Noise Traders in Event Studies? the Case of Equity Carve-outs

In this paper I hypothesize that the well documented positive mean excess stock return earned by parent firms when they announce they are carving out stock in a subsidiary is due to noise traders who optimistically misinterpret a carve-out’s true value-irrelevance, rather than to the impounding of new value-enhancing information by sophisticated investors. I offer three pieces of evidence that support the noise trade view. First, parents experience a reliably negative mean excess stock return of –2.4% when the carved-out subsidiary goes public. This is in contrast with a 2.3% rise at the announcement date a median of only 45 trading days earlier. Second, proxies for the intensity of noise trader demand at the carve-out announcement explain 11% of the cross-sectional variation in parent excess returns at the subsidiary stock issue date. Third, the coefficients on the noise trader demand proxies in a cross-sectional regression whose dependent variable is the parent excess return at the issue date are individually and jointly equal to minus one times the coefficients obtained in an identical cross-sectional regression but whose dependent variable is the parent excess return at the announcement date. It appears that parent stock prices are optimistically mispriced by noise traders at the carve-out announcement, but that such mispricing is corrected when the subsidiary stock goes public.