This paper provides evidence of excess returns earned by investors in acquired firms prior to the first public announcement of planned mergers. The study is distinguished from earlier merger studies in its use of daily holding period returns for the 194 firms sampled. The results confirm statistically what most traders already know. Impending merger announcements are poorly held secrets, and trading on this nonpublic information abounds. Specifically, leakage of inside information is a pervasive problem occurring at a significant level up to 12 trading days prior to the first public announcement of a proposed merger. THE SEMISTRONG FORM EFFICIENT market hypothesis states that all publicinformation is reflected in the market price of a security so that only those possessing inside information can outperform the market on a risk adjusted basis. To help prevent trading on nonpublic information, Rule lOb-5 of the Securities Exchange Act of 1934 regulates trading by insiders and requires trading by corporate officers, directors, and substantial owners to be reported to the S.E.C. Since it would be impossible to monitor trades by relatives and friends of insiders, the law also considers anyone possessing nonpublic information to be a de facto insider and prohibits trading on this information. In spite of these measures, trading on inside information does exist; however, the degree to which inside information is leaked and the amount of trading on this inside information is unknown.This study deals with one area of possible insider leakage-unannounced merger plans, and examines the impact of trading on inside information in advance of planned takeover announcements by focusing on the daily stock price movements of 194 successfully acquired firms (1975-78) prior to the first public announcement of their proposed mergers. Systematic abnormal price movements can be interpreted as prima facie evidence of the market's reaction to information in advance of its public announcement. Using residual analysis, the abnormal returns occurring prior to the announcement are calculated. A comparison is then made between the pre-announcement abnormal returns occurring on listed versus unlisted stocks to determine if regulation associated with an organized exchange acts to deter trading on inside information.Theremainder of the paper is organized as follows. Section I reviews the existing work pertaining to trading on inside information in general, and pre-* Respectively Associate and Assistant Professors of Finance, Virginia Polytechnic Institute and State University. The authors greatefully acknowledge the helpful comments of Michael J. Brennan and Jeffrey Jaffe. Any remaining errors are, of course, ours. We also thank Lewis Young for his extensive programming assistance. 855 856The Journal of Finance merger stock price changes of acquired firms in particular. An explanation is also provided as to why inside information concerning merger activity appears to be particularly susceptible to leakage. Section II presents the methodology and...

This paper provides evidence of excess returns earned by investors in acquired firms prior to the first public announcement of planned mergers. The study is distinguished from earlier merger studies in its use of daily holding period returns for the 194 firms sampled. The results confirm statistically what most traders already know. Impending merger announcements are poorly held secrets, and trading on this nonpublic information abounds. Specifically, leakage of inside information is a pervasive problem occurring at a significant level up to 12 trading days prior to the first public announcement of a proposed merger.

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When raising new equity capital managers have historically rejected the direct offer method favoring instead the seemingly more expensive underwritten public issue. This paper provides a resolution for this equity financing paradox by demonstrating empirically that firms which engage in direct offers enjoy a comparative cost advantage that is more than sufficient to account for the absolute reported cost differences between the two methods of equity financing.