When Bad News is Good News

Prior research finds that when investors receive credible bad news about a firm, they revise their valuations of that firm downward. We examine a setting where investors receive bad news about a firm and revise their valuations of that firm upward. Specifically, we find that when activist investment funds reveal bad news about their target firms but also suggest potential remedies to fix the underlying problems, these disclosures are significantly associated with positive abnormal returns at the target firms, as well as decreased bid-ask spreads and increased disclosure at the targets. Additional tests suggest that our findings are justified as the target firms do in fact show operational governance changes ex post, as measured by such outcomes as directorship changes. These findings make explicit the assumption in prior studies that entities who make bad news disclosures believe the underlying problem cannot be fixed, and that investors agree with this assessment