Hu - Financing Decision I Topics What do we know about stock repurchases? G. Grullon and D. L. Ikenberry 2019/1/16 Hu - Financing Decision I

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% 2019/1/16 Hu - Financing Decision I

What do we know about stock repurchases? Types 2019/1/16 Hu - Financing Decision I

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? 2019/1/16 Hu - Financing Decision I

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 2019/1/16 Hu - Financing Decision I

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% 2019/1/16 Hu - Financing Decision I

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 2019/1/16 Hu - Financing Decision I

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 2019/1/16 Hu - Financing Decision I

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) 2019/1/16 Hu - Financing Decision I

What do we know about stock repurchases? Why? Adjust capital structure To offset share increase from stock options 2019/1/16 Hu - Financing Decision I

Hu - Financing Decision I 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 2019/1/16 Hu - Financing Decision I

Hu - Financing Decision I 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) 2019/1/16 Hu - Financing Decision I

Hu - Financing Decision I 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 25%of average daily volume Black-out dates: prohibit insider trading 2019/1/16 Hu - Financing Decision I

Hu - Financing Decision I 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 2019/1/16 Hu - Financing Decision I