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.

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 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

Statistical inference in long-horizon event studies has been hampered by the fact that abnormal returns are neither normally distributed nor independent. This study presents a new approach to inference that overcomes these difficulties and dominates other popular testing methods. I illustrate the use of the methodology by examining the long-horizon returns of initial public offerings ~IPOs!. I find that the Fama and French ~1993! three-factor model is inconsistent with the observed long-horizon price performance of these IPOs, whereas a characteristic-based model cannot be rejected. RECENT EMPIRICAL STUDIES IN FINANCE document systematic long-run abnormal price reactions subsequent to numerous corporate activities. 1 Since these results imply that stock prices react with a long delay to publicly available information, they appear to be at odds with the Efficient Markets Hypothesis ~EMH!. Long-run event studies, however, are subject to serious statistical difficulties

The class of firms that obtain public equity financing expands dramatically in the 1980s and 1990s. After 1979, the rate at which new firms are listed on major U.S. stock exchanges jumps from about 160 to near 550 per year, and the characteristics of new lists change. The cross-section of new list profitability becomes progressively more left skewed, and growth becomes more right skewed. The result is a sharp decline in new list survival rates. We suggest that the changes in the characteristics of new lists are due to a decline in the cost of equity capital that allows weaker firms and firms with more distant expected payoffs to become viable candidates for public equity financing.

We examine the stock price reaction to earnings announcements in the five years following seasoned equity offerings (SEOs). On average, post-SEO earnings announcements are met with a significantly negative abnormal stock price reaction. Although this negative reaction accounts for a disproportionately large portion of long-run post-SEO abnormal stock returns, on average, abnormal stock price reactions to post-SEO earnings announcements are reliably negative only within the smallest quartile of equity issuers. For small firms, therefore, these findings are broadly consistent with the hypothesis that firms issue equity when the market over-estimates the firm’s future earnings performance.

go to Girts Graudins and Eric Nierenberg for their outstanding contributions to this project. Harvard Business School’s Division of Research provided financial support. The views expressed herein are those of the authors and not necessarily those of the National Bureau of Economic Research.

Our model of the initial public offering process links the three main empirical IPO ‘anomalies’ – underpricing, hot issue markets, and long-run underperformance – and traces them to a common source of inefficiency. We relate hot IPO markets (such as the 1999/2000 market for Internet IPOs) to the presence of a class of investors who are ‘irrational’ in the sense of having exuberant expectations regarding future performance. Underpricing and long-run underperformance emerge as underwriters attempt to maximize profits from the sale of equity, at the expense of these exuberant investors. Underpricing serves to compensate regular IPO investors for their role in restricting the supply of available shares and maintaining prices. The model is shown to be consistent with many aspects of the IPO process. It also generates a number of new empirical predictions.

Growth in capital expenditures conditions subsequent classification of firms to portfolios based on size and book-to-market ratios, as in the widely used Fama and French (1992, 1993) methods. Growth in capital expenditures also explains returns to portfolios and the crosssection of future stock returns. These findings are consistent with recent theoretical models (e.g., Berk, Green, and Naik (1999)) in which the exercise of investment growth options results in changes in both valuation and expected stock returns.

After 1979, the rate at which new firms are listed on the major U.S. stock exchanges increases sharply, asset growth rates of new lists are high, but their profitability declines and remains low for at least five years after listing. New lists also become less likely to survive, primarily because of delisting for poor performance. Overall, market prices reflect the volatile dynamics of new list fundamentals. Thus, for the full 1926 to 2000 period and the 1973 to 2000 Nasdaq period, value-weight and equalweight new list returns are close to benchmark returns. For the high action 1980 to 2000 period, equalweight new list returns are low, but value-weight returns are again close to benchmark returns. * Graduate School of Business, University of Chicago (Fama), and Tuck School of Business, Dartmouth College (French). We gratefully acknowledge the helpful comments of Frank Easterbrook, Kenneth Lehn, Jonathan Macey, Richard Roll, Hans Stoll, and seminar participants at UCLA. The market...