Thursday, 5 November 2015

"Law on the Market", the impact of court rulings and the risk of irrational response

"Law on the Market? Evaluating the Securities Market Impact of Supreme Court Decisions" is a 28-page article by three American scholars -- Daniel Martin Katz (Illinois Tech, Chicago Kent College of Law), Tyler Soellinger and James Ming Chen (both of the Michigan State University College of Law), together with infrastructure and business strategy specialist Michael James Bommarito II (Bommarito Consulting, LLC).

The abstract of this article, which is available in full on SSRN (browse here, download here), sets out the authors' thesis (the emphases are ours):
Do judicial decisions affect the securities markets in discernible and perhaps predictable ways? In other words, is there “law on the market” (LOTM)? This is a question that has been raised by commentators, but answered by very few in a systematic and financially rigorous manner. Using intraday data and a multiday event window, this large scale event study seeks to determine the existence, frequency and magnitude of equity market impacts flowing from Supreme Court decisions.

We demonstrate that, while certainly not present in every case, "law on the market" events are fairly common. Across all cases decided by the Supreme Court of the United States between the 1999-2013 terms, we identify 79 cases where the share price of one or more publicly traded company moved in direct response to a Supreme Court decision. In the aggregate, over fifteen years, Supreme Court decisions were responsible for more than 140 billion dollars in absolute changes in wealth. Our analysis not only contributes to our understanding of the political economy of judicial decision making, but also links to the broader set of research exploring the performance in financial markets using event study methods.

We conclude by exploring the informational efficiency of law as a market by highlighting the speed at which information from Supreme Court decisions is assimilated by the market. Relatively speaking, LOTM events have historically exhibited slow rates of information incorporation for affected securities. This implies a market ripe for arbitrage where an event-based trading strategy could be successful.
The abstract makes no mention of intellectual property -- but don't let that put you off.  The very first case the authors address is Association for Molecular Pathology v Myriad Genetics Inc., 133 S. Ct. 2107 (2013), about which the authors write:
The Court's ultimate decision was seen as a compromise that held that DNA sequences fall outside the definition of patentable subject matter under 35 U.S.C. s.101, but cDNA (complementary DNA) sequences, which do not occur in nature absent human intervention, may indeed be patented. Ultimately, the Court's decision was significant not only for its contribution to overall patent law doctrine but also to the value of Myriad as a company.

As displayed in Figure 1 [not reproduced here], the Court's compromise decision initially confused the equity market. Fueled in part by media reports, would-be arbitrageurs interpreted the Court's decision as positive to Myriad in the initial hours of trading. However, this view was ultimately displaced as more careful reading and subsequent understanding revealed that the decision was highly unfavorable to Myriad's business interests. As a result, the stock began to trade down in the second half of the session. Media coverage following the initial trading day called it a "wild ride" and a "market whipsaw."

As the dust settled, the Court's decision was indeed detrimental to Myriad's long-term financial value. Even after controlling for overall market trends, Myriad's stock lost in excess of 20% of value over the two-day trading window. Attendant to this change in price, there was also a significant increase in volume as traders sought to shift their positions in light the Court's decision. Specifically, on the date of decision, there was roughly a thirteen-fold increase in trading volume of the stock. The day thereafter witnessed an eighteen-fold increase in trading volume.
While this article demonstrates the vulnerability of stock values, and therefore of investments, to judicial rulings, readers of this weblog will bear in mind that there are other factors at play. These include the speed at which information concerning a court decision travels and, more importantly, how that information is interpreted or misunderstood.  A classical example of this, relating not to a court case but to the mere fact that a patent has been granted, was the effect on GoPro's share price of the announcement earlier this year that a patent had been granted to Apple -- this being just one of a very large number of patents for wearable camera technology and certainly not a market killer [for  more on this episode, click here]. The bottom line is that, in the absence of relevant and current IP analytics, the undeniable impact of court decisions on patent owners' share value can be an irrational one.

1 comment:

  1. Speculator Alligator5 November 2015 at 16:07

    I agree with your comment about other factors. The fact that a court ruling affects one patent does not necessary mean that it has any impact on other patents in the same market.

    Is there any data related to stock price movements of competitors of affected litigants? After all, if company A's shares crash when a patent is invalidated, we might expect shares in competing companies B, C and D to rise because they are in a stronger position against A rather than for their shares to drop in value because they too have patents that cover the same product.