CBR Briefing #16

Why no news is news

The absence of news reports and the passage of time often contain important information markets tend to overlook

A line chart plotting the probability of completing a merger, with percentages on the y-axis and the number of weeks after the announcement on the x-axis. The line starts at zero, arcs upward to nearly seven percent around week twenty-three, and then gradually descends below two percent by week fifty. A second line chart plotting weekly returns on merger investment strategies starts at about zero-point-two-five percent, holds at about to zero-point-four-five from weeks twenty-three to thirty-two, dips below zero-point-two percent by week thirty-eight, and then rises again to nearly zero-point-five percent by week forty-four.

Research suggests that investors, by underreacting to information tied to the passage of time, are ignoring potential profits.

  • Investors tend to give insufficient attention to the importance of a lack of big news when weighing whether a corporate merger will succeed, according to an analysis of more than 5,000 mergers from 1970 to 2010 by Chicago Booth’s Stefano Giglio and Kelly Shue.
  • The passage of time after a merger announcement offers information about the probability a merger will be completed. Following M&A announcements, the “hazard rate” of completion (the likelihood that a pending merger will be completed within the week) forms a consistent hump shape when charted. This pattern holds across a variety of mergers.
  • Weekly returns on merger investment strategies can be predicted by looking at the average probability, in each week, that a pending merger will be completed. When the probability of completion is high, average returns are also high (see chart). Investors can profit by investing in those weeks.
  • The higher returns do not come with higher risk or transaction costs. The researchers argue that by overlooking information tied to the passage of time, investors initially underestimate the probability a merger will be completed and then overestimate the probability later.
  • The mispricing is stronger for deals that involve less liquid stocks and higher transaction costs, suggesting that a lack of market liquidity prevents arbitrage by more sophisticated investors.

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