Some companies announce a share repurchase program and yet never end up repurchasing their shares. The authors’ theoretical model predicts that companies that are significantly undervalued announce share repurchase programs but never follow through, whereas companies that are trading closer to their intrinsic value do repurchase their shares.
What’s Inside?
The authors develop a model to understand why some companies that announce a share repurchase program follow through and repurchase shares and some do not. They find that companies that are significantly undervalued do not have to repurchase shares for the market to bring their share price more in line with their fundamental value. Firms whose market value is not significantly undervalued, however, do have to repurchase shares in the open market to help drive the share price up. This article is a considerable revision to Bhattacharya and Dittmar (working paper 2001) and has close links with two other papers: Oded (Review of Financial Studies 2005) and Allen, Bernardo, and Welch (Journal of Finance 2000).
How Is This Research Useful to Practitioners?
This research provides insight into two puzzles. The first is why some companies, which the authors call “non-repurchasers,” announce a share repurchase program but never end up repurchasing their shares versus companies that do end up repurchasing their shares, which they call “repurchasers.” The second is why stock prices increase at the announcement of a share repurchase program when it does not commit the company to repurchase stock; as a result of this occurrence, many firms never end up buying their shares.
The authors find that companies that are significantly undervalued are less likely to repurchase shares. They discover that 24% of all companies that announce a share repurchase program do not repurchase a share in the fiscal year of the announcement, and 13% never repurchase a single share within four fiscal years of the share repurchase announcement.
Companies that have higher trading costs, low analyst coverage, small market capitalization, low institutional ownership, and small advertising expenditures are significantly less likely to repurchase shares after making a share repurchase announcement. Interestingly, the authors’ theoretical model predicts that these non-repurchaser companies have their share price corrected by other market participants. The data show that companies that do not repurchase their shares have higher trading volume and abnormal returns in the short window around the share repurchase announcement, which indicates that speculators discover the mispricing and are driving the share price up toward its fundamental value.
The authors discuss important reasons why a firm might announce a share repurchase program other than to increase its share price. For example, (1) share repurchases have tax advantages over dividends; (2) share repurchase programs are flexible; (3) such programs are an alternative way to distribute cash to shareholders; (4) the share repurchases can be used to alter leverage ratios; and (5) share repurchases may be preferred over dividends when a company has employee stock options outstanding.
How Did the Authors Conduct This Research?
Using information from January 1985 through September 2012, the authors use data from the Securities Data Corporation’s Mergers and Acquisitions database, Compustat, CRSP, Thomson Reuters Institutional Holdings (13F), and I/B/E/S to obtain stock prices, returns, volume, and accounting and analyst information.
They exclude firms announcing share repurchases in the last quarter of 1987 because of the unusually large amount of announcements, which suggests that these announcements may differ from typical repurchase programs. Additionally, the authors exclude announcements made less than three years after the last repurchase announcement. As part of the data restriction, they also require that companies report the intended dollar value or the percentage of shares sought in the repurchase.
These screens result in a total sample of 7,602 companies making repurchase announcements over the 28-year period. Over this period, the number of share repurchase announcements in any one year ranged from a low of 24 to a high of 769. From these data, over the entire period, 76%, or 5,786 firms, ended up repurchasing shares within the first fiscal year of the announcement. The remaining 24%, or 1,816 firms, either repurchased shares after the first fiscal year of their announcement or never followed through on their repurchase announcement.
The authors classify non-repurchasers and repurchasers in two ways: (1) A company is considered a repurchaser if it repurchases shares within the fiscal year of the share announcement and a non-repurchaser otherwise, (2) a repurchaser is a company that repurchases shares within the first fiscal quarter of the share announcement and a non-repurchaser otherwise. Although the definitions are slightly different, the results are similar.
Abstractor’s Viewpoint
Although the authors exclude the specific dollar amount or percentage of float that companies announce to repurchase, it would be interesting to see how this information could affect the results. Unsurprisingly, the data reveal that companies with smaller market capitalization and lower analyst coverage tend to have their shares driven up by speculators after a share repurchase announcement. This supports the idea that there might be more opportunities in looking for undervalued companies in the small-cap universe because there seems to be more mispricing.