Some firms use stock repurchases to mislead investors for the benefit of corporate insiders. The authors investigate whether country-level investor protection, ownership structure, and adoption of financial reporting standards influence the risk of such mimicking behavior. They find that sending false signals through stock repurchases is more likely in countries with weak investor protection and in firms with concentrated shareholdings.
What’s Inside?
The authors contribute to the literature on signaling theory. They focus on differentiating truthful signals from mimicked signals in cases of stock repurchases. The authors examine open market stock repurchases in 30 countries and find that firms that mimic signals are worse in terms of operating and market performance than firms with truthful signals. Internationally, mimicking in stock repurchases is influenced by a country’s market, ownership, legal, and financial reporting characteristics.
How Is This Research Useful to Practitioners?
The authors incorporate an international context into the existing research on this subject. As it turns out, country-level variables have significant correlations with mimicking behaviors. Furthermore, the authors identify several parameters that correlate with signal mimicking; those parameters are related to the enforcement of investor protection, ownership controls, and financial reporting standards in a given country.
Mimicking repurchases are followed by smaller capital investments and a greater need for further external financing in the year of the repurchase. Consequently, in the year of the repurchase, mimicking firms repurchase relatively fewer shares, often issue new shares, and improve less in terms of operating and market performance that year.
The authors’ findings may be of interest to investment practitioners and academics. The former can use the methodology to assess ex ante announced stock repurchases as well as to attempt to quantify the implications for the firm in terms of market and operating standing. The latter now have a model constructed with an international context that can be developed further to account for specific country-level settings.
How Did the Authors Conduct This Research?
Stock repurchases that are undertaken to increase the private benefits of corporate insiders rather than to suggest undervaluation or distribute cash to shareholders are the authors’ focus. First, they examine whether investor protection level is related to the risk of mimicking behavior in stock repurchases. Second, they investigate whether higher ownership concentration is related to a higher probability of the mimicking behavior. Third, they study whether stronger legal institutions and the adoption of International Financial Reporting Standards (IFRS) can reduce the risk of this mimicking behavior.
To explore these issues, the authors use a logistic regression model. They identify three ex ante firm-specific characteristics that can help to capture managers’ incentives to undertake a stock repurchase: market-to-book ratio, cash flow from operating activities to assets, and the level of discretionary accruals. Using these variables, they compute a composite “mimic” variable, which is an indicator of mimicking behavior.
Next, the authors complement their model with measures for operating and market performance following the repurchase as well as variables representing legal, concentration, and firm-specific factors.
The financial data come from Worldscope. Stock-price data are sourced from Datastream. The data do not include financial companies, and country-year combinations that have fewer than 20 observations are excluded. The sample consists of 11,422 firm-year observations (on 4,142 unique firms from 30 countries over the period of 1998–2006). The authors focus on actual stock repurchases, not repurchase announcements. They also impose several restrictions on the firm characteristics and require three-year post-repurchase data to capture market performance. Moreover, the ultimate sample is further reduced for the specific analyses of operating cash flow, income, and market performance.
Abstractor’s Viewpoint
The authors’ findings benefit the literature in several ways. The issue of mimicking is placed in an international context, and the importance of investor protection and reporting standards to help reduce the risk of managers engaging in mimicking behavior is emphasized. The authors indicate two drawbacks of the study that should be further refined in future research: (1) the separation of mimicking signals from truthful ones and (2) the difficulty of capturing the controlling status of large shareholdings. Nevertheless, in my opinion, this is a high-quality article and its contribution to the literature is significant.