WHAT IS EVENT STUDY APPROACH (RELATED TO M&A PROFITABILITY MEASUREMENT)?
Answer by Nat Burgess:
The event study question is timely (December 2013) because we are in an M&A bubble, where acquisition announcements drive stock price – similar to in 2000 and 2007. Rather than analyze actual returns from M&A after the fact, the event study method focuses on the implications of the market reaction to an announcement on returns. This requires an important assumption: what would the share price of the acquirer (or acquirer and seller) have been if the transaction had not occurred? A premium (or discount) to this assumed chard price is then calculated by comparing the assumed price to the actual, post announcement price.
If an M&A deal will create efficiencies and drive down pricing and returns, the M&A event should reduce the valuations of the involved companies, and the other companies in their sector that are subject to the same market dynamics. Conversely, if an event will drive growth and profits, the event should raise valuations.
The analysis assumes an efficient, knowledgable market that prices equities intelligently. In the tech M&A market, where I have operated for the last 20 years, this cannot be safely assumed. In fact, companies go to great lengths to try convert complex technology strategies into rainbows and unicorns that they can fly over Wall Street. Therefore the event study approach is, in my opinion, unreliable in tech.