Answer Happy

Q 2: Correlation or Causation? [15]
Your client is worried about whether the relationship shown in
figure 1 is causal and s/he asks you additional questions about
those results.
(a) [5] First, your client says that correlation does not
imply causation. Is your client correct? Please explain.
(b) [5] Second, your client mentions that the drop in
performance prior to the intervention could be evidence of
selection. If there is mean reversion, that is, if ROA tends to
evolve around its mean, then the pattern depicted in figure 1 could
be present in the data even if the relationship was not causal. Is
this reasoning correct? Please explain.
(c) [5] To address your client’s concerns you obtain data
on operating perfor- mance not only for firms that are targeted by
activist shareholders, but also for a set of firms that have
similar characteristics and performance prior to the activist
intervention, but that are not targeted by activist shareholders.
This evidence is presented in figure 2 below. Does this help
alleviate the concerns your client raised? Please explain.