values, and long-run value to book. The fact that high M/B buys lower M/B is driven mostly by firm-specific deviations from short-run industry average pricing. However, both targets and acquires are priced above their long-run industry average. When we find differences between bidders and targets in long-run valueto-book, we find that low buys high. We also find that the industry-specific component of M/B is highly positively correlated with merger intensity, and correlated with the use of stock. However, long-run value-to-book is uncorrelated with cash merger intensity and negatively correlated with stock merger intensity, leading to little overall correlation between long-run

We review extensive evidence about how psychological biases affect investor behavior and prices. Systematic mispricing probably causes substantial resource misallocation. We argue that limited attention and overconfidence cause investor credulity about the strategic incentives of informed market participants. However, individuals as political participants remain subject to the biases and self-interest they exhibit in private settings. Indeed, correcting contemporaneous market pricing errors is probably not government’s relative advantage. Government and private planners should establish rules ex ante to improve choices and efficiency, including disclosure, reporting, advertising, and default-option-setting regulations. Especially

We analyze several hundred firms that expand via acquisition and0or increase their number of business segments. The combined market reaction to acquisition announcements is positive but acquiring firm excess values decline after the diversifying event. Much of the excess value reduction occurs because our sample firms acquire already discounted business units, and not because diversifying destroys value. This implies that the standard assumption that conglomerate divisions can be benchmarked to typical stand-alone firms should be carefully reconsidered. We also show that excess value does not decline when firms increase their number of business segments because of pure reporting changes. DOES CORPORATE DIVERSIFICATION destroy value? Several recent papers attempt to answer this question by comparing the market value of firms that operate multiple lines of business to the value of a portfolio of stand-alone firms operating in the same industries as the conglomerate’s divisions. Lang and Stulz ~1994! use this approach and find that multisegment firms have low

This paper tests the hypothesis that irrational market misvaluation a#ects firms' takeover behavior. We employ two contemporaneous proxies for market misvaluation, pre-takeover book/price ratios and pre-takeover ratios of residual income model value to price. Misvaluation of bidders and targets influences the means of payment chosen, the mode of acquisition, the premia paid, target hostility to the o#er, the likelihood of o#er success, and bidder and target announcement period stock returns. The evidence is broadly supportive of the misvaluation hypothesis