Corporate Investment and Asset Price Dynamics: Implications for SEO Event Studies and Long-Run Performance





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    • The authors are from the Sauder School of Business, University of British Columbia, 2053 Main Mall, Vancouver, BC, V6T 1Z2. We appreciate helpful comments from Jonathan Berk, Harjoat Bhamra, Martin Boyer, Glen Donaldson, Julian Douglass, Bernard Dumas, Joao Gomes, Rick Green, Jonathan Karpoff, David Koslowsky, Alan Kraus, Ali Lazrak, Lubos Pastor, Ed Rice, Ralph Winter, Lu Zhang, an anonymous referee, and seminar participants at the University of California at Berkeley, the University of Calgary, Hautes Etudes Commerciales Montreal, University of Houston, McGill University, the University of British Columbia, York University, the National Bureau of Economic Research Asset Pricing Program meeting, the 2004 Northern Finance Association Meetings, the 2004 Pacific Northwest Finance Conference at the University of Oregon, 2004 meetings of the Society for Economic Dynamics, the 2005 Texas Finance Festival, and the 2005 Western Finance Association Meetings. Support for this project from the Social Sciences and Humanities Research Council of Canada (grant number 410-2003-0741) is gratefully acknowledged.


We present a rational theory of SEOs that explains a pre-issuance price run-up, a negative announcement effect, and long-run post-issuance underperformance. When SEOs finance investment in a real options framework, expected returns decrease endogenously because growth options are converted into assets in place. Regardless of their risk, the new assets are less risky than the options they replace. Although both size and book-to-market effects are present, standard matching procedures fail to fully capture the dynamics of risk and expected return. We calibrate the model and show that it closely matches the primary features of SEO return dynamics.