Event Studies in International Arbitrations: Applications in Merits and Quantum
Mark Berberian, Chris Feige, and Samuel Weglein — 7 min read
Event studies are widespread in securities litigation matters. What are their prospects for international arbitration?
Introduction
A common claim made in international arbitration, and in investor-state disputes in particular, is that an action by a host state harmed the value of assets held by foreign investors. While quantum experts commonly assess whether, and to what extent, an allegedly improper action caused an investment to lose value using a discounted cash flow analysis or a comparable company multiples analysis, another potentially useful valuation approach is an event study.
The event study methodology is well established in academia and widely relied on in securities litigation to measure the impact of public disclosures on changes in the value of securities. Despite their acceptance by courts throughout the world in securities litigation, event studies are relatively less frequently relied on by parties in international arbitration matters (although this use has been increasing), and their reception by tribunals has been mixed. In this article, we explain the event study methodology, review its prior use in disputes, and explore its potential to contribute to international arbitration matters (including topics beyond quantum).
How event studies work
An event study is a method used to measure the market impact of new, potentially value-relevant information on the value of an asset or company, which is typically measured using the value of securities issued by the company. It has two primary applications: to evaluate whether there is a causal link between a disclosure of new information and a decline in asset value (liability, or merits), and to estimate the loss arising from such a disclosure or event (damages, or quantum).
Liability. To examine whether a particular event or disclosure of information caused a decline in an asset or company’s value, an event study uses market data to model the relationship between the price of a security issued by that company (or linked to an asset) and various marketplace factors. Using regression analysis, the model measures the impact of the allegedly improper event on changes in the security price while accounting for other known marketplace factors. The regression allows for the comparison of the predicted change in the price (i.e., the price change in a “but-for” world in which the event did not occur) with the observed change in price on a particular date. The difference between the predicted and observed changes in prices is called the abnormal return. Generally, if the observed change in price following an event differs significantly from the predicted change in the price (i.e., the abnormal return is statistically significant), it provides evidence that an event caused the change in price, supporting a finding of liability.
Damages. If liability is established, an event study can also be used to estimate the quantum of damages based on the reduction in the value of the asset or company specifically attributable to the event. Using regression analysis, it is possible to model the security price in the “but-for” world (absent the event) and, by comparing the observed price change to the predicted price change, to quantify the amount by which the at-issue event affected the price of the security and, therefore, the value of the asset or company. As in the liability analysis, an event study can account for external marketplace variables to isolate the portion of the loss in value attributable to the impact of the event.
Conclusion
Expert submissions in a number of litigation matters have established the usefulness and robustness of event studies for assessing critical elements of a case. We think that, under the right circumstances, the same is true for international arbitrations. To do so, however, they need to be designed, executed, and explained to tribunals with rigor and a keen sense of their fit to the matter. 
Endnotes
Methodological considerations. When using an event study to measure the existence and extent of causal relationships between events and price changes, there are certain factors that economists should consider.
Past use of event studies in international arbitration cases
In many investor-state disputes, tribunals are tasked with determining the nature of the impact of a host state’s action – such as the promulgation of a new regulation, the cancellation of a contract, or a seizure of property – on the value of assets held by foreign investors. Despite broad acceptance in securities and other financial litigation, however, event studies have encountered mixed receptions by international arbitration tribunals.
Several awards have been informative on tribunals’ views of event studies: Crystallex v. Venezuela and Rompetrol Group N.V. v. Romania are two well-known examples, and more recently, the awards in Elliott Associates, L.P. v. Republic of Korea and Mason Capital L.P., et al. v. Republic of Korea further contributed to the discussion of event studies. In these four cases, issues that the respective tribunals dealt with included an assessment of:
The existing case record suggests that event studies will continue to be offered in international arbitration matters. Their admissibility and effectiveness, however, will depend on their suitability for the matter at issue, the robustness of their design and analysis, and the tribunal’s understanding of the methodology and its application.
For the future: A new application?
Pending data availability, an event study could also be used in international arbitration matters to supplement a review of the qualitative evidence on the legitimacy of investor expectations of risk.
Investor expectations are often critical to the merits phase of an arbitration, during which the arbitrators are asked to determine whether the host government violated the applicable “fair and equitable treatment” (FET) standard by frustrating foreign investors’ legitimate expectations regarding the legal framework impacting an investment – for example, by enacting arbitrary policy changes. Host states often respond to investor claims by arguing that investors had access to information prior to their investment that should have contradicted expectations of stability. Put simply, the key legal question for tribunals is whether a reasonable investor would have had a legitimate expectation that the policy governing their investment would not be changed.
Experts can inform a determination of whether investor expectations were legitimate by putting them in the context of industry practices and market data. Industry experts could debate whether, based on their experience, relevant news or disclosures would be likely to change reasonable investors’ expectations. Although qualitative assessments based on industry context are valuable, event studies offer a quantitative approach. By analyzing changes in stock prices, event studies can evaluate the legitimacy of the expectations underlying investors’ claims in the context of market expectations.
Consider the following example:
A host state passed a law guaranteeing tax benefits to investors who developed infrastructure within a particular area. When an opposing political party prevailed in the next presidential election, the new administration overturned the law. Investors subsequently filed claims against the host government for violating their reasonable expectations that the law would remain unchanged.
As mentioned earlier, an event study could analyze the market reaction to publicly available information to evaluate the expectations held by foreign investors at the time of their investment (i.e., that their tax benefits would persist).
In this example, the study shows a statistically significant drop in stock price following the announcement of the new candidate’s campaign, likely representing market expectations that a new president could change the tax-free policy governing the investment. Accordingly, the market data depicted here suggest that investors who invested during Time 1 might have had legitimate expectations that the investment would enjoy tax benefits, but for those who invested after the announcement of a new presidential candidate (Time 2) those expectations were contradicted by the available information and thus were potentially no longer legitimate.
Of course, careful consideration of the qualitative evidence is required before determining the importance of news on investors’ expectations of stability, but an event study can be an important additional tool in this analysis.
Vice President, Analysis Group
Principal, Analysis Group
Managing Principal, Analysis Group
Event Studies in International Arbitrations: Applications in Merits and Quantum
7 min read
Event studies are widespread in securities litigation matters. What are their prospects for international arbitration?
Introduction
A common claim made in international arbitration, and in investor-state disputes in particular, is that an action by a host state harmed the value of assets held by foreign investors. While quantum experts commonly assess whether, and to what extent, an allegedly improper action caused an investment to lose value using a discounted cash flow analysis or a comparable company multiples analysis, another potentially useful valuation approach is an event study.
The event study methodology is well established in academia and widely relied on in securities litigation to measure the impact of public disclosures on changes in the value of securities. Despite their acceptance by courts throughout the world in securities litigation, event studies are relatively less frequently relied on by parties in international arbitration matters (although this use has been increasing), and their reception by tribunals has been mixed. In this article, we explain the event study methodology, review its prior use in disputes, and explore its potential to contribute to international arbitration matters (including topics beyond quantum).
How event studies work
An event study is a method used to measure the market impact of new, potentially value-relevant information on the value of an asset or company, which is typically measured using the value of securities issued by the company. It has two primary applications: to evaluate whether there is a causal link between a disclosure of new information and a decline in asset value (liability, or merits), and to estimate the loss arising from such a disclosure or event (damages, or quantum).
Liability. To examine whether a particular event or disclosure of information caused a decline in an asset or company’s value, an event study uses market data to model the relationship between the price of a security issued by that company (or linked to an asset) and various marketplace factors. Using regression analysis, the model measures the impact of the allegedly improper event on changes in the security price while accounting for other known marketplace factors. The regression allows for the comparison of the predicted change in the price (i.e., the price change in a “but-for” world in which the event did not occur) with the observed change in price on a particular date. The difference between the predicted and observed changes in prices is called the abnormal return. Generally, if the observed change in price following an event differs significantly from the predicted change in the price (i.e., the abnormal return is statistically significant), it provides evidence that an event caused the change in price, supporting a finding of liability.
Damages. If liability is established, an event study can also be used to estimate the quantum of damages based on the reduction in the value of the asset or company specifically attributable to the event. Using regression analysis, it is possible to model the security price in the “but-for” world (absent the event) and, by comparing the observed price change to the predicted price change, to quantify the amount by which the at-issue event affected the price of the security and, therefore, the value of the asset or company. As in the liability analysis, an event study can account for external marketplace variables to isolate the portion of the loss in value attributable to the impact of the event.
Methodological considerations. When using an event study to measure the existence and extent of causal relationships between events and price changes, there are certain factors that economists should consider.
Past use of event studies in international arbitration cases
In many investor-state disputes, tribunals are tasked with determining the nature of the impact of a host state’s action – such as the promulgation of a new regulation, the cancellation of a contract, or a seizure of property – on the value of assets held by foreign investors. Despite broad acceptance in securities and other financial litigation, however, event studies have encountered mixed receptions by international arbitration tribunals.
Several awards have been informative on tribunals’ views of event studies: Crystallex v. Venezuela and Rompetrol Group N.V. v. Romania are two well-known examples, and more recently, the awards in Elliott Associates, L.P. v. Republic of Korea and Mason Capital L.P., et al. v. Republic of Korea further contributed to the discussion of event studies. In these four cases, issues that the respective tribunals dealt with included an assessment of:
The existing case record suggests that event studies will continue to be offered in international arbitration matters. Their admissibility and effectiveness, however, will depend on their suitability for the matter at issue, the robustness of their design and analysis, and the tribunal’s understanding of the methodology and its application.
For the future: A new application?
Pending data availability, an event study could also be used in international arbitration matters to supplement a review of the qualitative evidence on the legitimacy of investor expectations of risk.
Investor expectations are often critical to the merits phase of an arbitration, during which the arbitrators are asked to determine whether the host government violated the applicable “fair and equitable treatment” (FET) standard by frustrating foreign investors’ legitimate expectations regarding the legal framework impacting an investment – for example, by enacting arbitrary policy changes. Host states often respond to investor claims by arguing that investors had access to information prior to their investment that should have contradicted expectations of stability. Put simply, the key legal question for tribunals is whether a reasonable investor would have had a legitimate expectation that the policy governing their investment would not be changed.
Experts can inform a determination of whether investor expectations were legitimate by putting them in the context of industry practices and market data. Industry experts could debate whether, based on their experience, relevant news or disclosures would be likely to change reasonable investors’ expectations. Although qualitative assessments based on industry context are valuable, event studies offer a quantitative approach. By analyzing changes in stock prices, event studies can evaluate the legitimacy of the expectations underlying investors’ claims in the context of market expectations.
Conclusion
Expert submissions in a number of litigation matters have established the usefulness and robustness of event studies for assessing critical elements of a case. We think that, under the right circumstances, the same is true for international arbitrations. To do so, however, they need to be designed, executed, and explained to tribunals with rigor and a keen sense of their fit to the matter. 
Endnotes
Consider the following example:
A host state passed a law guaranteeing tax benefits to investors who developed infrastructure within a particular area. When an opposing political party prevailed in the next presidential election, the new administration overturned the law. Investors subsequently filed claims against the host government for violating their reasonable expectations that the law would remain unchanged.
As mentioned earlier, an event study could analyze the market reaction to publicly available information to evaluate the expectations held by foreign investors at the time of their investment (i.e., that their tax benefits would persist).
In this example, the study shows a statistically significant drop in stock price following the announcement of the new candidate’s campaign, likely representing market expectations that a new president could change the tax-free policy governing the investment. Accordingly, the market data depicted here suggest that investors who invested during Time 1 might have had legitimate expectations that the investment would enjoy tax benefits, but for those who invested after the announcement of a new presidential candidate (Time 2) those expectations were contradicted by the available information and thus were potentially no longer legitimate.
Of course, careful consideration of the qualitative evidence is required before determining the importance of news on investors’ expectations of stability, but an event study can be an important additional tool in this analysis.
