Corporate Financing GBUS 8470
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This 2 page Class Notes was uploaded by Mrs. Brice Lang on Monday September 21, 2015. The Class Notes belongs to GBUS 8470 at University of Virginia taught by Susan Chaplinsky in Fall. Since its upload, it has received 49 views. For similar materials see /class/209570/gbus-8470-university-of-virginia in OTHER at University of Virginia.
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Date Created: 09/21/15
Note 1 Assessing Changes in Shareholder Wealth An Example The readings used in the course make heavy use of event study methodology to measure the speci c impact of corporate decisions on shareholder wealth This technique is widely used in practice to assess the change in shareholder wealth generated by announcements of corporate events eg security offerings mergers lawsuits earnings The example below reviews the fundamental assumptions behind this technique My example considers the change in shareholder wealth resulting from an announcement of a repurchase by Intel Inc in late 1991 Intel was considering a repurchase Below is the hypothetical sequence of prices P for Intel39s stock around the announcement day for the repurchase t0 The announcement day is the first day the public learns of the event Typically this day coincides with a public announcement by the rm to that effect The total percentage return to shareholders Rt on day t is given by the expression Rt Pt 39 Pt 1 t Dt R 1 However since at the time Intel paid no dividends D its observed or actual daily stock returns Rt are as follows Day t Returns Rt Announcement By what criterion does the 9 percent return observed on the announcement day constitute an extraordinary or abnormal return To measure ABNORMAL returns we first have to measure NORMAL returns By normal we mean quotwhat would we have expected to happen to Intel39s stock in the absence of the repurchasequot Now enter the quagmire What model of expected returns do we use to forecast the return on Intel39s stock on day t Suppose we pick the CAPM then the theoretical expected return ERt 011 day t is ERt Rf t B Rm 39 Rf 1 where Rf is the risk free rate of interest B is the beta coef cient for Intel s stock and Rmt is the return on the 39Market portfolio In practice the CAPM model is implemented using the empirical market model that is a regression of stock returns on a proxy for the market portfolio The market model regression is given in 2 below Corporate Financing 1 Rt Xt tBRmttSt 2 Suppose we have the stock prices for Intel and therefore daily returns for 120 days prior to any information being known about the repurchase Then using equation 2 we regress Intel s daily returns on those of the SampP500 as a proxy for the market portfolio Assume that the regression yields estimates of UFO and 8175 Alternatively we could go to Value Line or Bloomberg prior to the repurchase and obtain estimates of alpha and beta With these estimates we can compute the abnormal gain to shareholders at the time of the repurchase The daily abnormal returns AR on Intel39s stock are the di erenee between Intel39s actual returns 1 above and the CAPM determined expected returns 4 Day t SampP Intel s Exp Intel s Market return Abnormal Cumulative 3ampP 500 return CAPM Return Abnormal Index close Rm 175 Rm AR Return CAR 2 3 4 1 4 Sum ARC 4 358 3 354 0011 0020 0005 0005 2 354 0000 0000 0013 0018 1 352 0006 0010 0044 0025 Announcement day 0 356 0011 0020 0071 0096 1 360 0011 0020 0006 0090 2 358 0006 0010 0013 0077 Intuitively the abnormal return attempts to separate the effect of Intel39s repurchase decision from other market factors that in uence equity value Since the market rose on the announcement day 0011 Intel39s stockholders given their greater risk would have 39normally39 experienced a 0020 return 175 0011 On day 0 Intel39s stockholders 39actually39 earn 009 1 Therefore 2 of the observed 9 increase is due to overall market movements and thus cannot be ascribed uniquely to the repurchase Notice also that the estimates of alpha and beta are determined prior to the event period Thus the expected or normal return attempts to capture what would have happened to the firm in a period unaffected by the circumstances of the repurchase Because markets are informationally efficient in responding to this type of news39 the standard practice is usually to measure the impact of a corporate announcement with a twoday window ie add the AR on day l and day 0 Thus the cumulative abnormal return CARl0 is 0115 0044007l In dollar terms Intel had a market value of equity of approximately 8151 million before the repurchase announcement Hence the increase in shareholder wealth due to the repurchase is approximately 937 million Investment advising consulting corporate strategy firms make heavy use of the above technique Because of concerns about the CAPM firms are moving in two directions The 39low tech group now estimates expected returns using net of market returns This approach implicitly assumes that each fnm s beta is 1 Accordingly the net of market abnormal returns for Intel are simply Rt Rm The 39high Corporate Financing 2
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