Finance - Theses
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ItemEssays on distress risk and stock returns( 2012)Essay 1. Understanding the Distress Puzzle: Surprises in the Pre-Delisting Period This study decomposes realized returns into expected and unexpected returns and shows that the persistently low unexpected returns two years before a firm’s delisting due to financial distress (the pre-delisting period) drive the negative cross-sectional relation between distress risk and realized stock returns documented in previous studies. Investors are surprised by lower-than-expected firms’ earnings and stock returns in the pre-delisting period, especially around earnings announcements when they correct their valuation errors about the firms’ future prospects. Essay 2. Distress Risk and Stock Returns: Evidence from Earnings Announcements This paper finds that stocks with high distress risk earn an average market-adjusted return of 0.62% during the five days before earnings announcements and a corresponding average return of -0.96% in the five days after earnings announcements. The five-day post-announcement spread in returns between stocks with the highest and lowest distress risk accounts for a large portion of the negative annual spread in returns. Changes in risk around earnings announcements or cross-sectional differences in risk cannot explain the run-up and subsequent reversal in distressed stocks’ returns. Consistent with the mispricing hypothesis, the pattern in returns only exists in distressed stocks with both binding short-sales constraints and high divergence in investors’ opinion. Essay 3. Are Firms with Negative Book Equity in Financial Distress? This study examines the operating performance and financial characteristics of firms with negative book equity (BE) for signs of financial distress in the period surrounding the year when they first report negative BE and their subsequent survivability and stock returns. I find firms with small magnitude of negative BE (SNBE firms) suffer from persistent negative earnings and financial distress, while firms with large magnitude of negative BE (LNBE firms) experience a temporary shock to their earnings and BE. Unlike SNBE firms, most LNBE firms report consecutive years of negative BE, but they survive for many years. Moreover, LNBE firms have lower distress risk and failure rate than both SNBE firms and positive BE control firms. Although LNBE stocks outperform SNBE stocks subsequent to their first report of negative BE, both of them underperform control firms with positive BE.