Legal Institutions,Ownership Concentration,and Stock Repurchases Around the World: Signal Mimicking?

One of the central puzzles of signaling theory is how to assess signal quality, in particular the potential for signal mimicking. Our study provides evidence of signal mimicking in the context of stock repurchases. Employing an ex-ante proxy for the likelihood of mimicking stock repurchases and data on open market stock repurchases from 30 countries, we find that long-term operating and market performance following stock repurchases improve less for suspected mimicking firms. This finding contradicts the conventional characterization that managers use stock repurchases to signal undervaluation and enhanced future performance. We find that mimicking firms have smaller capital investments, need greater external financing, buy back fewer shares, and issue more new shares (and/or resell more treasury shares) in the year of the repurchase. Our analysis further shows that mimicking is more likely in countries with weak investor protections and in firms with higher ownership concentration. Further, mimicking associated with concentrated ownership is mitigated in countries with stronger investor protections and by the adoption of International Financial Reporting Standards (IFRS). Altogether, our findings provide evidence of signal mimicking in stock repurchases in international data that is influenced by market, ownership, legal, and financial reporting characteristics of countries.     

Insider Trading and Firm Performance Following Open Market Share Repurchase Announcements

The long‐run performance of equity securities subsequent to announcements of open market repurchases (OMR) remains a contentious topic. In this paper we propose the “dichotomous expectations hypothesis” which posits that insider trading following share repurchase announcements reveals private information concerning the future operating performance of announcing firms. In particular, insider abnormal purchases (abnormal sales) should predict an improvement (decline) in operating performance that leads to higher (lower) long‐run stock returns. Our hypothesis offers a credible economic link between insider trading and subsequent long‐run stock performance through the intervening variable of operating performance. The empirical results show consistency with this linkage.     

Share repurchases of initial public offerings: motives,valuation effects,and the impact of market regulation

This study investigates the motives and valuation effects of share repurchase announcements of German firms during the 1998–2008 period, addressing the question why initial public offering (IPO) firms repurchase shares soon after going public. While our focus is on IPO firms, we also examine the impact of firm size by differentiating between IPO and established DAX/MDAX firms and by analyzing the source of surplus cash holdings, that is, either from equity issuances or from operating cash flows. We further explore the impact of the regulatory environment. Our empirical analysis reveals significant differences between the IPO and DAX/MDAX subsamples regarding their repurchase motives, stock price performance, and explanatory factors. Standard corporate payout theories are essential in explaining the different valuation effects. Our empirical analysis suggests agency costs of free cash flow as the main reason for the observed valuation effects of both IPO and DAX/MDAX firms, yet for different reasons. While DAX/MDAX firms continuously generate high operating cash flows before and after repurchasing shares, IPO firms exhibit low operating cash flows during the entire period but large surplus cash holdings due to the mandatory equity issuance at their public offering. Overall, the repurchase decisions of IPO firms are best explained by the agency costs of cash holdings and the unique rules and regulations of the German stock exchange.     

THE INTRA-INDUSTRY EFFECTS OF OPEN MARKET SHARE REPURCHASES: CONTAGION OR COMPETITIVE?

We examine the extent to which announcements of open market share repurchase programs affect the valuation of competing firms in the same industry. On average, although firms announcing open market share repurchase programs experience a significantly positive stock price reaction at announcement, portfolios of rival firms in the same industry experience a significant and contemporaneous negative stock price reaction. This suggests that perceived changes in the competitive positions of the repurchasing firms occur at the expense of rival firms and dominate any signals of favorable industry conditions. Thus, the competitive intra-industry effects of open market repurchases outweigh any contagion effects. In addition, cross-sectional tests indicate that these competitive effects are more pronounced in industries characterized by a lower degree of competition and less correlation between the stock returns of the repurchasing firm and its rivals.     

The Conditional Performance of REIT Stock Repurchases

This paper uses a conditional performance measure to test whether real estate investment trust (REIT) managers announcing stock repurchases have private information about their firms' prospects. We use stock price to condition for public information and measure the managers' implied private information by the covariance between repurchase size and subsequent stock payoffs (or operating performance). Results show that managers have private information but mostly with respect to long-term as opposed to near-term payoffs. We also find that repurchase size is positively related to a stock's idiosyncratic return volatility, perhaps because noisy stocks deviate farther from fundamental value, offering informed managers larger profit potential. JEL Classification G12 G14 G35     

Does Labor Power Affect the Likelihood of a Share Repurchase?

This research examines the impact of labor power on the firm's repurchase decisions. Firms facing stronger labor power repurchase fewer shares, suggesting that, on average, repurchases are against the interests of labor. However, the negative effect of labor power on repurchases is significantly reduced when repurchases benefit employees by fending off an unwanted takeover or countering the dilution effects of employee stock options. We also examine the ex post consequences of share repurchases. Repurchases are positively related to the probability of a strike. Repurchase announcement returns and the operating performance of repurchasing firms are negatively related to labor power.     

REIT Open-Market Stock Repurchases and Profitability

This study examines whether the announcement of real estate investment trust (REIT) open-market stock repurchase programs contain information content about future operating performance over the period 1990–2001. We find no evidence that REIT stock buybacks are positively related to the operating performance. In fact, the operating performance of our sample REIT firms peak at the repurchase announcement year and deteriorate in the years following the announcement of share repurchases. Nevertheless, the sample REITs show higher levels of post-repurchase operating performance when compared to those of the pre-repurchase period. Additionally, our regression analysis shows that changes in future operating performance can explain the positive announcement effect.     

Stock Repurchases in Canada: Performance and Strategic Trading

During the 1980s, U.S. firms announcing stock repurchases earned favorable long-run returns. Recently, concerns have been raised over the robustness of these findings. This concern comes at a time of explosive growth in repurchase programs. Thus, we study new evidence from the 1990s for 1,060 Canadian repurchase programs. Moreover, because of Canadian law, we can carefully track repurchase activity monthly. Similarly to the situation in the United States, the Canadian stock market discounts the information in repurchase announcements, particularly for value stocks. Completion rates in Canada are sensitive to mispricing. Trades also appear linked to price movements; managers buy more shares when prices fall.     

Intraindustry Effects of Bank Stock Repurchases

Bank stock repurchases have become increasingly popular over time. Because of the unique capital requirements and regulatory constraints on the use of bank funds, the intraindustry effects of bank stock repurchases may differ from intraindustry effects of stock repurchases by other firms. We find that bank stock repurchases result in a positive and significant valuation effect for the repurchasing banks. Moreover, we find positive significant intraindustry effects of bank stock repurchases, unlike previous research by Hertzel on firms from numerous industries that found no evidence of intraindustry effects in response to stock repurchases. We attribute the difference in results to the unique characteristics of the banking industry, which results in a less ambiguous signal emitted from the stock repurchase announcement. In addition, we find that the intraindustry effects are more favorable when the valuation effect for the repurchasing bank is more favorable. This implies that the degree of signal to the industry is conditioned on the degree of signal about the bank that is repurchasing its shares. Furthermore, intraindustry effects are more favorable when the capital position of rival banks is high, when the proportion of residential loans of rival banks is low, and when the announcing bank is a money center bank.     

Open‐Market Stock Repurchases by Insurance Companies and Signaling

The signaling hypothesis of share repurchases implies that management uses repurchases to signal either that their firm's future operating performance will improve or that shares of their stock are simply underpriced by the market. This study examines which of the two interpretations can better explain open‐market share repurchase programs announced by insurance companies. We find no evidence that future‐operating performance of insurers improves following the repurchase announcement. In addition, changes in future operating performance cannot explain the announcement‐period abnormal return. Instead, the stock undervaluation prior to the repurchase announcement can significantly explain the announcement‐period abnormal return, particularly for life insurers. Overall, our results suggest that the positive market reaction to insurers’ open‐market share repurchase announcements is due to the stock undervaluation by the market, but not due to positive information content about future operating performance conveyed in the repurchase announcement.     

Stock repurchasing and corporate social responsibility

Stock repurchases are controversial. Researchers often view the positive association between free cash flow and the volume of the stock repurchases to be in the shareholders’ interest and the positive association between executive options and stock repurchases to be in the managers’ interest. Using firms’ corporate social responsibility (CSR) ratings as a measure of ethical culture—one that increases the cost of self-serving behavior for managers— we examine whether a firm’s CSR rating is related to its stock repurchase decisions. Although the baseline regression shows a positive association between CSR and repurchases, we find that CSR amplifies the positive association between free cash flow and stock repurchases and lessens the positive association between executive options and stock repurchases. These results indicate that ethical culture might play a role in repurchase decisions: it may encourage repurchases aligned with shareholders’ interests and discourage those primarily in managers’ interest. Furthermore, we also find that high CSR firms are associated with a greater completion rate of announced repurchase programs and receive more favorable stock market reaction to their repurchase announcements.     

Stock repurchases as an earnings management device

We investigate whether firms use stock repurchases to meet or beat analysts’ earnings per share (EPS) forecasts. We identify conditions under which repurchases increase EPS and document the frequency of accretive repurchases from 1988 to 2001. We find a disproportionately large number of accretive stock repurchases among firms that would have missed analysts’ forecasts without the repurchase. The repurchase-induced component of earnings surprises appears to be discounted by the market, and this discount is larger when the repurchase seems motivated by EPS management, although using the repurchase to avoid missing analyst forecasts appears to mitigate some of the negative stock price response.     

Actual Share Reacquisitions in Open-Market Repurchase Programs

Unlike Dutch auction repurchases and tender offers, open-market repurchase programs do not precommit firms to acquire a specified number of shares. In a sample of 450 programs from 1981 to 1990, firms on average acquire 74 to 82 percent of the shares announced as repurchase targets within three years of the repurchase announcement. We find that share repurchases are negatively related to prior stock price performance, suggesting that firms increase their purchasing depending on its degree of perceived undervaluation. In addition, repurchases are positively related to levels of cash flow, which is consistent with liquidity arguments.     

Capital structure,equity mispricing,and stock repurchases

We evaluate motives for share repurchases using a unified framework where a firm has a target capital structure and has equity that can be mispriced. We document that capital structure adjustments are a value-increasing motive for repurchases and that the extent to which adjusting capital structure through a repurchase creates value depends on the undervaluation of the firm. Underlevered and undervalued firms enjoy the greatest economic gains from a repurchase, as evidenced by the stock price reaction to the repurchase announcement, and these firms are more likely to announce a share repurchase program.     

Takeover vulnerability and the credibility of signaling: The case of open-market share repurchases

There is debate in the literature focuses on whether open market repurchases can be taken as a signal of stock undervaluation. This research argues that takeover pressures before a repurchase announcement can be a credible signal of undervaluation. The empirical results indicate that repurchasing firms with a higher probability of takeover experience greater announcement effects, improvements in operating performance and long-run abnormal return, positive forecast revisions by financial analysts, and enhanced agreement between management and shareholders. These findings suggest that takeover probability and open-market share repurchases appear to constitute a double-signal for conveying stock undervaluation to the market.     

Financial constraints and share repurchases

We examine how the financial constraints of repurchasing firms affect their post-buyback performance. By every constraint measure we use, a set of constrained firms repurchase. They display significantly poorer post-buyback abnormal return and operating performance than unconstrained firms. Financial constraints are more important in explaining the performance of share buybacks for firms with high actual repurchase ratios. Constrained firms, especially those with high actual repurchase ratios, experience a significantly greater increase in post-buyback distress risk than unconstrained firms. Managerial hubris could explain why constrained firms buy back shares even if the buybacks do not improve shareholder wealth.     

Insider trading and share repurchases: Do insiders and firms trade in the same direction?

Signaling undervaluation is often considered a primary motive for repurchasing stock, but insider trading activity by repurchasing firms is not always consistent with undervaluation. Net insider buying and selling are both more frequent in quarters when firms are repurchasing non-trivial amounts of stock, with the odds of observing a repurchase the highest in quarters with net insider selling. In multinomial logit models, share repurchases associated with net insider selling are positively related to illiquidity, option exercises by insiders, and pre-repurchase returns and negatively correlated with industry-adjusted book to market ratios when compared to other repurchases. Hence, repurchases when insiders are selling stock are more likely done to support share prices or avoid dilution and are less likely undervaluation signals. We find that insider trades either validate or mitigate the undervaluation signal of the repurchase. Abnormal returns of repurchasing firms with net insider buying versus net insider selling in a given quarter are significantly higher for the quarter immediately after the repurchase and the three subsequent years. For repurchases accompanied by net insider selling, abnormal returns are negligible after only one year.     

Accelerated share repurchases

Accelerated share repurchases (ASRs) are credible commitments by firms to repurchase shares immediately. Including an ASR in a repurchase program reduces the flexibility that firms have to alter an announced program in response to subsequent changes in the price and liquidity of its shares, unexpected shocks to cash flow and/or investment, etc. Thus, we investigate whether firms' decisions to include ASRs in their repurchase programs are associated with factors expected to influence the costs of lost flexibility and the benefits of enhanced credibility and immediacy. We find robust evidence consistent with the costs of lost flexibility and the benefits of credibility and immediacy being important determinants of ASR adoption. Additionally, we find that ASR announcements are associated with positive average abnormal stock returns.     

Stock price behavior surrounding stock repurchase announcements: Evidence from Japan

This paper examines stock price behavior surrounding announcements of stock repurchases made by Japanese firms from 1995 to 1998. Our analysis shows that, much as in the case of the U.S. markets, stock prices in Japan go up in response to stock repurchase announcements. We also find that there is no significant difference between the market reaction to the announcement for intention of repurchase execution and the market reaction to the announcement of an article alteration to allow stock repurchases. On the other hand, there is a significant difference in the pre-announcement period returns motivating these two announcements. While a large decline in stock price will motivate a firm to execute a stock repurchase, a smaller price decline will motivate a firm to merely alter its articles of association to allow future repurchases.     

Why do stock repurchases change over time?

Recent studies have shown the time trends of firm stock repurchase behavior. We examine these time changes for stock repurchase through the lens of real activities earnings management. Managers appear more likely to manipulate earnings through stock repurchases since the passage of the Sarbanes–Oxley Act (SOX) in 2002. Furthermore, suspect firms that just missed analyst earnings per share forecasts have higher incentives to manipulate earnings through stock repurchases. The results are not driven by changes in corporate governance associated with the passage of SOX. Overall, our results suggest earnings management can be a significant determinant of the dynamics of stock repurchases.