Economic Sources of Gain in Stock Repurchases

Abstract

Previous studies offer a mixed understanding of the economic role of stock repurchases. This paper investigates three key economic motivations-mispricing, disgorging free cash flow, and increasing leverage-by evaluating cross-sectional differences in both the initial market reaction and long-run performance. The initial reaction provides some support for the mispricing story. However, subsequent earnings-related information shocks suggest that the initial market reaction is incomplete and that long-run performance may be informative. The long-horizon return evidence is most consistent with the mispricing hypothesis and, to some degree, the free cash flow hypothesis. We find little support for the leverage hypothesis.

Prediction of open market share repurchases and portfolio returns: evidence from France, Germany and the UK

“…The results reported in Table 4 (Panel C) show that for the pooled sample the small-firms portfolio consistently outperforms the large-firms portfolio for all holding periods up to 9 months, after which the pattern is reversed and large stocks outperform the small stocks in the longer run. This is also in line with Chan et al (2004) who find that at the time of the announcement smaller firms enjoy a higher market reaction but on the long run (a four year holding period) it is large firms that have a better stock price performance. For the country-specific portfolios, we observe that in France, with the exception of the first month the small-stocks portfolio consistently outperforms the large stocks for all holding periods.…”

“…1995Ikenberry at al. , 2000McNally and Smith 2007) which tend to persist in the long-run, hence offering economic sources of gain to long-term shareholders (Ikenberry and Vermaelen 1996;Chan et al 2004). Since open market share repurchases are not firm commitments, they are essentially options that managers can use when they believe the firm's share price is undervalued.…”

Impact of Open-Market Share Repurchases on Long-Term Stock Returns

“…By using buy-and-hold returns over 4 years, Chan et al (2004) found that high BTM companies have larger returns over their matched sample which is 28.35% compared with 22.92% for low BTM companies. Firms with high BTM, or "value stocks," were also proven by Hackethal and Zdantchouk (2006) to have outperformed the "glamour stocks" or firms with low BTM by 45%.…”

“…Market capitalization has been identified as an important factor by local and overseas researchers in determining the share price performance following share buyback programs (Chan et al, 2004;Ikenberry et al, 1995;Vermaelen, 1981;Wong et al, 2011;Zhang, 2005). These studies including Ramakrishnan et al (2007) found that information asymmetry which has caused greater undervaluation and mispricing is larger in small firms due to less public disclosure and focus by the analysts as compared with bigger firms.…”

“…Studying U.S. market using data from 1980 to 1997, they found that 3-year post-announcement abnormal return is positively related to the current and future profitability while inversely related to the cost of capital. Chan, Ikenberry, and Lee (2004) found in the U.S. openmarket repurchase program that the long-term result suggests the market does not fully incorporate the information during the announcement of the buyback. They reported that by controlling both size and BTM effects, the abnormal return over a 4-year period is 23.56%.…”