1. 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

2. 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

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

4. 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

5. 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

6. 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

7. 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

8. 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

9. 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

10. 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

11. 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

12. 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

13. 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

14. 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