Unexpected Share Repurchase Announcements

Abstract

Open-market stock repurchase announcements are generally perceived by the stock market as a signal of firm undervaluation. Our study shows that repurchase announcements that were preceded by SEOs of other firms in the same industry within the prior six months (namely SEO-RPs) are more likely the result of lacking investment opportunities than signaling undervaluation, especially in concentrated industries. Specifically, we find investors response negatively to SEO-RP announcements while react positively to regular repurchase announcements. The higher the intensity of SEO activities in the industry, the more negative market reaction to SEO-RP announcements. We argue that the market doesn’t expect a repurchase announcement when other rival firms are raising more capital via SEOs. These SEO-RPs represent a negative surprise to the market and lead to a downward adjustment in value of the repurchasing firms in the announcement window. In the three-year post-announcement periods, the SEO-RP firms underperform regular repurchasing firms in both stock return and operating performance. Moreover, while regular repurchasing firms gradually increase their capital expenditures, SEO-RP firms significantly reduce their capital expenditures. These findings support our arguments that repurchase announcements that immediately follow SEOs of rival firms (SEO-RPs) more likely indicate the announcing firms entering a slower growth rate with fewer investment opportunities than signal the undervaluation problem. The underperformance in stock return and operation combined with a significant reduction in capital expenditures in the post-announcement periods are consistent with this logic and also explain why the market reacts negatively to SEO-RP announcements.

Keywords:

• Stock repurchase
• Buy-back
• Long-term performance
• SEOs
• Anomaly
• Payout choices

JEL classification:

• G14
• G32
• G35

Notes

1 .Undervaluation hypothesis (Ikenberry, Lakonishok, and Vermaelen, 1995; Stephen and Weisbach 1998; Chan, Ikenberry, and Lee 2004); Agency cost of Free Cash Flow Hypothesis (Stephen and Weisbach 1998; Dittmar 2000; Grullon and Michaely 2004); Stock options dilution (Banyi, Dyl, and Kahle 2008); Optimism (Nguyen et al. 2018)

2 .1988 is the first year SDC report repurchase announcements with sufficient data and ending in 2013 is because we require data for computing returns for three years after the announcements

3 .Stephen and Weisbach (1998), Guay and Harford (2000), Dudley and Manakyan (2011), among others find a firm’s repurchases and its cash position are directly related. Bagwell and Shoven (1988) and Opler and Titman (1994) find firms use share repurchases as a means to adjust their capital structure. Massa, Rehman, and Vermaelen (2007) find that operating income, non-operating income, capital expenditures, price-earnings ratio (P/E), and dividend ratio are determinant factors of repurchase decisions.

4 .When compounding for 36 months, (1 + 0.53%)36 – 1 = 20.96%, this is comparable to the 18.9% when using buy-and-hold approach in the previous part.