This paper develops a model in which managers can signal their firms' true values by using either a dividend or a stock repurchase or both. The authors explain a number of stylized facts about these cash-disbursement mechanisms, particularly those concerning the relative magnitudes of stock price responses to dividends and repurchases. Most importantly, they explain why a stock repurchase elicits a significantly higher price response, on average, than a dividend announcement.DIVIDENDS AND SHARE REPURCHASES are the principal mechanisms by which corporations disburse cash to their shareholders. The sheer volume of these corporate activities invites research attention; the majority of U.S. firms pay dividends, and, in 1984 alone, 600 firms spent $26 billion in repurchasing their own stock. Several studies have analyzed the responses of share prices and bond prices to the announcements of specific modes of cash distribution by firms, and the following stylized facts have been noted. * Both dividends and stock repurchases have significant "announcement effects." When a firm announces a stock repurchase or a dividend increase, its stock price increases (Aharony and Swary [11, Asquith and Mullins [31, Dann [10], Handjinicolaou and Kalay [13], Stewart [28], and Vermaelen [29]). (Jensen and Smith [15] provide a summary. See also Loomis [18].. The usual disclaimer applies. This work was initiated while Thakor was visiting the KGSM at Northwestern University.1 The Loomis paper is a recent report on research by the Fortune staff. It states that the average gross annual returns to shareholders in firms repurchasing stock between 1974 and 1983-excluding "nonvoluntary" repurchases via "greenmail"-was 22.6% as compared with 14.1% for the S&P 500 over the same period. This suggests an apparent methodological weakness in the Fortune study. Comparing risk-unadjusted returns on the stocks of repurchasing firms with the returns on an index portfolio may not be meaningful if there are marked differences in systematic risk between the two portfolios. We cite this study, however, to indicate the interest in this issue even in the "nonacademic" literature and among managers. 365 366The Journal of Finance More direct evidence-using a more discriminating empirical methodologythat changes in dividend policy convey information has recently been provided by Ofer and Siegel [231.) * On average, a stock repurchase provokes a significantly higher stock price response than a dividend increase (Aharony and Swary [1], Dann [10], Jensen and Smith [15], Masulis [20], and Vermaelen [29]).2 * Firms that repurchase stock offer premia above the prerepurchase market prices for their own stock (Vermaelen [29, 30]). * In many cases, despite an increase in the price per share subsequent to the announcement of the repurchase, the stock price drops in the "aftermarket," i.e., after the execution of the repurchase (Vermaelen [29]). * Despite the postrepurchase price decline, the price increase subsequent to the repurchase announcement is relatively permanent in...

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This paper develops a model in which managers can signal their firms' true values by using either a dividend or a stock repurchase or both. The authors explain a number of stylized facts about these cash‐disbursement mechanisms, particularly those concerning the relative magnitudes of stock price responses to dividends and repurchases. Most importantly, they explain why a stock repurchase elicits a significantly higher price response, on average, than a dividend announcement.

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