Ownership Structure and Share Repurchases in an Emerging Market: Incentive alignment or Entrenchment

1
Ownership Structure and Share Repurchases in an
Emerging Market Incentive alignment or
Entrenchment?

2
Background information on payout policy

• US and some countries experience an increasing
  trend of share repurchase in payout policy.
• Cash dividends decrease
• Share repurchase increases
• In some countries, overall payout level does not
  necessarily decrease
• Why do firms choose share repurchase programs to
  distribute firm resources?
• What are the determinants?
• What are the effects?

3
Signaling effects of cash dividends repurchases

• Both cash-dividends and share repurchases can
• signal future firm value or under-valuation to
  capital markets
• Lower agency problems by using free-cash flows
• Both Payout can yield similar effects if the
  purpose is to send a signal.
• Many event studies show that initiation or an
  increase in cash dividends yield positive stock
  returns.
• In US, Share repurchase program also yields
  positive returns.

4
Share repurchase and Managerial Incentives

• Managerial incentives may affect corporate payout
  choice
• Stock repurchases can serve managerial incentives
  better than cash dividends
• MA Deterrence Firms facing MA threats use
  share repurchases to increase share price for
  potential acquirers to pay. (Bagwell 1991, Denis
  1990)
• Managers with stock options repurchase to reduce
  dilution effects of previous stock options (Fenn
  Liang 1997) Weisbenner (2000)

5
This Papers Motivation

• We still need an explanation whether share
  repurchase can serve managerial incentives even
  if
• hostile MAs are rare
• managerial stock options are not strong
• We examine the effects of control rights
  ownership concentration
• Ownership/control issues are most relevant to
  insiders who derive personal benefits from the
  firm
• Controlling families with weak control rights
  need to strengthen their control position and
  protect their private benefits
• There can be incentive problems in firms without
  large managerial stock options, nor immediate MA
  threats.

6
Family Ownership and Control

• In an emerging market, controlling families
  derive huge private benefit.
• value of corporate control is high
• Family incentive to maintain control position is
  higher than management incentive to protect their
  control
• Family ownership and control bequest over
  generations
• Professional Managers do not bequest their
  control to their children. Managers concern
  immediate MA threats only.

7
Does buybacks strengthen control position?

• Share repurchase affects ownership structure, and
  strengthen control
• Upward sloping supply curve
• Stock repurchase ? ? outside shareholders sell
  stocks ?, remaining shareholders valuation ? ?
  more costly for outsiders to buy shares
  ?insiders control position ?
• If the purpose of share repurchase is to secure
  control position of controlling minority family,
  market should consider potential costs of
  entrenchment.

8
Why Korea?

• Many firms are controlled by family members
• Very high value of corporate control
• Nenova (2003), Dyck and Zingales (2004)
• Typical case of controlling minority structure
  (CMS)
• Family ownership (cash-flow rights) is low
• Through complicate interlocking ownership, family
  controls the firm despite their low ownership
• Korean firms have become more exposed to outside
  threats since the 1997 economic crisis
• Legalize hostile MAs
• Abolish mandatory tender offer requirement
• Abolish ceiling on foreign ownership
• Korean firms have increased payout activities

9
Chaebols ownership control (as of 2005)
10
DATA

• Public announcement on share repurchase on the
  KINDS 1994 2005
• No financial institutions
• Open market repurchase announcements
• Increase in contribution to trust funds
• Controlling shareholders ownership rights and
  control rights TS-2000
• Daily stock return, foreign investors ownership
  information FNGuide
• MA threats news paper articles
• Managerial stock option plans disclosure on the
  KINDS

11
Annual trend of share repurchase in Korea
12
Official Objectives for Share repurchase
13
Three Main Questions

• Does Control/Ownership structure affect choice
  of dividends?
• Logit Model
• a) cash dividend or not
• b) share repurchase or not
• Does Control/Ownership structure affect the
  magnitude of Share repurchase?
• Tobit Model
• a) share repurchase over total dividend payments,
  
• b) ratio of share repurchase amount over market
  value,
• c) number of shares to be purchased over total
  shares.
• Does Control/Ownership structure affect stock
  market return to announcement on share
  repurchase?
• Event Study Method

14
Cash dividends
15
Share repurchases
16
Methodology I

• Logit Regression of probability that a firm
  adopts a cash dividend
• When a firm i has a payout policy, yi takes a
  value of one otherwise it takes zero.
• Explanatory variables firm size, free cash
  flows, capital structure, market to book value
  (MTB), financial volatility, Ownership, MA
  dummy, Stock Option dummy etc.

17
Logit regression of payout policy adoption
18
Logit regression of cash dividends
19
Logit regression of share repurchase program
20
Logit regression of share repurchase program-II
21
Effects on dividends/share repurchase
22
Findings from logit tests

• Large firms, firms with more free cash flow,
  firms with lower debt ratio, firms with lower M/B
  are more likely to distribute firm resources
  through dividends or buybacks
• Consistent with free cash flow hypothesis
• Consistent with signaling or under-valuation
  hypothesis
• Firms with higher ownership concentration is more
  likely to adopt cash dividend program.
• Firms with higher ownership, or higher control
  rights are less likely to adopt a share
  repurchase program.

23
Methodology II

• Tobit Regression of the magnitude of share
  repurchase
• a) share repurchase over total dividend payments
  (STP),
• b) ratio of share repurchase over market value
  (REP),
• c) shares to be purchased over total shares
  (SRR).
• Explanatory variables firm size, free cash
  flows, capital structure, market to book value
  (MTB), financial volatility, Ownership, MA,
  Stock Options

24
Tobit regression of targeted shares/total shares
25
Tobit regression of targeted shares/total
shares-II
26
Tobit regression of repurchase/market value
27
Tobit regression of repurchase/market value-II
28
Tobit regression of share repurchase/total payout
29
Effects on magnitude of share repurchase
30
Findings II

• Greater share repurchase programs
• Large firms, firms with higher free cash flows,
  and lower debt ratios
• Firms with managerial stock options adopt more
  share repurchase programs.
• Stand alone firms not belong to chaebol
• Firms with affiliated firms ownership, and firms
  with higher control rights adopt smaller share
  repurchase programs.

31
Methodology III

• Event study around announcement day
• Use Market Model to derive abnormal return
• Derive Cumulative Abnormal Return CAAR (-1, 1)
• Examine factors affecting CAAR using OLS

32
CAAR with share repurchase/mkt value
33
CAAR with Share repurchase/total dividends
34
CAAR with Shares to be purchased/total shares
35
Effects on CAR(-1,1) around announcement day
36
Findings III

• Higher CAAR is associated with
• Larger magnitude of share repurchase,
• Higher ownership concentration
• Higher Control rights

37
Summary

• Firms with higher control rights are less likely
  to adopt share repurchase program. If they adopt,
  the magnitude is small. When they adopt share
  repurchase, the market responds positively.
• In addition to financial factors, MAs, stock
  options, this paper shows that incentive to
  secure controlling position is an important
  factor for firms decision to adopt share
  repurchase program.

38
Thank you
39
Policy Implications

• We require more stringent scrutiny on firms
  decision on payout policy
• Suggest shareholders approval on the magnitudes