Agency issues in share repurchase programmes
The corporate finance literature generally views open market share repurchase announcements as a signal of equity undervaluation. Managers also frequently cite undervaluation as a rationale for their decision to repurchase firm equity. However, such an announcement cannot necessarily be viewed as a strong signal of firm undervaluation as it lacks characteristics of a credible signal. Firstly, managers are increasingly relying on share repurchases as a mechanism for distributing cash to shareholders. Secondly, open market buyback announcements are not binding obligation on the part of firm management to complete. In addition, such programmes have a positive effect on executive compensation, so managers can also employ these opportunistically to accumulate personal wealth at the expense of shareholders. Thus, buyback announcements can be either value signalling or agency driven. Since these two theories (agency vs signalling) are not mutually exclusive and a pure ex ante measure of managerial intent does not exist, the challenge is to distinguish value signalling announcements from “cosmetic” ones.\ud \ud My thesis consists of three papers (chapters 2-4). In my first paper, I test whether the market distinguishes between agency driven and value signalling open market share buybacks by observing the underlying managerial wealth and repurchase incentives. In theory, better convergence between the executive and shareholder wealth interests and risk preferences should lower agency costs thus increasing the “perceived” credibility of managements’ buyback announcements (signals). My results suggest that executive compensation arrangements play an important role in explaining the market reaction to, and actual share repurchase decisions of, firms that announce buyback programmes. This study makes an original contribution to the literature by demonstrating that investors approximate the value signalling effect of a buyback announcement by observing the underlying managerial repurchase incentives and respond accordingly.\ud \ud My second paper addresses the open market buyback announcement credibility issue directly by capitalising on the soft information conveyed in such announcements. This is novel to the literature on share buybacks. Recent studies show that news disclosure tone affects investor reaction to an information event. In my study, I demonstrate that the disclosure tone of buyback press releases contains value relevant information and has significant explanatory power for short term announcement returns. The hand collected data I use in this chapter also allows me to explore other aspects of buyback announcements where the extant literature is limited.\ud \ud In my third paper, I analyse insider trading behaviour around buyback announcements. The key insight of this paper is to infer insiders’ private information about firm value by observing their trading behaviour around the repurchase announcement event. Insiders add credibility to the (repurchase) undervaluation signal by trading parallel to their signal (i.e., purchasing more or selling fewer shares in advance of the repurchase announcement). However, insiders seeking to time the market (cash out at a higher price) will sell more shares post-announcement. My analysis shows that, consistent with the undervaluation signalling argument, investors respond more positively to buyback announcements where insiders buy more or sell less equity before the announcement event. However, I also document that insiders sell more shares (time the market) in the first 3-months post-announcement. This is especially true for firms that are less (more) likely to be undervalued (overvalued) and for smaller firms that present the greatest potential for gain through insider trading. My results suggest that net insider sales are significantly positively related to repurchase announcement returns. Finally, I show that higher post-announcement net insider sales are slightly negatively related to longer-term returns suggesting such firms do not out perform in the long-run.\ud \ud My research adds significantly to the literature on share buybacks by addressing the agency issues associated with share repurchase programmes. It finds that the market is conscious of the managerial incentives attached to repurchase programmes and the potential for their opportunistic use. Investor reaction to repurchase programme announcements is sensitive to executive compensation arrangements, the information content and disclosure tone of buyback announcement press releases and insider trading behaviour. This study seeks to add to our understanding of share buybacks and how the market treats and reacts to these announcements. The market realises that managements’ promises to spend billions of dollars on share repurchases may not necessarily add to shareholders’ wealth. Repurchase announcements cannot be uniformly viewed as a signal of equity undervaluation; insiders also use such programmes for personal gains. In summary, my research highlights novel factors that explain investor reaction to share buyback announcements.
views in local repository
downloads in local repository
The information is available from the following content providers: