WHAT DO WE KNOW ABOUT STOCK REPURCHASES?

Stock repurchases by U.S. companies experienced a remarkable surge in the 1980s and ‘90s. Indeed, in 1998, the total value of all stock repurchased by U.S. companies exceeded for the first time the total amount paid out as cash dividends. And the U.S. repurchase movement has gone global in the past few years, spreading not only to Canada and the U.K., but also to countries like Japan and Germany, where such transactions were prohibited until recently. Why are companies buying back their stock in such amounts? After dismissing the popular argument that stock repurchases boost earnings per share, the authors argue that repurchases serve to add value in two main ways: (1) they provide managers with a tax‐efficient means of returning excess capital to shareholders and (2) they allow managers to “signal” to investors their view that the firm is undervalued. Returning excess capital is value‐adding for two reasons: First, it helps prevent companies from pursuing growth and size at the expense of profitability and value. Second, by returning capital to investors, repurchases (like dividends) play the critically important economic function of allowing investors to channel their investment from mature or declining sectors of the economy to more promising ones. But if stock repurchases and dividends serve the same basic economic function, why are repurchases growing more rapidly? Part of the explanation is that, because repurchases are taxed as capital gains and dividends as ordinary income, repurchases are a more tax‐efficient way of distributing excess capital. But perhaps even more important than their tax treatment is the flexibility that (at least) open market repurchases provide corporate managers‐flexibility to make small adjustments in capital structure, to exploit (or correct) perceived undervaluation of the firm's shares, and possibly even to increase the liquidity of the stock, which could be particularly valuable in bear markets. For U.S. regulators, the growth in open market stock repurchases raises some interesting issues. Perhaps most important, companies are not required to (and rarely do) furnish their investors with details about a given program's structure, execution method, number of shares repurchased, or even its duration. Policy regulators (and corporate executives as well) should consider some of the benefits provided by other systems, notably Canada's, which provide greater transparency and more guidelines for the repurchase process.     

Comovement and investment banking networks

We test the hypothesis that investment banking networks affect stock prices and trading behavior. Consistent with the notion that investment banks serve as information hubs for segmented groups of investors, the stock prices of firms that use the same lead underwriter during their equity offerings tend to move together. We also find that when firms switch underwriters between their initial public offering (IPO) and a seasoned equity offering (SEO), they comove less with the stocks associated with the old bank and more with the stocks associated with the new bank. This change in comovement is greater for stocks completing their first SEO and for those experiencing large changes in institutional ownership.     

Advertising, Breadth of Ownership, and Liquidity

We provide empirical evidence that a firm's overall visibilitywith investors, as measured by its product market advertising,has important consequences for the stock market. Specificallywe show that firms with greater advertising expenditures, ceterisparibus, have a larger number of both individual and institutionalinvestors, and better liquidity of their common stock. Our findingsare robust to a variety of methodological approaches and tovarious measures of liquidity. These results suggest that theinvestors' degree of familiarity with a firm may affect itscost of capital and consequently its value.     

Capital Adequacy, Bank Mergers, and the Medium of Payment

We examine how banks' capital requirements affect the way bank mergers are financed, as well as the stock-market reaction to the merger announcement. We find that the capital position of the acquirer is one of the two factors most strongly influencing the choice of financing method; the other is the relative size of the merging banks. The smaller the acquirer in relation to the target bank and the higher the acquirer's capital adequacy ratio, the more likely it is that the acquisition will be financed by a stock swap. The capital requirements also affect the market reaction, through their effect on the financing method choice. The value of the acquirer's equity decreases more at the time of the merger announcement if the method of payment is stock. Like prior studies, we find that the abnormal return on the target banks' stock is positive.     

The Information Content of Share Repurchase Programs

Contrary to the implications of many payout theories, we find that announcements of open‐market share repurchase programs are not followed by an increase in operating performance. However, we find that repurchasing firms experience a significant reduction in systematic risk and cost of capital relative to non‐repurchasing firms. Further, consistent with the free cash‐flow hypothesis, we find that the market reaction to share repurchase announcements is more positive among those firms that are more likely to overinvest. Finally, we find evidence to indicate that investors underreact to repurchase announcements because they initially underestimate the decline in cost of capital.     

Dividends, Share Repurchases, and the Substitution Hypothesis

We show that repurchases have not only became an important form of payout for U.S. corporations, but also that firms finance their share repurchases with funds that otherwise would have been used to increase dividends. We find that young firms have a higher propensity to pay cash through repurchases than they did in the past and that repurchases have become the preferred form of initiating a cash payout. Although large, established firms have generally not cut their dividends, they also show a higher propensity to pay out cash through repurchases. These findings indicate that firms have gradually substituted repurchases for dividends. Our results also suggest that before 1983, regulatory constraints inhibited firms from aggressively repurchasing shares.