Measuring Security Price Performance in Size-Clustered Samples.

Abstract ABSTRACT: This study assesses the impact of the firm size effect on test statistics based on market-adjusted and market model abnormal returns. The performance of two alternative abnormal return methods that explicitly control for the effect of firm size on expected returns is also examined. These methods, the size control portfolio and size model approaches, are based upon a companion portfolio approach where companion portfolios are constructed on the basis of firm size. Simulation results indicate that when event dates are clustered in calendar time and the event affects either small or large firms, conventional t-statistics based on market-adjusted or market model abnormal returns are misspecified in that their empirical Type I error rates deviate significantly from those expected under a true null hypothesis. Significance tests based on empirical distributions mitigate these over-rejection tendencies but, in doing so, they sacrifice power. On the other hand, conventional t-statistics based on size control portfolio or size model abnormal returns are well-specified across a variety of event conditions. Accordingly, either size-based method can control for the firm size effect in event study contexts where such control is warranted. Since the size control portfolio approach is simpler to implement, it is the preferred alternative. The study also documents that abnormal performance is detected more often when large firms are affected than when small firms are affected.