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March 7th, 2010, 03:08 PM
This study examines a sample of best managed firms for evidence on the investor overreaction hypothesis. The standard event study method supports the overreaction hypothesis. Pre-award stock excess returns are abnormally high and post award excess returns are negative. Corrections for potential size and risk changes eliminate the negative postaward excess returns. The results support recent criticism that considers evidence of overreaction as an artifact of technical methodological flaws.
Recent research such as DeBondt and Thaler (1985, 1987) and Lehman (1990) finds that abnormal profits can be made in the stock market by buying losers and selling winners. This evidence frequently is interpreted as suggesting that investors overreact to news; stock prices of successful firms are bid up, while stocks of loser firms falls below their fundamental values.
Opposition to the overreaction hypothesis focuses on technical flaws in the DeBondt and Thaler studies. Chan (1988), Brown and Harlow (1988), Brown, Harlow, and Tinic (1988), and Zarowin (1990) criticize DeBondt and Thaler for improper adjustments for risk and size changes. Once these changes are accounted for, overreaction phenomena diminish.
The purpose of this study is to provide further evidence on the investor overreaction hypothesis and its criticism. The focus of the current study is a different brand of winners: excellence award winners. The sample consists of 101 companies whose chief executive officer received a best manager award from a panel of specialists appointed by Financial World magazine. If the award is a manifestation of market overenthusiasm about these firms, by the time of the award their stock could be overvalued; in the postaward period, performance could be dismal.
Standard empirical tests support the overreaction hypothesis. Using standard event study methodology, a +21 percent average excess return was documented in the two years preceding the award, and a -9.3 percent average excess return was documented in the two years following the award. After correcting the tests for potential biases, however, the postaward excess return vanishes. These findings lend support to recent criticism of the overreaction evidence.
Recent research such as DeBondt and Thaler (1985, 1987) and Lehman (1990) finds that abnormal profits can be made in the stock market by buying losers and selling winners. This evidence frequently is interpreted as suggesting that investors overreact to news; stock prices of successful firms are bid up, while stocks of loser firms falls below their fundamental values.
Opposition to the overreaction hypothesis focuses on technical flaws in the DeBondt and Thaler studies. Chan (1988), Brown and Harlow (1988), Brown, Harlow, and Tinic (1988), and Zarowin (1990) criticize DeBondt and Thaler for improper adjustments for risk and size changes. Once these changes are accounted for, overreaction phenomena diminish.
The purpose of this study is to provide further evidence on the investor overreaction hypothesis and its criticism. The focus of the current study is a different brand of winners: excellence award winners. The sample consists of 101 companies whose chief executive officer received a best manager award from a panel of specialists appointed by Financial World magazine. If the award is a manifestation of market overenthusiasm about these firms, by the time of the award their stock could be overvalued; in the postaward period, performance could be dismal.
Standard empirical tests support the overreaction hypothesis. Using standard event study methodology, a +21 percent average excess return was documented in the two years preceding the award, and a -9.3 percent average excess return was documented in the two years following the award. After correcting the tests for potential biases, however, the postaward excess return vanishes. These findings lend support to recent criticism of the overreaction evidence.