Week 2 - Giglio and Shue (2014).

Question 1

What is the main idea of this paper?

Answer 1

This article aims at finding out the effect of ‘no-news’ periods on the rate of success in M&A
activity. It looks at ‘the hazard rate’ of completion, which is the risk of a merger not being
completed even though it has been announced. On the contrary it also looks at the hazard rate of withdrawal, in which one of the two parties involved in the M&A withdraws from the deal.
It is argued that absence of news and the passage of time also contain information. In this
article it is tested whether this information is also incorporated fully into the market. More
specifically, during the year after the merger announcement, the time that has passed carries
an informational aspect about the probability that the merger will be completed. Variation in
hazard rates of completion after the announcement strongly predicts returns.

Question 2

What are the main findings of this paper?

Answer 2

Hazard rates of merger completion vary over time.
Hazard rates of withdrawal are constant over time.
Returns are predictable: the average return across deals move together with the hump shaped completion hazard rates.

Question 3

What is the theoretical explanation for these findings according to this paper?

Answer 3

Behavioral model of underreaction.
Compensation for risk factors.
Variation in frictions and asymmetric information.
Limits to arbitrage explain part of the returns.

Question 4

What are the limits of arbitrage in this paper?

Answer 4

The abnormal returns are higher among small cap targets.
The abnormal returns are higher in the earlier sample period.
The abnormal returns are higher among less liquid stocks.
Transaction costs reduce substantially the alphas.

Question 5

What is the summary of this paper?

Answer 5

• Passage of time after a merger announcement contains information, but investors underreact to it because it is less salient.
• The behavioral theory of underreaction to no news tested on merger deals.
• Hazard rates of merger completion vary over time and predict returns.
• These abnormal returns of 72 bps per month (8.64 percent per year) cannot be explained by rational models.
• Sophisticated investors are unable to fully arbitrage away the mispricing due to limits to
  arbitrage.