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Does Prior Record Matter in the Wealth Effect of Open-Market Share Repurchase Announcement?

Shao-Chi Chang National Cheng Kung University, Taiwan

Sheng-Syan Chen National Taiwan University, Taiwan

Li-Yu ChenNational Cheng Kung University, Taiwan

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Main Idea

Announcing datePrior experience

◆ Actual share repurchase ◆ Wealth effect

◆ Stock performance

◆ Not required to publicly disclose for

open-market share repurchasing firms

◆ The amount of actual share repurchase

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Motivation (1/2) Positive wealth effect of share buybacks

(Vermaelen, 1981; Comment and Jarrel, 1991; Nohel and Tarhan, 1998; Stephens and Weisbach, 1998)

undervaluation redistribution of excess cash flow capital structure changes takeover attempts deterrence

The amount of actual repurchases achieving above goals managerial motives of share repurchase

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Motivation (2/2) No actual completion of the repurchase program

only 20% of their buyback programs following their announcements (Fortune, 1995)

no acquisitions of shares made by most of the announcing firms in the 3 years following the announcements of repurchase programs (Stephens and Weisbach, 1998)

The evidence of incomplete actual repurchases difficult to achieve above goals

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Motives for failure of complete buyback Boosting share price without the intention of

actual completion (Wall Street Journal ,1995)

Increase in earnings-per-shares by reducing total shares outstanding (Bens, Nagar, Skinner and Wong, 2003) improvement of stock performance

The amount of actual repurchasesSorting managers into those that signal truthfully

and those that signal falsely

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1st Purpose

Announcing datePrior experience

◆ Actual share repurchase ◆ Wealth effect

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Main Idea

Announcing datePrior experience

◆ Actual share repurchase ◆ Wealth effect

◆ Stock performance

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Motivation Undervaluation as the most cited reason for

share repurchases (Ofer and Thakeor, 1987; Comment and Jarrel, 1991; Stephens and Weisbach, 1998; Ikenberry, Lakonishok, and Vermaelen, 2000)

An average buy-and-hold yearly return of 26.2% following the announcement date (Chan, Ikenberry and Lee, 2004)

Not meeting market expectation no improvement of stock price

managers’ intentionally sending incorrect signals their optimistically biased toward the intrinsic equity value

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2nd Purpose

Announcing datePrior experience

◆ Wealth effect ◆ Stock performance

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Data The announcements from Securities Data

Corporation (SDC) during 1986 to 2005 Criteria

at least two repurchase announcements during the sample period

return data available on the Center for Research in Security Prices (CRSP) database

financial information available from Compustat database

Sample Distribution- Table 1

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Table 1-Sample Distribution (1/2)

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Table 1-Sample Distribution (2/2)

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Sample Selection

Total initial sample 5,717

First announcement (-)1,741

Consecutive announcements <one year (-)1,403

Final sample 1,758

Missing control variables (-) 815

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Methodology (1/2) Measuring Abnormal Stock Return

Standard event-study methods Table 2

Measuring Reacquired Shares (Stephens and Weisbach, 1998) Changes in outstanding common shares, dollars

spent on requiring shares, and the value increase of treasury stocks

Scaling each measure of actual repurchase by the total number of shares outstanding at the time of announcement

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Methodology (2/2)1. Monthly decreases in the firm’s shares outstanding from

CRSP cumulated quarterly 2. Quarterly decreases in the firm’s shares outstanding from

Compustat3. Dollars spent on reacquiring securities / the minimum share

price in a given quarter4. Dollars spent on reacquiring securities / the average share

price in a given quarter5. Quarterly increases in the dollar value of the firm’s treasury

stock / the minimum share price in a given quarter6. Quarterly increases in the dollar value of the firm’s treasury

stock / the average share price in a given quarter

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Empirical Results (1/5) Abnormal Returns Classified by the Actual

Share Repurchases Table 3 - Panel A

Abnormal Returns Classified by Market- Adjusted Buy-and-Hold Return Table 3-Panel B

Learning from prior evidence of share repurchase

Cross-Sectional Regression Analyses of the Announcement Period Returns Table 4

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Empirical Results (2/5) Robustness of the results

scaling actual repurchase by the number of shares to be repurchased in announced program

different event windows of cumulated abnormal returns (CAR (0, 1) , CAR (-1, 2) & CAR (2, 2) )

different period of cumulative repurchases over the half year, one and half years and over the entire two years

different intervals in measuring the market-adjusted BHR or raw BHR (6-month & 9-month)

consecutive announcements made more than one and half years

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Empirical Results (3/5) The earnings forecast revision of financial

analysts valuable information of investors’ expectation on the

prospects of future cash flow (Givoly and Lakonishok, 1979; Fried and Givoly, 1982)

improving our understanding of stock market reactions (Brous and Kini, 1993)

Cross –Sectional Regression of Analyst’s Adjusted Forecast Revisions Table 5

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Empirical Results (4/5) Actual share buyback and long-run return

Conditions the market to expect large current actual share repurchases

Loss of reputation Surprising expectation

B Group

A Group

Prior

Low actual buy

Prior

High actual buy

Current

Low actual buy

Current

High actual buy The difference between the current and prior actual share repurchases

Long-horizon abnormal return of following share repurchases

announcement

+

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Empirical Results (5/5) Robustness Check

actual share repurchases obtained from Compustat databases

no other share repurchases announcing firms in the four years after the announcing date

long-run return from second year to fourth year consecutive announcements made more than one

and half years

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Conclusions

Announcing datePrior experience

◆ Actual share repurchase ◆ Wealth effect

◆ Stock performance

◆ Short-term and long-term earnings forecasts

Investors will learn from past experience about share repurchase announcements

Simultaneously consider the current and prior actual share repurchases into their long-term returns

◆ Long-run return

◆ Wealth effect

◆ Short-term and long-term earnings forecasts

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Contributions To explore the relationship between prior

evidence of share repurchase and the wealth effect on the following share repurchase announcements to test the above mentioned relationship

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Thank you for your Attentions!

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Table 2-Abnormal Returns

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Table 3-Abnormal Returns Classified by the Actual Share Repurchases

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Table 3-Abnormal Returns Classified by Market-adjusted BHR quintiles

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Variables’ DefinitionsVariables Definitions

Actual share repurchases

Crsp-share CRSP

Compustat-share Compustat

PC/low price Repurchase dollars divided by the low price

PC/mean price Repurchase dollars divided by the mean price

TS/low price Increase in the dollar value of treasury stock divided by low price

TS/mean price Increase in the dollar value of treasury stock divided by mean price

Market-adjusted BHRSample’s one-year BHR minus value-weighted market index’s one-year BHR following the last repurchase plan announcement

Sequence A firm announces during the sample period

Prior 6-month AR Prior 6-month buy-and-hold returns compounded before the announcement date minus the compounded return of market index over the same period

FCF Industry median-adjusted free cash flows /assets

LEV Industry median -adjusted ratio of the total debt to total assets

Shares announced/out.Percentage of announced repurchases shares relative to total outstanding shares

LSIZE Natural logarithm of market value of equity

LBM Logged book-to-market ratio

TAKEOVER=1 if a firm is the object of a takeover or a rumor of a takeover=0 otherwiseTakeover attempts deterrence

UndervaluationRedistribution of excess cash flowCapital structure changes

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Table 4- Regression Analyses of the Announcement Period Returns

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Analyst’ Earnings Forecast Revisions Brous (1992) and Brous and Kini (1993)

analysts’ forecast revision on the current-year earnings per share

Yoon and Starks (1995) analysts’ forecasts of long-term earnings growth

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Table 5- Analyst’s Adjusted Forecast Revisions of Current-year Earnings Per Share

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Table 6- Analyst’s Adjusted Forecast Revisions of Long-term Earnings Growth

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Definition of Variables

Variables Definition

AR1 Sample’s 3-year BHR minus size matching firm’s 3-year BHR

AR2 Sample’s 3-year BHR minus industry-and-size matching firm’s 3-year BHR

AR3 Sample’s 3-year BHR minus industry-size-and-BM matching firm’s 3-year BHR

AR4 Sample’s 3-year BHR minus market index’s 3-year BHR

Change actual share Difference between current actual share and pervious actual share

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Table7-Cross-Sectional Regression Analyses of the

Long-run Stock Returns of Shares Repurchases