Informed Trading Risk and Bid‐ask Spread Changes Around Open Market Stock Repurchases in the Nasdaq Market

Abstract

Microstructure theory contends that dealers' bid-ask spreads should vary intertemporally with changes in the asymmetric information component of the spread. Corporate theory suggests that stock repurchase announcements signal management's private information to the securities markets. An examination of dealers' spread behavior around firms' open market repurchases in the NASDAQ market reveals a decline in spreads adjusted for dealers' inventory-holding and order-processing costs. This decline is attributed to a reduction in informed trading risk associated with the open market repurchase announcements.

Optimal execution of open-market stock repurchase programs

“…The signs of these coefficients are consistent with the findings in Stoll (1978), Franz et al (1995), and Miller and McConnell (1995). Panel A reports the average quarterly completion rate ðCRÞ of repurchases relative to the announcement, beginning with the announcement quarter and ending with the eighth quarter after the announcement quarter.…”

“…In the U.S., Barclay and Smith (1988) find widening of the spread. Miller and McConnell (1995) find no widening of the bid-ask spread, while Wiggins (1994), Franz et al (1995), and Cook et al (2004) actually find narrowing of the spread during periods of actual repurchases. Outside the U.S., Brockman and Chung (2001) and Ginglinger and Hamon (2007) find widening of the spread during actual repurchase periods in Hong Kong and France, respectively.…”

“…Stoll (1978) shows that percentage spreads are positively correlated with return variance and negatively correlated with price and trade volume. Following Franz et al (1995) and Miller and McConnell (1995), we perform a multivariate analysis that controls for these factors. Specifically, in addition to running a univariate regression in which the dependent variable is the bid-ask spread and the independent variable is the completion rate, we run a regression in which the dependent variable is the bid-ask spread and the independent variables are (1) price, (2) trade volume, (3) return volatility, and (4) completion rate.…”

Stock Market Liquidity: Financially Constrained Firms and Share Repurchase

“…By examining relative bid-ask spreads before and after repurchase announcements for companies listed on the NYSE, they find that stock liquidity decreases following announcements, consistent with the information asymmetry hypothesis. Franz, Rao and Tripathy (1995) study repurchase announcements by NASDAQ-listed firms and find that stock liquidity increases with the repurchase announcements, due to a reduction in the informed trading costs. Brockman and Chung (2001) examine firms listed on the Stock Exchange of Hong Kong and conclude that stock liquidity deteriorates on repurchase days because market participants detect the presence of informed trading and partially or completely withdraw from the market.…”

Share Repurchases: A Literature Review

“…So it concludes that firms should not deter themselves from buying back shares in the fear that it widens the bid-ask spread and reduces liquidity in the market. Franz et al (1995) examined changes in spread around repurchase to know the liquidity of the stocks. The result shows that both spread and percentage of spread narrow but only change in the spread is significant.…”