Brad M. Barber

Detecting Long-Run Abnormal Stock Returns: The Empirical Power and Specification of Test Statistics

We analyze the empirical power and specification of test statistics in event studies designed to detect long-run (one- to five-year) abnormal stock returns. We document that test statistics based on abnormal returns calculated using a reference portfolio, such as a market index, are misspecified (empirical rejection rates exceed theoretical rejection rates) and identify three reasons for this misspecification. We correct for the three identified sources of misspecification by matching sample firms to control firms of similar sizes and book-to-market ratios. This control firm approach yields well-specified test statistics in virtually all sampling situations considered.

Improved Methods for Tests of Long-Run Abnormal Stock Returns

We analyze tests for long-run abnormal returns and document that two approaches yield well-specified test statistics in random samples. The first uses a traditional event study framework and buy-and-hold abnormal returns calculated using carefully constructed reference portfolios. Inference is based on either a skewnessadjusted t-statistic or the empirically generated distribution of long-run abnormal returns. The second approach is based on calculation of mean monthly abnormal returns using calendar-time portfolios and a time-series t-statistic. Though both approaches perform well in random samples, misspecification in nonrandom samples is pervasive. Thus, analysis of long-run abnormal returns is treacherous. COMMONLY USED METHODS TO TEST for long-run abnormal stock returns yield misspecified test statistics, as documented by Barber and Lyon ~1997a! and Kothari and Warner ~1997!. 1 Simulations reveal that empirical rejection levels routinely exceed theoretical rejection levels in these tests. In combination, these papers highlight three causes for this misspecification. First, the new listing or survivor bias arises because in event studies of long-run abnormal returns, sampled firms are tracked for a long post-event period, but firms that constitute the index ~or reference portfolio! typically include firms that begin trading subsequent to the event month. Second, the rebalancing bias arises because the compound returns of a reference portfolio, such as an equally weighted market index, are typically calculated assuming periodic ~generally monthly! rebalancing, whereas the returns of sample firms are compounded without rebalancing. Third, the skewness bias arises because the distribution of long-run abnormal stock returns is positively skewed, * Graduate School of Management, University of California, Davis. This paper was previously entitled “Holding Size while Improving Power in Tests of Long-Run Abnormal Stock Re

Detecting Abnormal Operating Performance: The Empirical Power and Specification of Test Statistics

This research evaluates methods used in event studies that employ accounting-based measures of operating performance. We examine the choice of an accounting-based performance measure, a statistical test, and a model of expected operating performance. We document the impact of these choices on the test statistics designed to detect abnormal operating performance. We find that commonly used research designs yield test statistics that are misspecified in cases where sample firms have performed either unusually well or poorly. In this sampling situation, the test statistics are only well specified when sample firms are matched to control firms of similar pre-event performance.

Just How Much Do Individual Investors Lose by Trading

Individual investor trading results in systematic and economically large losses. Using a complete trading history of all investors in Taiwan, we document that the aggregate portfolio of individuals suffers an annual performance penalty of 3.8 percentage points. Individual investor losses are equivalent to 2.2% of Taiwans gross domestic product or 2.8% of the total personal income. Virtually all individual trading losses can be traced to their aggressive orders. In contrast, institutions enjoy an annual performance boost of 1.5 percentage points, and both the aggressive and passive trades of institutions are profitable. Foreign institutions garner nearly half of institutional profits. The Author 2008. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: journals.permissions@oxfordjournals.org., Oxford University Press.

Challengers, Elites, and Owning Families: A Social Class Theory of Corporate Acquisitions in the 1960s

This paper analyzes data on 461 large U.S. industrial corporations to determine the factors that led large firms to participate in the wave of diversifying acquisitions that peaked in the late 1960s. We elaborate and test a class theory of corporate acquisitions, maintaining that firms pursued acquisitions in this period when they were commanded by well-networked challengers who were central in elite social networks but relatively marginal with respect to social status, isolated from the resistance of established elites, and free from control of owning families. We also consider a wide range of factors highlighted by alternative accounts of acquisition likelihood, including resource dependence, institutional pressures, and principal-agent conflicts. The results provide support for our main theoretical arguments, even when controls related to alternative explanations are taken into account.

The Behavior of Individual Investors

We provide an overview of research on the stock trading behavior of individual investors. This research documents that individual investors (1) underperform standard benchmarks (e.g. a low-cost index fund), (2) sell winning investments while holding losing investments (the “disposition effect†), (3) are heavily influenced by limited attention and past return performance in their purchase decisions, (4) engage in naA¯ve reinforcement learning by repeating past behaviors that coincided with pleasure while avoiding past behaviors that generated pain, and (5) tend to hold undiversified stock portfolios. These behaviors deleteriously affect the financial well being of individual investors.

Is the Aggregate Investor Reluctant to Realise Losses? Evidence from Taiwan

We ask whether the typical investor and the aggregate investor exhibit a bias known as the disposition effect, the tendency to sell investments that are held for a profit at a faster rate than investments held for a loss. We analyse all trading activity on the Taiwan Stock Exchange (TSE) for the five years ending in 1999. Using a dataset that contains all trades (over one billion) and the identity of every trader (nearly four million), we find that in aggregate, investors in Taiwan are about twice as likely to sell a stock if they are holding that stock for a gain rather than a loss. Eighty-four percent of all Taiwanese investors sell winners at a faster rate than losers. Individuals, corporations, and dealers are reluctant to realise losses, while mutual funds and foreigners, who together account for less than 5% of all trades (by value), are not.

Are Individual Investors Tax Savvy? Evidence from Retail and Discount Brokerage Accounts

Using brokerage account data, we analyze the tax awareness of individual investors. We find strong evidence that taxes matter: investors prefer to locate bonds and mutual funds in retirement accounts and, in December, harvest stock losses in their taxable accounts. However, investors also trade actively in their taxable accounts, realize gains more frequently than losses, and locate a material portion of their bonds in taxable accounts. Though taxes leave clear footprints in the data we analyze, many investors could improve their after-tax performance by fully capitalizing on the tax avoidance strategies available to equities, while optimally locating their assets.

Product Reliability and Firm Value: The Experience of American and Japanese Automakers, 1973-1992

This research analyzes the recall experience of threeAmerican (Chrysler, Ford, and GM) and three Japanese (Honda, Nissan, and Toyota) automakers during the period 1973-1992 to provide more conclusive evidence that the stock market imposes a reputation penalty on automakers that produce unreliable vehicles. We view recall campaigns as a manifestation of underlying product reliability, which is an important aspect of product quality. First, we document that the incidence of recalls for American automakers has been significantly higher than their Japanese counterparts. Furthermore, the Japanese advantage has persisted during the second decade of our sample (1983-1992). Second, we document a link between recalls and firm value by analyzing the stock market reaction to the announcement of recall campaigns. On average when an automaker announces a recall campaign, (1) the announcement has a statistically and economically significant impact on the shareholder value of the announcing firm, (2) the announcement does not significantly impact the shareholder value of competitor firms, (3) the market response to each recall is marginally larger for Japanese automakers, but (4) the total cumulative losses are larger for the US automakers. These findings suggest that the stock market functions as a disciplinary mechanism and that, ceteris paribus, automakers can improve the welfare of their shareholders by improving product reliability.

Good Reasons Sell: Reason-Based Choice Among Group and Individual Investors in the Stock Market

In this paper, we compare the investment decisions of groups (stock clubs) and individuals. Both individuals and clubs are more likely to purchase stocks that are associated with good reasons (e.g., a company that is featured on a list of most-admired companies). However, stock clubs favor such stocks more than individuals, despite the fact that such reasons do not improve performance. We describe why social dynamics may make good reasons more important for groups than individuals.