What do we know about stock repurchases?

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Topics

• What do we know about stock repurchases?
• G. Grullon and D. L. Ikenberry

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What do we know about stock repurchases?Types

• Fixed-price tender offer
• Large scale (15 shares), high premium 16
• Announcement effect 15
• Dutch-auction tender offer
• Open market repurchase program
• 5 shares, lasting 2 to 3 years
• Announcement effect 4

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What do we know about stock repurchases?Types
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What do we know about stock repurchases?Why?

• Increase EPS
• If the drop in earnings is less than the drop in
  the number of shares
• Can it increase stock price?
• Is it due to a better use of asset or stock
  repurchase?

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What do we know about stock repurchases?Why?

• Signal future cash flow
• Information revealing needs to be credible
• Stock repurchase is credible because lying is
  costly
• Fixed price tender offer
• More credible, observe earnings improvement
• Open market repurchase
• Observe earnings decline

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What do we know about stock repurchases?Why?

• Exploit market undervaluation
• Observe Four year abnormal return is 12.14
• Concentrates on value stocks (high book-to-market
  value), four year return is 45.29

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What do we know about stock repurchases?Why?

• Reduce agency costs of free cash flows
• Managers can pursue their personal interests
• Observation 1
• Tender offer firms have higher levels of cash
• Announcement effect is higher when excess cash is
  higher
• Observation 2
• Announcement effect is higher when operating
  return on investment is lower

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What do we know about stock repurchases?Why?

• Reallocate investment among companies
• Shareholders can reallocate investment more
  efficiently
• Observation
• After repurchase, asset is less and capital
  expenditure is less

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What do we know about stock repurchases?Why?

• Substitute cash dividend
• Personal dividend income tax or capital gains
  tax?
• To maintain stock price (cash dividend will cause
  the stock price to drop)

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What do we know about stock repurchases?Why?

• Adjust capital structure
• To offset share increase from stock options

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What do we know about stock repurchases?Planning
an open market repurchase

• Repurchase and stock liquidity
• Increase informed traders
• Increase depth
• Observation
• Spread declines for less liquid stocks
• Volatility drops
• Price drops less with market

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What do we know about stock repurchases?Planning
an open market repurchase

• Flexibility and completion rate
• Will firms mislead the market and repurchase very
  few shares?
• Disclosure
• US does not disclose
• Canada disclose
• Observation
• Price increases the most for companies that do
  not repurchase
• Announcement effect is higher when flexibility is
  more valuable (stock is more volatile)

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What do we know about stock repurchases?Planning
an open market repurchase

• Transaction limitations
• SEC rule 10b-18 in 1982
• Made through only one broker
• Not executed at the opening or during the last
  half hour of trading
• Not done at a price exceeding the highest bid
• Not exceed 25of average daily volume
• Black-out dates prohibit insider trading

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What do we know about stock repurchases?Planning
an open market repurchase

• Alternatives
• Buy stocks
• Buy call options
• When price is higher, exercise call
• When price is lower, buy stocks on open market
• Sell put