Activist investors and open market share repurchases

Journal of Banking and Finance 107 (2019) 105614

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Activist investors and open market share repurchases Don M. Autore, Nicholas Clarke, Baixiao Liu∗ College of Business, Florida State University, 821 Academic Drive, Tallahassee, FL 32306, United States

a r t i c l e

i n f o

Article history: Received 29 October 2018 Accepted 19 August 2019 Available online 21 August 2019 Keywords: Activist investors Open market share repurchases

a b s t r a c t This study examines the role of activist investors in firms’ decisions to conduct open market share repurchases. Compared with firms making ordinary share repurchases, firms making activist-involved repurchases have more cash holdings, are more undervalued, experience better subsequent stock performance and similar improvements in operating performance, and eventually repurchase more shares. Moreover, repurchasing firms in which an activist investor claims to take a passive role exhibit no undervaluation, and repurchasing firms that make multiple repurchases exhibit share undervaluation only in repurchases where an activist is involved. In all, our findings suggest that activist-involvement is associated with improved corporate repurchase decisions. © 2019 Elsevier B.V. All rights reserved.

1. Introduction “[BlackRock co-founder and CEO Laurence] Fink said he fears that a growing network of short-term activists are pestering companies into share buybacks and other short-term measures that run counter to the long-term interests of shareholders.”1

There is a growing consensus in the literature that shareholder activism is associated with an increase in firm value (e.g., Gillan and Starks, 2007; Bebchuk et al., 2015; Denes et al., 2016). Nevertheless, in recent years investment professionals and media outlets have criticized activist shareholders for pressuring firms into open market share repurchases (henceforth, OMRs).2 The criticism asserts that activist pressure can cause firms to forgo value-adding investments in favor of returning capital to shareholders via share buybacks. To this extent, activists could take quick profits from the favorable stock price reaction at OMR announcements and then exit, whereas the firm might experience subsequent declines in performance resulting from suboptimal investment decisions.

∗

Corresponding author. E-mail addresses: [email protected] (D.M. Autore), [email protected] (N. Clarke), [email protected] (B. Liu). 1 See “Icahn, Blackrock’s Fink Argue Over Who Is More Dangerous”, MarketWatch, July 15, 2015. 2 For example, see: “Capital Group Raps Activists for Pushing Share Buybacks”, Financial Times, October 8, 2014; “As Activism Rises, U.S. Firms Spend More on Buybacks Than Factories”, Wall Street Journal, May 27, 2015; “Stock Buybacks: Too Much of a Good Thing”, Barron’s, September 26, 2015. https://doi.org/10.1016/j.jbankfin.2019.105614 0378-4266/© 2019 Elsevier B.V. All rights reserved.

Signaling and free cash flow theories are well-established in the literature as motivations for share repurchases.3 Share repurchases signal stock undervaluation (e.g., Dann, 1981; Vermaelen, 1981; Comment and Jarrell, 1991; Ikenberry et al., 1995; Brav et al., 2005; Peyer and Vermaelen, 2009; Dittmar and Field, 2015) and reduce agency costs associated with excess cash (Grullon and Michaely, 2004). Despite these value-adding motives, a relatively recent and growing stream of literature links share repurchases to managerial short-termism.4 In particular, there is evidence that repurchase decisions are motivated by earnings management (Brav et al., 2005; Hribar et al., 2006; Almeida et al., 2016), employee stock options (Fenn and Liang, 2001; Kahle, 2002), and CEO equity vesting (Edmans et al., 2018). This evidence on short-termism associated with OMRs lends some credibility to the recent criticism of activist-involved OMRs, to the extent that activist investors pushing for share buybacks are focused on short-term objectives. To date, however, there is little empirical evidence on the motives of repurchase decisions in the context of activist-involved firms. We fill this gap by directly examining activist-involved OMRs. Our analysis addresses several open questions about activist involvement in share repurchases. To what extent are activists involved in OMR-announcing firms? Are they long-term or shortterm shareholders? Are activist-involved OMRs timed differently than typical OMRs based on cash holdings, stock valuation, and future performance? Does it matter whether the activist truly takes an active role in the firm as opposed to passive ownership? 3 Signaling through financial decisions was first articulated by Ross (1977) and Leland and Pyle (1977), and the agency cost of free cash flow was developed by Jensen (1986). 4 Lazonick (2014) and Kaplan (2018) outline the central ideas of managerial shorttermism.

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D.M. Autore, N. Clarke and B. Liu / Journal of Banking and Finance 107 (2019) 105614

To begin, we merge OMRs during the period of 1997–2015 with manually collected data on shareholder activism. We identify activist-involved OMRs as those in which there is an ongoing activist campaign against the repurchasing firm that was initiated in the prior two years through the filing of a Schedule 13D (henceforth, Activist OMRs). In our sample, one in every ten firms announces at least one Activist OMR. We further focus on the subset of Activist OMRs in which the activist investor has a stated goal of initiating or increasing share repurchases, increasing shareholder payout, or returning excess cash holdings to investors (henceforth, Payout OMRs). We find these activists are not short-term investors, retaining ownership positions of at least 5% in the target firms for an average of about two years. We compare cash holdings, stock valuation, and subsequent firm performance of Activist OMRs and Payout OMRs with that of non-activist-involved OMRs (henceforth, Non-Activist OMRs). If activist involvement is detrimental to firm value, we expect that Activist OMRs are chiefly motivated to achieve a quick price response at the announcement rather than to distribute excess cash or capitalize on share undervaluation. Potential consequences are reduced future investment, weaker operating performance, and an immediate price reaction that subsequently reverses. Our findings do not support the recent criticism of activists’ involvement in share repurchases. First, industry-adjusted cash holdings are persistently high in the quarters both before and after Non-Activist OMRs, Activist OMRs, and Payout OMRs, and decomposed market-to-book ratios suggest that Activist OMRs and Payout OMRs are undervalued relative to Non-Activist OMRs. Second, we find no evidence that activist-involved OMRs are conducted at the expense of long-term firm performance. Using matched samples, we find that firms conducting Activist OMRs and Payout OMRs do not underinvest or exhibit poor subsequent operating performance. Similarly, based on calendar-time portfolio estimations using the Fama and French (2015) five-factor model, activist-involved OMRs are associated with alphas of over 1% per month during the six months after the announcement, whereas Non-Activist OMRs exhibit alphas that are small in magnitude and statistically insignificant. Thus, the findings do not support the criticism that activists encourage firms to conduct OMRs against the long-term interests of existing shareholders. Rather, activist-involved firms conduct OMRs during periods of excess cash and stock undervaluation, and subsequently they do not underinvest or suffer declines in stock or operating performance. A natural question is whether activists play a causal role in firms’ decisions to conduct OMRs. For example, one could argue that our findings are driven by activists taking stakes in firms that, regardless of an activist presence, are better than average at using excess cash to capitalize on undervaluation through OMRs. We address this endogeneity concern in two ways. First, we identify 81 instances in which an activist who files a 13D as part of our Payout OMRs sample takes a separate passive position (as indicated by a Schedule 13G filing) in another firm announcing a NonActivist OMR (henceforth, Passive OMRs). If activists merely identify firms that repurchase during periods of undervaluation but do not influence the firms’ decisions, then whether an activist takes an active or passive role should not make a difference. Contrary to this conjecture, we find that firms conducting Passive OMRs are not undervalued prior to the announcement nor do they experience post-OMR abnormal stock returns. Second, we examine a subset of firms that conduct multiple OMRs in which one is activist-involved and the other is not. Specifically, from the set of firms who conduct Payout OMRs, we identify 318 OMRs (from our sample of Non-Activist OMRs) that are announced when no activist is involved in the firm (henceforth, Multiple OMRs). Again, if activists simply pick firms who are adept

at timing OMRs to undervaluation but do not influence their repurchase decisions, then we should observe little difference between Payout OMRs and Multiple OMRs. To the contrary, for Multiple OMRs we find no evidence of pre-OMR undervaluation or postOMR abnormal stock returns, which is in stark contrast to the preOMR undervaluation associated with Payout OMRs. Together, the two aforementioned analyses are suggestive of a causal relation between activist involvement and the degree of undervaluation in the repurchasing firm’s share price. However, because we do not directly observe private interactions between activists and OMR firms, we cannot completely rule out the possibility that the extent of the activists’ influence is merely taking an activist position in the firm. Our study contributes to a growing literature that uses specific corporate events to identify channels through which shareholder activism is related to favorable firm outcomes. For example, the presence of activist investors is associated with more efficient debt restructuring (Lim, 2015), increases in production efficiency following ownership changes (Brav et al., 2015), and improved monitoring during takeover bids (Boyson et al., 2017). Our results refute the recent scrutiny concerning activist-involved repurchases, and further, imply that activist involvement is associated with better repurchase decisions with respect to distributing excess cash holdings and capitalizing on undervaluation without hindering longterm performance. In this sense, one could view share repurchases as a channel through which activists help firms improve long-term value. Finally, the findings are consistent with the idea that firms listen to activists to make better corporate decisions. This interpretation connects our paper to a recent stream of literature suggesting that managers can learn about their firms’ prospects from outside investors (e.g., Luo, 2005; Chen et al., 2007; Bakke and Whited, 2010; Bond et al., 2012; Edmans et al., 2012; Goldstein and Yang, 2016; Autore et al., 2018). The remainder of the paper is organized as follows. Section 2 details our data collection and sample construction processes. Section 3 provides summary statistics on the OMR announcements and preceding activist campaigns. Section 4 examines firms’ cash holdings and misvaluation, and Section 5 provides tests of post-OMR stock returns, operating performance, and investment. Sections 6 and 7 address endogeneity concerns and Section 8 concludes.

2. Data and sample construction This section describes our sample construction of open market share repurchases (OMRs) and our identification and classification of activist investors.

2.1. Open market repurchase announcements We collect share repurchase announcements between January 1, 1997, and December 31, 2015 from the Securities Data Company’s (SDC) U.S. Mergers and Acquisitions database. If a firm announces multiple repurchases in the same month, we keep only the first one. We restrict the sample to OMRs of common stock with a price of at least $1 on the trading day prior to the announcement. Sample firms must be included in both CRSP and Compustat and their stocks are traded on NYSE, AMEX, or NASDAQ. We assign firms to industries using the Fama and French (1997) 17-industry classification system. Similar to Grullon and Michaely (2004) and Babenko et al. (2012), we include utilities and financials because they represent over a quarter of sample repurchasing firms. All results are qualitatively similar if we exclude these firms.

D.M. Autore, N. Clarke and B. Liu / Journal of Banking and Finance 107 (2019) 105614

2.2. Activist classifications of OMRs We classify OMRs based on activist involvement in several steps. First, for each sample OMR, we collect all schedule 13Ds filed in the prior two years in which the subject company of the 13D matches the firm that is announcing the share repurchase. We obtain 13Ds from the Securities and Exchange Commission’s (SEC) EDGAR archives, and match on company name and then verify by matching the Central Index Keys (CIKs) of repurchasing firms from Compustat with the CIKs listed on the 13D form. Under the Securities and Exchange Act of 1934, any person or group that directly or indirectly owns voting or investment power over 5% of a company’s equity securities with the intent to influence the company must file a Schedule 13D form within ten days of crossing the 5% threshold. This form is referred to as the “beneficial ownership report” and is used throughout prior literature to identify activist campaigns (see, for example, Gillan and Starks, 2007; Brav et al., 2008; Clifford, 2008; Bebchuk et al., 2015; Denes et al., 2016). Second, since Schedule 13Ds are also used for non-activist corporate events (e.g., mergers, employee stock options, and corporate reorganizations), we remove these 13Ds from our sample. We also remove 13Ds where the filer only reserves the right to buy and sell additional securities in the future; this information is in part (a) of Item 4: Purpose of Transaction. After this matching and screening procedure, we identify the remaining 13D filers as activist investors and refer to this sample of repurchase announcements as Activist OMRs. The final sample contains 643 Activist OMRs, which are connected to 524 unique 13D filings. For each 13D we obtain the filing date and the identity of and percentage of shares owned by the filer. Third, we partition Activist OMRs on two separate dimensions by reading Item 4: Purpose of Transaction and any additional forms filed in conjunction with the 13D, such as letters to the boards of directors and press releases, for the 524 unique 13Ds in our Activist OMRs sample. We start by classifying each 13D as either ‘engaged’ or ‘monitoring.’ An engaged 13D explicitly discloses that the activist has had or intends to have discussions or interactions with the company’s management, whereas a monitoring 13D does not mention communicating with the firm or only references the possibility to do so. We then classify whether the 13D filing specifically cites shareholder ‘payout,’ whether it be initiating, continuing, or increasing a share repurchase or payout policy or returning capital or cash to shareholders. We are particularly interested in Activist OMRs that are classified as both ‘engaged’ and ‘payout’ and we refer to this subsample as ‘Payout OMRs.’ Our final sample contains 168 Payout OMRs. Appendix A provides two examples of 13Ds used to classify Payout OMRs. If multiple 13Ds are filed on the same OMR company, we aggregate ownership across activists and categorize the OMR observation as Payout if at least one of the 13Ds is assigned to each respective group (engaged and payout).5 Finally, if a 13D amendment filed prior to the OMR announcement reflects a change in the activist’s intent, we modify its classification appropriately. Similarly, if an amendment prior to the OMR announcement indicates that the activist ownership has dropped below the 5% threshold, the OMR is not classified as activistinvolved.

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Table 1 Annual frequency of open market share repurchases. This table presents the annual frequency of open market share repurchase (OMR) announcements. Activist OMRs represent repurchase announcements in which a Schedule 13D is filed on the company in the two years prior to the repurchase that is unrelated to mergers and acquisitions, employee stock options, corporate reorganizations, IPOs, or tender-offers. Payout OMRs are the subsample of Activist OMRs in which the filer has already engaged or plans to engage management and specifically mentions initiating, increasing, or continuing a share repurchase program, returning capital to shareholders, or increasing payout policy. We identify these types of repurchases from the Schedule 13D Item 4 (Purpose of Transaction), and modify the classification appropriately if a 13D amendment is filed before the repurchase announcement. The sample is restricted to firms with common stock that trade on NYSE, AMEX, or NASDAQ, are listed on both CRSP and Compustat, and have a price of at least one dollar on the day prior to the repurchase announcement. Year

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Total Unique firms

All repurchases

942 1488 1156 658 506 341 356 459 522 490 782 854 313 449 650 459 436 524 488 11,873 4637

Activist OMRs

Payout OMRs

N

% of Total

N

% of Total

27 68 46 31 26 22 16 15 21 26 51 79 30 23 30 33 38 30 31 643 487

2.9% 4.6% 4.0% 4.7% 5.1% 6.5% 4.5% 3.3% 4.0% 5.3% 6.5% 9.3% 9.6% 5.1% 4.6% 7.2% 8.7% 5.7% 6.4% 5.4% 10.5%

6 8 6 6 3 7 3 3 5 8 14 26 11 2 7 16 20 10 7 168 127

0.6% 0.5% 0.5% 0.9% 0.6% 2.1% 0.8% 0.7% 1.0% 1.6% 1.8% 3.0% 3.5% 0.4% 1.1% 3.5% 4.6% 1.9% 1.4% 1.4% 2.7%

ple of 11,873 repurchase announcements by 4637 unique firms, there are 643 Activist OMRs announced by 487 unique firms, and within this group there are 168 Payout OMRs announced by 127 unique firms. Thus, over 10% of sample repurchasing firms are involved in an Activist OMR and almost 3% are involved in a Payout OMR. It is noteworthy that the annual frequency of Payout OMRs has increased in the latter part of the sample period, indicating an increased tendency in recent years for activist 13D filings to specifically engage firms with the intention of achieving increased shareholder payout. 3. Descriptive statistics on open market repurchases and the preceding 13D filings In this section we first examine the details of the initial Schedule 13Ds that are filed in the two years prior to a sample OMR announcement. Then we analyze the features of OMR firms with a particular focus on the differences between each activist subsample and the non-activist-involved subsample.

2.3. Sample description

3.1. Schedule 13D characteristics

Table 1 provides the annual frequency of sample OMR announcements during the period of 1997–2015. From the full sam-

Table 2 presents features of activist investors and Schedule 13Ds for Activist OMRs and Payout OMRs. Panel A presents activist characteristics. A single schedule 13D can result in multiple OMRs by the same firm in the 2-year period following the initial filing. However, the first row indicates that the number of unique Schedule 13Ds for Activist OMRs and Payout OMRs equals 524 and 137, respectively. Thus, our activist subsamples are not driven by a small

5 In unreported analysis, we manually collect information on activist identity and classify each as a hedge fund or non-hedge fund. Within Activist OMRs and Payout OMRs, our main results regarding corporate outcomes are similar whether the activist is a hedge fund or not.

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D.M. Autore, N. Clarke and B. Liu / Journal of Banking and Finance 107 (2019) 105614 Table 2 Statistics on schedule 13D filings. This table presents statistics on Schedule 13Ds that are filed in the two years prior to sample OMRs, partitioned by the type of activist-involved OMR (defined in Table 1). Mean values are reported. Panel A provides statistics on the number of unique activist 13Ds prior to the sample of 643 Activist OMRs and 168 Payout OMRs. ACTIVIST_SHARES is the percentage of shares owned by the activist, as reported on the Schedule 13D. INST_OWN_PRE_13D is INST_OWN measured as of the quarter prior to the 13D filing. Panel B provides cumulative abnormal returns (CARs) in two windows (3- and 11-days) centered on the 13D filing date (3_DAY_CAR and 11_DAY_CAR). CARs are estimated from a market adjustment using the CRSP value-weighted index. P-values based on t-tests are provided in parentheses below the CARs. Panel C provides details on the 13D amendments filed after the OMR announcement. If a filer’s ownership stake drops below the 5% threshold, an amendment to the original 13D must be filed. In these cases, we measure the calendar days between the original 13D and amendment as well as the OMR announcement and amendment. We also report the new ownership percentage as recorded in the amendment. Finally, we note that, if a 13D is followed by an amendment prior to the OMR announcement indicating that the activist ownership has dropped below the 5% threshold, the OMR is not classified as an activist-involved OMR. Panel A: summary statistics

Unique schedule 13Ds Unique 13D Filers ACTIVIST_SHARES (%) Calendar days between: 13D & OMR Ann. INST_OWN_PRE_13D (%)

Within our sample of 643 activist OMRs

Within our sample of 168 payout OMRs

524 229 8.59

137 72 7.96

263 48.92

234 55.01

Panel B: mean CARs around 13D filings

3_DAY_CAR (%) 11_DAY_CAR (%)

Activist OMRs (Number of 13Ds = 501)

Payout OMRs (Number of 13Ds = 126)

2.12 (0.000) 3.97 (0.000)

2.83 (0.000) 4.30 (0.000)

Panel C: 13D amendments filed after repurchase announcement

Calendar days between: Rep. Ann. & 13D Amend. 13D & 13D Amend. New ownership stake (%)

Activist OMRs (Number of 13D amendments = 249)

Payout OMRs (Number of 13D amendments = 71)

752 989 2.82

550 756 2.60

number of 13Ds. In addition, the Activist OMRs sample includes 229 unique activist filers and the Payout OMR sample contains 72 unique activists. For each activist group, the average number of shares owned by activists at the time of the 13D filing is about 8%, the average time between 13D filings and OMR announcements is roughly 8 calendar months, and institutional ownership in the quarter prior to the 13D filing is close to 50%. Panel B reports cumulative abnormal returns (CARs) in the 3day and 11-day windows centered around the activist 13D filing date. CARs are calculated based on a market-adjusted model using the CRSP value-weighted index. For each activist group, 3-day CARs are approximately 2–3% and 11-day CARs are around 4%. These reactions are significant at the 1% level and are similar to those reported in prior activist studies that do not focus on OMRs. Finally, in Panel C we examine activist investment horizon. We can observe an amendment to the original 13D filing after the OMR announcement if the ownership level drops below 5%, and for these cases we measure the number of calendar days between the announcement and the amendment as well as between the initial 13D filing and the amendment. We also document the new percentage of shares owned, which is disclosed in the amendment. The panel shows the average activist in Activist OMRs remains above the 5% threshold for roughly 2 years (752 calendar days) after the OMR announcement and for almost 3 years (989 calendar days) after the initial 13D filing. While activists in Payout OMRs have shorter investment time frames, on average they retain at least a 5% stake for roughly 1.5 years (550 calendar days) after the OMR announcement and roughly 2 years (756 calendar days) after the initial 13D filing. Further, the amendments show activists in both subsamples continue to maintain meaningful positions in

the targeted companies, with average ownership for Activist OMRs and Payout OMRs remaining at 2.82% and 2.60%, respectively. 3.2. OMR characteristics We calculate OMR summary statistics for three samples: NonActivist OMRs (i.e., all OMRs not preceded by an activist 13D in the prior two years), Activist OMRs, and Payout OMRs. All trading data are from CRSP, and all accounting data are from Compustat’s quarterly database and measured as of the fiscal quarter ending prior to the repurchase announcement. To eliminate the effect of outliers, we winsorize all accounting variables at the 1st and 99th percentiles. Appendix B provides variable definitions. Table 3 provides summary statistics and includes two-sample t-tests of Non-Activist OMRs versus each activist sample. Panel A presents OMR characteristics. If investors expect activist-involved OMRs to have better outcomes, the stock price reaction should be stronger for these OMRs. However, we find little evidence that activist-involved OMRs are associated with better reactions than Non-Activist OMRs in the immediate window surrounding the OMR announcement, as both groups exhibit positive 3-day and 11day CARs ranging from 1.4% to 2.7% (consistent with past OMR studies). A possible reason for the lack of difference in reaction between groups is that investors partially (but incompletely) anticipate activist-involved OMRs given the prior filing of the Schedule 13D stating the activist’s intent. This anticipation might lead to a partial stock price adjustment as the market’s assessment of the probability of an OMR announcement increases and investors more fully capitalize this increase probability in the weeks prior to the OMR announcement. Thus we extend the 11-day CAR window to

D.M. Autore, N. Clarke and B. Liu / Journal of Banking and Finance 107 (2019) 105614

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Table 3 Summary statistics for open market repurchases. This table presents summary statistics of OMRs (Panel A) and the announcing firm characteristics (Panel B). Non-Activist OMRs are all repurchases not classified as Activist OMRs. We report the means for all three samples and the test statistic from t-tests of the differences between each activist sample and the non-activist sample (calculated as the mean of either Activist OMRs or Payout OMRs minus the mean of Non-Activist OMRs). Variable definitions are provided in Appendix B. Panel A: OMR characteristics Characteristic

3_DAY_CAR (%) 11_DAY_CAR (%) 28_DAY_CAR (%) PERC_SOUGHT (%) ACTUAL_REP (%)

Non-activist OMRs

Activist OMRs

N (1)

Mean (2)

N (3)

Mean (4)

t(4–2) (5)

Payout OMRs N (6)

Mean (7)

t(7–2) (8)

11,211 11,211 11,211 10,127 11,230

1.91 1.46 −1.33 8.46 5.13

643 643 643 577 643

2.00 2.05 0.57 10.48 7.13

0.31 1.29 3.18 5.96 6.27

168 168 168 153 168

1.58 2.71 2.26 11.17 7.14

−0.85 1.80 3.73 4.17 4.41

Panel B: firm characteristics Characteristic

RET6 (%) RET_VOL (%) AVG_TURN (%) MB AT (Mil $) CAT (%) IND_ADJ_CAT (%) LEV (%) IND_ADJ_LEV (%) INV (%) IND_ADJ_INV (%) OP (%) IND_ADJ_OP (%) INST_OWN (%) ABN_ACC (%) ACC_QUAL

Non-Activist OMRs

Activist OMRs

N (1)

Mean (2)

N (3)

Mean (4)

t(4–2) (5)

N (6)

Mean (7)

t(7–2) (8)

10,859 10,261 10,261 11,026 11,067 11,048 11,048 10,493 10,493 9371 9371 9933 9933 11,093 6529 7407

−6.34 2.66 0.72 1.82 7682 15.84 4.77 18.14 0.36 1.97 0.21 3.24 1.48 48.98 −0.11 0.05

622 592 592 626 632 632 632 582 582 520 520 582 582 634 357 422

−2.82 2.63 0.68 1.40 2004 16.16 5.15 18.34 0.71 1.85 0.15 2.27 0.62 48.32 −0.08 0.06

3.20 −0.42 −1.07 −8.16 −6.70 0.42 0.57 0.28 0.47 −1.28 −0.71 −8.04 −6.61 −0.45 0.15 1.28

166 159 159 164 166 166 166 153 153 151 151 156 156 166 89 112

0.22 2.38 0.74 1.34 2222 17.31 7.51 17.37 −0.82 1.55 0.08 2.24 0.51 55.16 −0.11 0.04

3.15 −2.27 0.29 −4.72 −3.31 1.03 2.17 −0.52 −0.83 −2.43 −0.89 −4.34 −3.94 2.19 0.01 −0.22

include the month (22 trading days) before the OMR announcement date. This 28-day CAR is significantly higher for activistinvolved OMRs, suggesting a higher reaction for activist-involved OMRs when we allow the event window to capture investors’ partial anticipation of these repurchases. Our approach in measuring CARs over this window is similar to Boyson et al. (2017), who examine CARs up to 25 days prior to merger announcements involving activist-targeted firms. We also report that, compared to Non-Activist OMRs, firms who announce Activist OMRs and Payout OMRs seek to repurchase significantly larger percentages of outstanding shares. Moreover, these firms follow through and actually repurchase significantly more shares (i.e. firms in the activist subsample repurchase about 7% of shares outstanding, compared to 5% for the non-activist sample.) Panel B provides firm characteristics prior to OMR announcements. Repurchasing firms in the activist subsamples are smaller and exhibit slightly better stock performance in the six months prior to OMRs, although they do not outperform the market. Furthermore, firms in the activist subsamples are associated with significantly lower market-to-book ratios in the quarter prior to the OMRs, indicating more undervaluation and / or fewer investment opportunities. Next, in the quarter prior to the OMRs each OMR group exhibits positive industry-adjusted cash holdings, but this measure of cash is significantly higher for firms in Payout OMRs. The industry-adjusted operating performance in the quarter prior to the OMRs is non-negative in each group, albeit significantly lower in the activist groups. Thus, our sample repurchasing firms

Payout OMRs

do not underperform their industry peers leading up to the OMR announcement. In Sections 4 and 5 we provide a closer examination of the motivations for and information content of OMRs. 4. Cash holdings and market-to-book decomposition If activists pressure firms into suboptimal share repurchase decisions, OMRs by these firms are likely to be associated with lower cash holdings and less share undervaluation, compared to nonactivist-linked repurchases. However, in Table 3 we report both Activist OMRs and Payout OMRs are associated with positive levels of industry-adjusted cash and lower market-to-book ratios relative to Non-Activist OMRs (suggesting more undervaluation). In this section we further explore these issues. 4.1. Cash holdings Panel A of Table 4 shows consistently positive industry-adjusted cash holdings in the eight quarters prior to OMR announcements, the announcement quarter, and the next three quarters for firms in Non-Activist OMRs, Activist OMRs, and Payout OMRs. Thus, OMR firms hold persistently high levels of cash both before and after OMRs regardless of whether an activist is involved. Further, cash levels are persistently higher for firms making Payout OMRs than firms making Non-Activist OMRs with a difference of about two to three percentage points each quarter (difference t-stats range from 1.80 to 2.84).

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D.M. Autore, N. Clarke and B. Liu / Journal of Banking and Finance 107 (2019) 105614 Table 4 Cash holdings around open market repurchases. This table presents analyses of cash holdings for Non-Activist OMRs, Activist OMRs, and Payout OMRs. For both Panels A and B, Quarter 0 represents the OMR announcement quarter. For Activist OMRs and Payout OMRs, we provide the test statistics from t-tests of differences between each activist sample and the non-activist sample. Panel A presents the evolution of cash holdings from quarters −8 through +3. Panel B presents statistics based on reasons for holdings excess cash. Means for IND_ADJ_CAT and CF_VOL are in percent. Variable definitions are provided in Appendix B. Panel A: evolution of cash holdings Industry-adjusted cash-to-assets (IND_ADJ_CAT) Quarter

−8 −7 −6 −5 −4 −3 −2 −1 0 +1 +2 +3

Non-activist OMRs

Activist OMRs

Payout OMRs

Mean (1)

t (2)

Mean (3)

t (4)

t(3–1) (5)

Mean (6)

t (7)

t(6–1) (8)

4.54 4.63 4.63 4.81 4.83 4.98 4.93 4.77 4.57 4.26 3.97 3.75

28.86 29.16 29.33 30.34 30.82 31.80 31.92 32.56 30.23 28.40 26.67 25.32

4.76 4.68 4.77 4.93 4.84 4.67 4.91 5.15 5.04 4.94 4.50 4.41

7.44 7.29 7.46 7.53 7.89 7.57 7.78 8.38 8.06 7.82 7.12 7.13

0.33 0.08 0.21 0.17 0.02 −0.45 −0.03 0.57 0.72 1.05 0.81 1.03

7.77 7.70 7.33 7.93 7.21 7.26 7.33 7.51 7.46 7.76 7.04 6.65

5.85 6.05 5.70 6.14 6.18 6.16 5.90 6.04 6.09 6.48 5.48 5.59

2.50 2.41 2.11 2.44 1.88 1.80 1.92 2.17 2.34 2.84 2.49 2.36

Panel B: reasons for excess cash Quarter(s)

Non-Activist OMRs

Activist OMRs

Mean (1)

Mean (3)

t (4)

t(3–1) (5)

Mean (6)

t (7)

t(6–1) (8)

3.06 2.90 3.06

23.09 27.03 21.12

−0.64 −1.04 0.44

2.39 2.52 3.11

14.85 15.39 9.35

−2.62 −1.89 0.43

1.88 3.73 3.70

0.16 0.70 1.46

5.45 9.83 11.12

−0.37 −0.18 0.27

t (2)

Operating cash flow volatility (CF_VOL) −5 3.16 87.93 −1 3.06 90.71 +3 2.99 89.18

Payout OMRs

Number of quarters with negative operating cash flows (NEG_CF) −1 0.17 45.19 0.20 11.75 −4 to −1 0.71 72.62 0.87 19.49 −8 to −1 1.40 79.02 1.69 21.71

Panel B examines why firms conducting Payout OMRs are associated with more cash holdings than firms conducting Non-Activist OMRs. We study operating cash flow volatility and the number of quarters with negative operating cash flow, motivated by prior studies on cash holdings such as Gao et al. (2013) and Denis and McKeon (2017). Firms are likely to hold more cash if they have greater cash flow volatility or an increased chance of negative operating cash flows. The panel shows that prior to OMR announcements, cash flow volatility is significantly lower for Payout OMRs firms, and the frequency of negative operating cash flows is similar across groups. The high level of cash even after activist-involved OMRs, though counterintuitive when viewed from an agency perspective, makes sense from a governance perspective. In particular, we conjecture that maintaining higher cash levels is less problematic when there is an activist investor who has a motive to monitor management. 4.2. Market-to-book decomposition We decompose the market-to-book ratio (MB) to further analyze valuation by following the methodology in Rhodes-Kropf et al. (2005), who decompose MB into three components: a firm-specific error, a sector-specific error, and a long-run value component reflecting investment and growth opportunities. In particular, we estimate the following cross-sectional regression for each industry (j = 1,…,12) and quarter (t) in our sample using quarterly data from Compustat:

mit =

α0 jt + α1 jt bit + α2 jt ln(NI )+it + α3 jt I(<0) ln(NI )+it + α4 jt LEVit + εit ,

(1)

where mit is firm i’s natural log of market equity, bit is the natural log of book equity, (NI )+ is the absolute value of net income, it I( < 0) is an indicator for negative net income, and LEVit is market leverage.6 We define the three market-to-book components as: (1) Firm-specific misvaluation: mit − v(θit ; αˆ jt ), where v (θit ; αˆ jt ) is firm i’s fitted value using its quarter t accounting data and coefficients from the regression for industry j in quarter t; (2) Sector-specific misvaluation: v(θit ; αˆ jt ) − v(θit ; α¯ jt ), where v(θit ; α¯ jt ) is firm i’s fitted value using its quarter t accounting data and coefficients averaged across all quarterly regressions for industry j; and (3) Long-run growth opportunities: v(θit ; α¯ jt ) − bit . We calculate total misvaluation as the sum of firm- and sectorspecific misvaluation. Negative (positive) values of misvaluation indicate undervaluation (overvaluation) as in Rhodes-Kropf et al. (2005): “Cash targets are undervalued (they have negative firm specific error…” (pg. 564). Table 5 presents the results. In Panel A, we focus on the quarter immediately prior to the OMR announcement. For Non-Activist OMRs, the firm-specific error is 0.106 (t = 19.13), implying overvaluation. This positive value is partially offset by sector undervalua6 Consistent with prior studies, we use the Fama and French (1997) 12-industry classifications. Market equity is from CRSP and book equity is from Compustat. Market leverage is one minus (ME/MV), where ME is market equity and MV is market equity plus total assets minus deferred taxes minus book equity. In untabulated results, the average adjusted R-squared for the industry-quarter regressions is 84% and is at least as large as similar industry-year regressions for 11 of 12 industries.

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Table 5 Market-to-book decomposition. This table displays the separate components of the market-to-book ratio based on a decomposition following the methodology of Rhodes-Kropf et al. (2005). We decompose the market-to-book ratio into three components: firm specific misvaluation, sector specific misvaluation, and long-run growth opportunities. We calculate total misvaluation as the sum of firm specific and sector specific misvaluation. Section 4.2 provides details of the decomposition methodology. Means and corresponding test statistics from t-tests are provided. We also provide the test statistic from ttests of the differences in means between each activist sample and the non-activist sample. Panel A measures component values as of the quarter ending immediately prior to the repurchase announcement. Panel B measures component values as of the quarter ending at least one year after the OMR announcement. Panel A: market-to-book decomposition prior to repurchase announcements Component

ln (MB) Firm misvaluation Sector misvaluation Total misvaluation Growth

Non-activist OMRs (n = 10,782)

Activist OMRs (n = 617)

Payout OMRs (n = 162)

Mean (1)

t (2)

Mean (3)

t (4)

t(3–1) (5)

Mean (6)

t (7)

t(6–1) (8)

0.729 0.106 −0.013 0.093 0.637

98.81 19.13 −7.59 16.26 107.93

0.428 −0.015 −0.019 −0.034 0.462

15.56 −0.62 −2.62 −1.39 19.93

−9.55 −5.06 −0.81 −5.16 −6.90

0.337 −0.063 −0.033 −0.096 0.433

7.03 −1.49 −2.42 −2.17 9.36

−6.49 −3.71 −1.41 −4.03 −4.21

Panel B: market-to-book decomposition one year after repurchase announcements Component

ln (MB) Firm misvaluation Sector misvaluation Total misvaluation Growth

Non-activist OMRs (n = 10,424)

Activist OMRs (n = 576)

Payout OMRs (n = 151)

Mean (1)

t (2)

Mean (3)

t (4)

t(3–1) (5)

Mean (6)

t (7)

t(6–1) (8)

0.683 0.148 −0.026 0.122 0.561

78.48 23.34 −12.64 18.46 87.73

0.448 0.059 −0.052 0.007 0.442

13.05 2.12 −6.07 0.23 17.84

−6.21 −3.22 −2.97 −3.99 −4.30

0.341 −0.008 −0.043 −0.051 0.392

5.99 −0.18 −2.59 −1.08 8.53

−4.72 −2.94 −1.03 −3.14 −3.17

tion, but the sum of these two variables reflected by the total misvaluation remains positive at 0.093 (t = 16.26). This is consistent with Fu and Huang (2015), who find overvaluation prior to OMR announcements from 2003 through 2012 using the same methodology and conclude undervaluation is not a dominant motivating factor for OMRs during this period. In contrast to firms conducting Non-Activist OMRs, firms announcing Activist OMRs are not overvalued. In fact, while these firms’ total undervaluation of –0.034 (t = –1.39) is not significant at traditional levels, it is significantly less than the misvaluation for firms announcing Non-Activist OMRs (difference t = –5.16). In the Payout OMRs subsample, evidence of undervaluation is even more pronounced, with total undervaluation equaling –0.096 (t = –2.17) and significantly less than Non-Activist OMRs (difference t = – 4.03). Further, the activist subsamples exhibit significantly lower growth opportunities prior to the OMR announcement. In Panel B, we examine the MB components as of the first fiscal quarter ending at least one year after the OMR announcement. To the extent that share undervaluation is a motivation for share repurchases and is corrected in the year after the OMR announcement, we would expect to observe corresponding changes in the MB components. Indeed, in the Activist OMRs subsample, total misvaluation is 0.007 (t = 0.23), and for firms in the Payout OMRs subsample total undervaluation is no longer statistically different than 0 (t = –1.08). In contrast, in the non-activist group, we continue to find positive values of firm-specific and total misvaluation.7

7 In unreported results, we investigate the effect of ownership structure. First, we categorize OMRs where the activist owns more than 10% as high ownership and less than 6% (but above the 5% cutoff) as low ownership. The high ownership OMRs have economically larger magnitudes of cash holdings and also exhibit more undervaluation (i.e. lower total misvaluation) than firms in low ownership OMRs. The findings suggest that the size of the activist’s stake is large when the firm’s cash levels and valuation are more advantageous for a share repurchase. Second, we partition Activist OMR firms into single versus multiple blockholders and above versus below median insider ownership. The findings suggest that activist investors suc-

The pre-OMR undervaluation and its subsequent disappearance in the activist groups suggest a market correction of the mispricing. We speculate that this correction is triggered by the combination of lower valuations (compared to the non-activist group) along with the presence of the activist and the eventual OMR. Premised on this upward price correction for activist-involved OMRs, two further questions arise: (i) At what horizon does the correction occur? (ii) Is there an over- or under-correction leading to a subsequent reversal or continuation? In the next section we address these questions by examining OMR firms’ stock performance. 5. Stock returns, operating performance, and investment To the extent that activist-involved firms repurchase undervalued shares, as indicated in the prior section, we expect to find an upward price correction. Additionally, given that activist-involved repurchases are not in a weaker cash position compared to ordinary repurchases, we do not expect that they forgo investment in more profitable projects to repurchase shares, and accordingly we do not expect to observe relatively weaker future operating performance. 5.1. Calendar-time portfolios Given that activist-involved OMRs are positioned favorably (e.g. high levels of cash and undervaluation), it is not surprising that the analysis in Table 3 reveals more favorable initial market reactions for activist-involved OMRs in the 28 day window leading up and including the announcement. Here we examine long-run stock performance to better assess whether activist-involved OMRs are detrimental to long-term firm value. cessfully push for buybacks more frequently when there are no other blockholders (>5%), arguably because there are no other large shareholders competing for management’s attention. Moreover, cash and valuation levels are more advantageous for share repurchases when inside ownership is high, possibly because the interests of insiders and activists are aligned with respect to value creation.

8

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We analyze long-run stock performance using a calendar-time portfolio approach. We form value-weighted portfolios (results are robust to using equal-weighted portfolios) consisting of firms that announce an OMR in a specific prior period (e.g. in the prior 12 or 24 months). If a firm has announced multiple repurchases in the preceding specified period, it is represented in the portfolio only once for a given month. To mitigate heteroscedasticity concerns, we require a minimum of five firms in the portfolio each month for holding periods of 12 months or longer and calculate heteroscedasticity-robust standard errors (Mitchell and Stafford, 20 0 0). Because shorter holding periods reduce the number of firms in a portfolio each month, for six month holding periods we create portfolios with and without the five firm restriction. Our longest post-OMR horizon is 36 months, so we truncate the sample at December 31, 2014, to ensure that we have three years of future stock returns for each sample observation. We then estimate the following time-series regression of the portfolio’s monthly excess returns on the corresponding Fama and French (2015) five factors:

R pt − R f t =

α p + β1 MK Tt + β2 SMBt + β3 HMLt + β4CMAt + β5 RMWt + ε pt ,

(2)

where Rpt is the portfolio return, Rft is the risk-free rate, MKTt is the market factor, SMBt is the size factor, HMLt is the value factor, CMAt is the investment factor, and RMWt is the profitability factor (all in month t), all collected from Kenneth French’s online data library. Then, α p is the portfolio’s abnormal monthly return. In unreported analyses, our results are qualitatively similar when using the Hou et al. (2015) q-factor model. 5.1.1. Calendar-time portfolios with 6-, 12-, 24-, and 36-month holding periods We begin our study of long-run stock performance by forming a value-weighted portfolio consisting of firms that announce an OMR in either the preceding 6, 12, 24, or 36 months. Specifically, firms enter the portfolio the month after the repurchase announcement and are dropped either 6, 12, 24, or 36 months later. For example, for the portfolio with a 12 month holding period, firms that announce a repurchase in January 1997 enter the portfolio in February 1997 and are held through January 1998. Panel A of Table 6 provides the monthly alphas from the timeseries regressions using calendar-time portfolio returns in excess of the risk-free rate. We conduct separate estimations for firms making Non-Activist OMRs, Activist OMRs, and Payout OMRs. In NonActivist OMRs, there is no evidence of long-run abnormal returns, as all specifications and holding periods produce statistically insignificant monthly alphas. This finding is consistent with the studies of Obernberger (2014) and Fu and Huang (2015), who find insignificant alphas following OMR announcements made during a similar sample period using the calendar-time portfolio approach with a 36-month holding period. In Activist OMRs, the monthly alpha for the 6-month holding period unrestricted-portfolio is 1.14% (t = 3.26). Restricting the portfolio to a minimum of five firms each month, the monthly abnormal return is a similar 1.07% (t = 3.15). Alphas are insignificant for all holding periods longer than 6 months. In Payout OMRs, alphas are economically and statistically significant across all specifications except with a 36-month holding period. The 6-month holding period monthly alphas for the unrestricted and restricted portfolios are 1.52% (t = 2.81) and 1.08% (t = 1.66), respectively. The 12- and 24-month holding period monthly alphas remain significant but decrease in magnitude to 0.83% and 0.88%, respectively. We find similar results in untabulated tests using daily data, where firms are added two days after the OMR announcement.

Do activists try to increase their return by pushing through other decisions? It is possible that our evidence of post-OMR positive abnormal returns for activist-involved firms is directly related to events such as subsequent repurchase announcements, takeover bids, or turnover in the CEO or board of directors. For example, Bargeron et al. (2017) find that post-OMR abnormal stock returns are in part driven by firms who announce additional OMRs or are the targets of takeover attempts. Greenwood and Schor (2009) and Boyson et al. (2017) document that abnormal stock returns for the targets of activist interventions are partially driven by an increased probability of being the subject of a takeover attempt. Brav et al. (2008) and Gantchev (2013) find that activist campaigns could result in changes in the CEO or chairman. We reasonably rule out that these types of events drive our calendar-time portfolio results. In particular, we restrict our sample to firms that do not announce an additional OMR, become a takeover target, or change their CEO or chairman during the holding period for the calendar time portfolio. We follow Bargeron et al. (2017) and collect takeover bids from SDC, excluding recapitalizations, self-tenders, exchange offers, minority stake purchases, and acquisitions of remaining interest. We identify changes in CEO or chairman using data from Institutional Shareholder Services. We then re-estimate alphas for our calendar time portfolios. Panel B of Table 6 reports the results. The 6month holding period monthly alphas for Activist OMRs are 1.33% (t = 3.50) in the standard approach and 1.21% (t = 3.27) in the restricted approach. The respective alphas for Payout OMRs are 1.77% (t = 2.95) and 1.96% (t = 2.13). The results reported in Table 6 imply that OMR firms with activist investors are associated with favorable long-run abnormal stock performance. It is notable that the 12-, 24-, and 36- month holding period alphas are all smaller than their 6-month counterparts. These differences suggest that the abnormal performance largely occurs in the immediate period after the OMR announcement. We further explore this issue below. 5.1.2. Calendar-time portfolios with delayed entrance In Table 7 we report alphas for calendar-time portfolios in which we delay the entrance of repurchasing firms into the portfolio. Firms enter either 7 or 13 months after their OMR announcement as opposed to one month afterwards in our Table 6 estimations. We use the same calendar-time approach and employ either 12- or 24-month holding periods. For Non-Activist OMRs and Payout OMRs, the alpha estimates are small in magnitude and statistically insignificant across all holding periods. While Activist OMRs have statistically significant alphas when firms are added after 13 months, the monthly abnormal returns (0.66% and 0.44% for the 12- and 24-month holding periods, respectively), are smaller in magnitude than those observed when firms enter one month after the OMR and are held for six months. Our interpretation of this evidence is that (i) the significant alphas reported in Table 6 are concentrated in the first six months after the OMR announcement, and (ii) these short-run positive abnormal returns do not reverse in the subsequent two years. A reversal would indicate that the short-run abnormal returns were an overcorrection to undervaluation, but the lack of such adjustment suggests that the 6-month abnormal returns reflect a proper price correction. Additionally, the lack of negative abnormal returns in the three years after an activist-involved OMR announcement is direct evidence against activists pressuring firms into detrimental repurchase programs. 5.1.3. Activist gains In our sample, activists often stay in the targeted company for two or more years. Why would activists stay involved for this length of time despite the fact that an OMR can be done relatively

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Table 6 Calendar-time portfolios. This table presents results from calendar-time portfolio regressions using the Fama and French (2015) five-factor model. For each month, value-weighted portfolios are formed that consist of firms who have announced an OMR in the previous specified period (either 6, 12, 24, or 36 months). Firms are added to the portfolio the month after the announcement. The portfolio’s monthly excess returns are then regressed on the corresponding monthly five factors (MKT, SMB, HML, RMW, and CMA) collected from Kenneth French’s data library. The alpha from this time series regression represents the portfolio’s abnormal monthly return. Except for the first column (unrestricted), all portfolios are required to have at least five firms each month. In Panel B, the sample is restricted to firms who (1) do not announce an OMR, (2) are not the subject of a takeover bid, or (3) do not have a change in CEO or Chairman during the portfolio holding period. Standard errors, which are robust to heteroscedasticity, are provided in parentheses below the estimates. ∗ , ∗∗ , and ∗∗∗ indicate significance at the 0.10, 0.05, and 0.01 levels, respectively. Panel A: portfolio returns in excess of the risk-free rate Monthly alphas from Fama-French 5-factor model Group

Unrestricted

Restricted to minimum of 5 firms each month

6-Month

6-Month

12-Month

24-Month

36-Month

0.19 (0.12) 221

0.08 (0.09) 227

−0.02 (0.06) 239

0.02 (0.06) 251

1.07∗∗∗ (0.34) 210

0.28 (0.29) 224

0.34 (0.24) 236

0.22 (0.22) 246

1.08∗ (0.65) 84

0.83∗ (0.44) 146

0.88∗∗∗ (0.33) 224

0.44 (0.31) 235

1.18∗ (0.65) 84

0.75∗ (0.44) 146

0.91∗∗∗ (0.33) 224

0.42 (0.31) 235

Non-activist OMRs Alpha (%) 0.19 St. Error (0.12) N (months) 221 Activist OMRs Alpha (%) 1.14∗∗∗ St. Error (0.35) N (months) 220 Payout OMRs Alpha (%) 1.52∗∗∗ St. Error (0.54) N (months) 212 Payout – Non-activist Alpha (%) 1.37∗∗ St. Error (0.56) N (months) 212

Panel B: excluding subsequent OMR announcements, takeover bids, and CEO/Chairman turnover Monthly alphas from Fama-French 5-factor model Group

Unrestricted

Restricted to minimum of 5 firms each month

6-Month

6-Month

12-Month

24-Month

36-Month

0.20 (0.14) 221

0.11 (0.12) 227

−0.03 (0.09) 239

0.00 (0.08) 251

1.21∗∗∗ (0.37) 210

0.26 (0.33) 224

0.37 (0.28) 234

0.24 (0.26) 246

1.96∗∗ (0.92) 70

1.35∗∗ (0.66) 106

0.59 (0.49) 201

0.76∗ (0.40) 227

2.16∗∗ (0.90) 70

1.09∗ (0.65) 106

0.57 (0.50) 201

0.77∗ (0.41) 227

Non-activist OMRs Alpha (%) 0.20 St. Error (0.14) N (months) 221 Activist OMRs Alpha (%) 1.33∗∗∗ St. Error (0.38) N (months) 220 Payout OMRs Alpha (%) 1.77∗∗∗ St. Error (0.60) N (months) 210 Payout – Non-activist Alpha (%) 1.61∗∗∗ St. Error (0.60) N (months) 210

quickly? To examine this question, we approximate the value gain of activists by calculating their dollar gain, return (%), and marketadjusted return (%) from the day prior to the 13D filing through 180 calendar days after the OMR announcement. We calculate an activist’s (i) dollar gain as the change in the stock price multiplied by the number of shares held by the activist; (ii) return (%) as the percentage stock return; and (iii) market-adjusted return (%) as the stock return minus the corresponding return on the S&P 500. The mean dollar gain equals $1.84 million for the Activist OMR group and $2.18 million for the Payout OMR group. The corresponding returns are 14.16% and 12.85%, and market-adjusted returns are 4.99% and 6.69%. Thus, it appears that activists do indeed

benefit substantially from holding their stock position from their 13D filing through at least six months after the OMR announcement. 5.2. Changes in operating performance and investment We measure changes in operating performance and investment following OMR announcements using quarterly data. We measure operating performance as operating income before depreciation and investment as the sum of capital expenditures and research and development expense. If research and development expense is missing, we set it equal to 0. Operating performance and invest-

10

D.M. Autore, N. Clarke and B. Liu / Journal of Banking and Finance 107 (2019) 105614 Table 7 Calendar-time portfolios with delayed entrance. This table presents results from calendar-time portfolio regressions using the Fama and French (2015) five-factor model. Each month, value-weighted portfolios are formed where firms are added to the portfolio either 7 or 13 months after the OMR announcement and dropped after the specified holding period (either 12 or 24 months). The portfolio’s monthly excess returns are then regressed on the corresponding monthly five factors (MKT, SMB, HML, RMW, and CMA) collected from Kenneth French’s data library. The alpha from this time series regression represents the portfolio’s abnormal monthly return. All portfolios are required to have at least five firms. Standard errors, which are robust to heteroscedasticity, are provided in parentheses below the estimates. ∗ ∗∗ , , and ∗∗∗ indicate significance at the 0.10, 0.05, and 0.01 levels, respectively. Monthly alphas from Fama-French 5-factor model Group

Firms added 7 months after repurchase announcement

Firms added 13 months after repurchase announcement

12-Month

24-Month

12-Month

24-Month

−0.05 (0.06) 239

−0.01 (0.08) 227

0.02 (0.06) 239

0.08 (0.24) 234

0.66∗∗ (0.26) 224

0.44∗ (0.23) 234

0.22 (0.38) 220

−0.08 (0.49) 124

0.05 (0.37) 216

0.25 (0.34) 220

−0.08 (0.48) 124

0.07 (0.38) 216

Non-activist OMRs Alpha (%) −0.04 St. Error (0.08) N (months) 227 Activist OMRs Alpha (%) 0.09 St. Error (0.29) N (months) 224 Payout OMRs Alpha (%) 0.07 St. Error (0.41) N (months) 141 Payout – Non-Activist Alpha (%) 0.05 St. Error (0.42) N (months) 141

ment are both scaled by the average cash-adjusted total assets at the beginning and end of period. By subtracting cash from total assets, we mitigate the concern that changes in operating performance or investment are a mechanical result attributable to a decrease in assets from repurchasing shares (Lie, 2005). If a firm announces multiple repurchases in the same fiscal quarter, only the first one is kept. Following Gong et al. (2008) and Caton et al. (2016), we examine quarterly operating performance and investment. Specifically, we subtract the average quarterly operating performance (investment) over the four-quarters ending in the announcement quarter from the average quarterly operating performance (investment) over the two subsequent four-quarter periods (e.g. four-quarter periods ending in quarters +4 and +8). Adjusted-changes in operating performance (investment) are the change in the sample firm’s performance (investment) minus the change in a matched firm’s performance (investment). For operating performance, to match sample firms to control firms, we use the matching algorithm of Lie (2005). We first require that matched firms have not had an OMR announcement in the prior two years, and that sample and match firms must have operating performance data for all periods. We then require that match firms have the same two-digit SIC code, operating performance within +/–20% or +/–0.01 in the announcement quarter, operating performance within +/–20% or +/–0.01 over the prior four quarters ending with the announcement quarter, and marketto-book ratios within +/– 20% or +/–0.1. The vast majority of firms yield a match using this criteria, however if this process does not yield a match, we ease our SIC restriction to one-digit. If a match is still not produced, we first remove the SIC restriction and then finally the prior performance and market-to-book restrictions. The match firm minimizes the sum of the absolute differences between the four-quarter prior operating performance and the announcement quarter operating performance. Because operating performance is positively skewed, we measure medians and means winsorized at the 1st and 99th percentiles similar to Lie (2005) and Gong et al. (2008). We also report

p-values associated with t-tests and sign tests. Panel A of Table 8 presents the results. The Non-Activist OMRs sample exhibits increases in operating performance in the one and two years immediately following OMR announcements. Firms in both activist samples experience increases in operating performance in the second year after the OMR announcement. Post-OMR increases in operating performance are consistent with Lie (2005). For changes in investment, we match sample firms to control firms with an algorithm similar to Lie (2005), but we substitute investment for operating performance. In Panel B of Table 8, we find a decline in investment after Non-Activist OMRs, which is consistent with a negative relationship between repurchases and investment documented by Grullon and Michaely (2004). While there is some evidence of a marginal decline in investment in the one year following Activist OMRs, the two year change is indistinguishable from zero. Following Payout OMRs, we find no evidence firms reduce their levels of investment. Finally, In Panels C and D we report changes in CAPEX and R&D separately. We find that, compared with the Non-Activist OMR group where the average firm significantly decreases CAPEX and R&D expenditures, firms in the Payout OMRs keep their CAPEX and R&D expenditures at a level similar to that prior to the OMR. Moreover, the mean difference in the change in R&D between firms in Non-Activist OMRs and those in Payout OMRs is significant both economically and statistically. These findings represent direct evidence against recent scrutiny originating from investment professionals that activist-involved OMRs represent suboptimal corporate decisions with myopic motives. To wit: not only do activist-involved firms exhibit high levels of cash and undervaluation prior to OMRs, they subsequently experience positive abnormal returns and increases in operating performance. 5.3. Changes in dividend policies connected to activist-involved OMRs To the extent that an activist pushes for a share repurchase, it could cause a change in the firm’s dividend policy. Thus, we examine the change in dividend payout policy for activist OMRs

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Table 8 Changes in operating performance and investment. This table presents adjusted-changes in operating performances and investment. Quarter 0 represents the OMR announcement quarter. Operating performance is measured as operating income before depreciation. Investment is measured as the sum of research and development expense and capital expenditures; if research and development expense is missing, we set it equal to 0. Operating performance and investment are both scaled by the average of beginning- and ending-period cash-adjusted assets (total assets minus cash and short-term investments). For changes in operating performance, sample firms are matched to control firms on industry, prior operating performance, and market-to-book ratios using the Lie (2005) matching algorithm. For changes in investment, we use an algorithm similar to Lie (2005) to match sample firms to control firms, but we substitute investment for operating performance. Changes are measured as the average quarterly operating performance (investment) over a four quarter period (either quarters +1 through +4 or quarters +5 through +8) minus the average quarterly operating performance (investment) over the four quarter period ending in the announcement quarter (quarters −3 through 0). Adjusted-changes are measured as the change in the sample firm’s operating performance (investment) minus the change in the control firm’s operating performance (investment). Means have been winsorized at the 1st and 99th percentiles. P-values (based on t-tests and sign tests) are reported in parentheses. ∗ , ∗∗ , and ∗∗∗ indicate significance at the 0.10, 0.05, and 0.01 levels, respectively. Panel A: changes in operating performance Quarters

−3 to 0 through +1 to +4 −3 to 0 through +5 to +8

Non-activist OMRs (n = 7743)

Activist OMRs (n = 412)

Payout OMRs (n = 117)

Payout – Non-activist

Mean (%)

Mean (%)

Median (%)

Mean (%)

Median (%)

Mean (%)

Median (%)

0.036 (0.812) 0.391∗∗ (0.045)

0.036 (0.301) 0.031 (0.183)

0.216 (0.344) 0.843∗∗∗ (0.009)

0.062 (0.267) 0.061 (0.139)

0.033 (0.915) 0.507 (0.115)

0.049 (0.561) 0.031∗∗ (0.045)

∗∗∗

0.183 (0.000) 0.336∗∗∗ (0.000)

Median (%) ∗∗

0.013 (0.012) 0.030∗∗∗ (0.000)

Panel B: changes in investment Quarters

Non-activist OMRs (n = 7765)

Activist OMRs (n = 392)

Payout OMRs (n = 112)

Payout – Non-activist

Mean (%)

Median (%)

Mean (%)

Median (%)

Mean (%)

Median (%)

Mean (%)

Median (%)

−3 to 0 through +1 to +4

−0.335∗∗∗ (0.004) −0.459∗∗∗ (0.001)

−0.002∗∗ (0.017) 0.000 (0.845)

−0.203∗ (0.089) −0.250 (0.284)

−0.001 (0.879) 0.000 (0.960)

0.001 (0.992) 0.099 (0.646)

0.001 (0.777) 0.001 (0.925)

0.33∗ (0.058) 0.558∗∗ (0.028)

0.003 (0.480) 0.001 (0.278)

−3 to 0 through +5 to +8

Panel C: changes in capital expenditures Quarters

−3 to 0 through +1 to +4 −3 to 0 through +5 to +8

Non-activist OMRs (n = 7765)

Activist OMRs (n = 392)

Payout OMRs (n = 112)

Payout – Non-activist

Mean (%)

Mean (%)

Median (%)

Mean (%)

Median (%)

Mean (%)

Median (%)

0.001 (0.678) 0.001 (0.723)

−0.049 (0.659) 0.033 (0.821)

0.001 (0.925) 0.001 (0.412)

0.059 (0.601) 0.146 (0.332)

0.004 (0.592) 0.001 (0.250)

∗∗∗

−0.107 (0.000) −0.112∗∗∗ (0.000)

Median (%) −0.003 (0.000) 0.000 (0.354)

∗∗∗

∗

−0.169 (0.066) −0.189∗ (0.084)

Panel D: Cchanges in research and development Quarters

Non-activist OMRs (n = 7765)

Activist OMRs (n = 392)

(n = 112)

Mean (%)

Median (%)

Mean (%)

Median (%)

Mean (%)

Median (%)

Mean (%)

Median (%)

−3 to 0 through +1 to +4

−0.228∗∗ (0.047) −0.347∗∗∗ (0.006)

0.000 (0.671) 0.000 (0.696)

−0.034 (0.665) −0.062 (0.660)

0.000 (0.495) 0.000 (0.942)

0.050 (0.418) 0.066 (0.612)

0.000 (0.236) 0.000 (0.601)

0.278∗∗ (0.033) 0.413∗∗ (0.024)

0.000 (0.285) 0.000 (0.943)

−3 to 0 through +5 to +8

from before to after the OMR announcement. Table 9 presents the results. We find that, across the entire sample of OMRs, there is a significant decrease in dividend yield, dividend payout ratio, and the actual dividend per share from before to after the OMR announcement. This finding is consistent with Grullon and Michaely (2002) who provide evidence that firms have gradually substituted repurchases for dividends. Importantly, we find that the decrease in dividend payout is larger in magnitude for our Payout OMRs, suggesting that activist involvement is more often associated with repurchases substituting for dividends.

6. Endogeneity The results to this point suggest that activist involvement in OMR firms is associated with improved OMR timing. Activistinvolved firms conduct OMRs with excess cash holdings and undervalued stock prices. It is more difficult, however, to determine whether activists cause firms to use repurchases to distribute ex-

Payout – Non-activist

cess cash and capitalize on undervaluation, or whether they merely take positions in firms that subsequently use repurchases in this way. In this section we try to distinguish between these two possibilities. In Section 6.1 we exploit the fact that blockholders can choose to identify as either passive or active investors. In Section 6.2 we study the subsample of firms that make multiple OMRs to compare activist-involved OMRs versus non-activist OMRs conducted by the same firms.8

8 In unreported analyses, we examine the likelihood of a firm announcing an OMR after being targeted by an activist investor seeking an increase in shareholder payout. Using Bloomberg’s ‘Document Search’ tool, we identify 504 Schedule 13Ds filed from 2001-2013 that fit our ‘engaged’ and ‘payout’ classifications but are not followed by an OMR in the next two years. Based on logistic estimations using this expanded 13D sample, we find that firms that are the subject of an ‘Engaged’ Schedule 13D are more likely announce a subsequent OMR if they are larger and have lower market-to-book ratios, higher levels of cash holdings, and better operating performance.

12

D.M. Autore, N. Clarke and B. Liu / Journal of Banking and Finance 107 (2019) 105614 Table 9 Changes in dividend policies. This table presents summary statistics for change in dividend policies after OMR announcements. We measure changes in dividend yield (dividends per share divided by share price), dividend payout (total dividends divided by net income), and dividends per share in Panels A, B, and C, respectively. For each measure, we calculate the average over the four quarters prior to and eight quarters after the OMR announcement, as well as the average change from before to after the announcement. Panel A: changes in dividend yield Group

Average DY (%) over 4 Quarters prior to OMR Mean (1)

Average DY (%) over 8 Quarters after OMR Mean (2)

Average change in DY (%) Mean (3)

t (3) (4)

Non-activist OMRs Activist OMRs Payout OMRs

0.25 0.21 0.21

0.23 0.16 0.13

−0.02 −0.04 −0.08

−6.04 −2.52 −2.48

Panel B: changes in dividend payout Group

Average DP (%) over 4 Quarters prior to OMR Mean (1)

Average DP (%) over 8 Quarters after OMR Mean (2)

Average change in DP (%) Mean (3)

t (3) (4)

Non-activist OMRs Activist OMRs Payout OMRs

16.27 12.45 12.62

14.80 10.58 6.25

−1.48 −1.88 −6.37

−3.58 −1.00 −2.14

Panel C: changes in dividends per share Group

Average Div/Shr over 4 Quarters prior to OMR Mean (1)

Average Div/Shr over 8 Quarters after OMR Mean (2)

Average change in Div/Shr Mean (3)

t (3) (4)

Non-activist OMRs Activist OMRs Payout OMRs

7.84 4.76 5.71

6.22 3.23 3.38

−1.62 −1.54 −2.33

−15.73 −3.57 −2.38

6.1. Passive investors An investor whose equity stake in a company exceeds 5% but who only wants to take a passive investment position can file a Schedule 13G. Like 13D filings, 13Gs require investors holding more than 5% of a company’s equity to report their ownership to the SEC within ten days of crossing the 5% threshold. However, unlike 13D filers, 13G filers are legally forbidden from influencing the firm and its management. Moreover, 13G filings are less stringent and require less information disclosure. Thus, 13G filers are often referred to as passive investors. Prior studies also exploit this difference between 13Ds versus 13Gs (e.g., Clifford, 2008; Brav et al., 2015; Boyson et al., 2017). We exploit this active versus passive heterogeneity in block holdings to better understand the role of activists in OMRs. If activists play a causal role in OMR decisions to help firms time periods of undervaluation and excess cash holdings, we should detect better OMR timing when the repurchase is associated with a 13D filing as opposed to a 13G filing. Alternatively, if activists have little direct influence on firms’ OMR decisions, we should observe little difference between OMRs partitioned by the type of activist filing. To conduct our tests, we identify OMRs associated with 13G filings by activists who also make 13D filings in our sample. In this way, we are studying the impact of a 13G filing only for activist investors who take both active (13D filings) and passive (13G filings) positions during our sample period. This method mitigates the concern that some activists only use 13Gs while others use 13Ds. In particular, we collect Schedule 13Gs filed by all activists who also filed a 13D within our Payout OMRs sample. We examine only activists in Payout OMRs because we are interested in investors who explicitly focus on shareholder payout decisions. We identify 81 OMRs within the Non-Activist OMRs sample that are associated with a passive 13G filing by an activist investor who is also a 13D filer within our Payout OMRs sample. We refer to this sample of 13G-associated OMRs as Passive OMRs. Panel A of Table 10 shows that compared to firms conducting Payout OMRs, firms conducting Passive OMRs are smaller,

have higher market-to-book ratios, announce smaller repurchase programs, and subsequently buy back fewer shares. Although industry-adjusted cash levels are lower in magnitude for Passive OMRs, we find no statistical difference between groups. In Panel B, the decomposed market-to-book ratio reveals that firms announcing Passive OMRs are not undervalued, and, compared to firms announcing Payout OMRs, they are overvalued and have more growth opportunities. Finally, in Panel C we find the differences in misvaluation are no longer present one year after the OMR announcement. Table 11 presents calendar-time portfolio abnormal stock returns for Payout OMRs and Passive OMRs. Because the Passive OMRs sample is small, we do not restrict the number of firms in each portfolio for either group. For Payout OMRs, the alphas based on unrestricted holding periods are positive and significant, similar to the restricted portfolio alphas reported in Table 6. However, for Passive OMRs the alphas are insignificant at all time horizons. Thus, for OMR firms in which the same activists from Payout OMRs take passive investment roles, we find no evidence of pre-OMR undervaluation or post-OMR abnormal stock returns. In view of this non-finding for Passive OMRs, our interpretation of the main findings for Payout OMRs is that activist investors have a direct and positive influence on firms’ OMR decisions.

6.2. Firms that make multiple OMR announcements We examine firms who make multiple OMR announcements in which one is associated with an activist presence and the other is not. If activists simply pick firms who are adept at timing repurchases to periods of undervaluation and excess cash holdings, then the presence of an activist should not affect the timing or outcomes of OMRs by these firms. To conduct this test, we identify 318 OMRs (from our Non-Activist OMR sample) that are announced by firms in our Payout OMRs sample at a time when there is no activist campaign initiated on the firm in the prior two years. We refer to this sample as Multiple OMRs and provide the results in columns 6 to 8 of Table 10 and rows 7 to 9 of Table 11.

D.M. Autore, N. Clarke and B. Liu / Journal of Banking and Finance 107 (2019) 105614

13

Table 10 Passive OMRs and multiple OMRs. This table presents summary statistics and decomposed market-to-book ratios for Payout OMRs, Passive OMRs, and Multiple OMRs. Passive OMRs are defined as Non-Activist OMRs in which a Payout OMRs activist holds over a 5% passive stake (identified through Schedule 13G filings) in the announcing firm. Multiple OMRs are defined as Non-Activist OMRs by firms who announce at least one Payout OMR. We report the test statistic from t-tests of the differences between Payout OMRs and the other two samples. Panel A provides summary statistics for OMR and firm characteristics. Panels B and C report components of the decomposed market-to-book ratio. Panel B reports values as of the quarter ending immediately prior to the repurchase announcement, and Panel C reports values at the quarter ending at least one year after the OMR announcement. Variable definitions are presented in Appendix B. Panel A: OMR and firm characteristics Payout OMRs Characteristic

28_DAY_CAR (%) PERC (%) ACTUAL_REP (%) MB AT (Mil $) CAT (%) IND_ADJ_CAT (%)

Passive OMRs

Multiple OMRs

N (1)

Mean (2)

N (3)

Mean (4)

t(4–2) (5)

N (6)

Mean (7)

t(7–2) (8)

168 153 168 164 166 166 166

2.26 11.17 7.14 1.34 2222 17.31 7.51

81 75 81 81 81 81 81

−1.82 7.97 5.25 1.61 1422 19.08 4.47

−2.03 −2.25 −2.36 2.96 −1.77 0.67 −1.26

318 281 318 307 308 308 308

−1.88 8.96 7.15 1.67 3367 16.80 5.59

−3.25 −2.36 −0.02 3.97 1.44 −0.28 −1.20

Panel B: market-to-book decomposition prior to repurchase announcements Component

ln (MB) Firm misvaluation Sector misvaluation Total misvaluation Growth

Payout OMRs (n = 162)

Passive OMRs (n = 81)

Multiple OMRs (n = 301)

Mean (1)

t (2)

Mean (3)

t (4)

t(3–1) (5)

Mean (6)

t (7)

t(6–1) (8)

0.337 −0.063 −0.033 −0.096 0.433

7.03 −1.49 −2.42 −2.17 9.36

0.703 0.102 −0.028 0.073 0.630

8.11 1.25 −1.35 0.84 10.44

4.01 1.99 0.20 1.93 2.52

0.593 0.010 −0.034 −0.024 0.617

16.52 0.35 −3.56 −0.81 18.74

4.25 1.44 −0.07 1.39 3.27

Panel C: market-to-book decomposition 1-year after repurchase announcements Component

ln (MB) Firm misvaluation Sector misvaluation Total misvaluation Growth

Payout OMRs (n = 151)

Passive OMRs (n = 76)

Mean (1)

t (2)

Mean (3)

t (4)

t(3–1) (5)

Mean (6)

t (7)

t(6–1) (8)

0.341 −0.008 −0.043 −0.051 0.392

5.99 −0.18 −2.59 −1.08 8.53

0.610 0.101 −0.056 0.045 0.565

5.93 1.26 −2.94 0.53 8.69

2.49 1.30 −0.48 1.07 2.18

0.557 0.030 −0.036 −0.006 0.563

13.03 0.94 −3.50 −0.17 16.31

2.97 0.69 0.39 0.77 2.91

Table 10 shows that compared to Payout OMRs, Multiple OMRs are associated with higher market-to-book ratios but statistically similar pre-OMR cash levels. Similar to Passive OMRs, the decomposed market-to-book ratio for the Multiple OMRs subsample reveals no total misvaluation. In Table 11, we estimate calendar time portfolios and report no post-OMR abnormal stock returns at any time horizon for firms conducting Multiple OMRs. It is possible that the differences between Multiple OMRs and Payout OMRs is driven by a change in the firm’s management, not a change in activist presence. Of the 318 Multiple OMRs, we identify 24 which are conducted under either a different CEO or Chairman relative to the Activist OMR. In unreported analysis, all Multiple OMRs results are qualitatively similar if we exclude these 24 OMRs. The results are consistent with the view that firms that make multiple OMRs only capitalize on undervaluation in their OMRs when an activist is involved. 6.3. Interpretation of causal role Together, the evidence in Sections 6.1 and 6.2 point toward a casual interpretation in which activist involvement influences firms to announce repurchases when their shares are undervalued, but there is not enough evidence to statistically support a causal interpretation with regard to pre-OMR cash levels. However, it is important to note that we are unable to completely rule out endogeneity because we cannot observe private in-

Multiple OMRs (n = 307)

teractions between activists and firms. It is possible that a Schedule 13D filing and its disclosed purpose (i.e., seeking payouts of excess cash as mentioned in Purpose of Transaction for Payout OMRs) are enough to influence the firm’s management. It is also possible that after the initial 13D filing, activists hold private discussions with the firm to influence the exact timing of the OMR. Nonetheless, since there is no evidence of pre-OMR undervaluation or postOMR abnormal returns when activists take only a passive role and when the same firms announce OMRs without an activist present, the evidence points toward a causal interpretation whereby activists have a direct and favorable influence on the timing of Activist OMRs. 7. Expanded sample of 13D filings In this section we construct an expanded sample of 13D filings in which activist investors target increased payout, irrespective of whether the targeted firm makes an OMR announcement in the following two years. This approach enables us to examine whether activists pushing for payout are successful in achieving OMRs or possibly other forms of payout including special dividends or tender offers. Specifically, we use Bloomberg’s ‘Document Search’ tool to identify Schedule 13Ds filed during 2001–2013 (for which we have access to Bloomberg data) that fit our ‘engaged’ and ‘payout’ criteria (i.e. where the activist has the specific intent to increase firm

14

D.M. Autore, N. Clarke and B. Liu / Journal of Banking and Finance 107 (2019) 105614 Table 11 Calendar-time portfolios for passive OMRs and multiple OMRs. This table presents results from calendar-time portfolio regressions using the Fama and French (2015) five-factor model. Each month, value-weighted portfolios are formed that consist of firms that have announced an OMR in the previous specified period (either 6, 12, or 24 months). Firms are added to the portfolio the month after the announcement. The portfolio’s monthly excess returns are then regressed on the corresponding monthly five factors (MKT, SMB, HML, RMW, and CMA) collected from Kenneth French’s data library. The alpha from this time series regression represents the portfolio’s abnormal monthly return. There are no restrictions on the minimum number of firms in each portfolio. Standard errors, which are robust to heteroscedasticity, are provided in parentheses below the estimates. ∗ , ∗∗ , and ∗∗∗ indicate significance at the 0.10, 0.05, and 0.01 levels, respectively. Type

Payout OMRs Alpha (%) St. Error N (months) Passive OMRs Alpha (%) St. Error N (months) Payout – Passive Alpha (%) St. Error N (months) Multiple OMRs Alpha (%) St. Error N (months) Payout – Multiple Alpha (%) St. Error N (months)

Monthly alphas from Fama-French 5-factor model 6-Month

12-Month

24-Month

1.52∗∗∗ (0.54) 212

1.16∗∗∗ (0.39) 224

0.88∗∗∗ (0.33) 236

−0.56 (0.73) 168

−0.64 (0.61) 208

0.19 (0.55) 221

∗∗

∗∗∗

1.69 (0.93) 168

1.92 (0.72) 208

0.57 (0.60) 221

0.16 (0.42) 221

−0.12 (0.33) 227

−0.39 (0.30) 229

1.24∗ (0.69) 212

1.31∗∗ (0.52) 224

1.34∗∗∗ (0.42) 236

payout) but are not necessarily connected to a subsequent OMR. In this way, we can assess a starting point of activist intent, and then compare outcomes; i.e. successful attempts to increase payout versus failed attempts. We identify 605 Schedule 13D filings that meet this criteria and refer to these observations as “Payout 13Ds.” Within this group, we identify a subset of 101 Schedule 13Ds that are followed by at least one OMR in the following two years (henceforth OMR Payout 13Ds). Moreover, an additional 47 of the 13Ds are followed by a large dividend increase, defined as an increase of at least 10% in the average dividend yield from the four quarters prior to the 13D filing to the eight quarters after the 13D filing, or the payment of a special dividend (CRSP code 1262 or 1272). A further two 13D filings lead to a tender offer. We refer to these 49 observations as Dividend and Tender Offer Payout 13Ds. For the remaining 455 13Ds, we are not able to identify subsequent payout activity and refer to these as Failed Payout 13Ds. In Panels A and B of Table 12, we observe that Failed Payout 13Ds are associated with lower magnitudes of cash holdings, greater operating cash flow volatility and more quarters of negative operating cash flows, compared to OMR Payout 13Ds. Interestingly, Dividend and Tender Offer Payout 13Ds are also associated with high magnitudes of cash levels than Failed Payout 13Ds. Moreover, In Panel C we report that prior to the 13D filing, OMR Payout 13Ds have a negative value of total misvaluation that is three times larger in magnitude than the value for Failed Payout 13Ds (–0.09 versus –0.03), and Dividend and Tender Offer Payout 13Ds have a value equal to 0.00. Thus it appears that successful activist campaigns more often result in repurchases when there is undervaluation and dividend-related payouts when there is not. Overall, across panels the consistent differences in magnitude be-

tween groups, though often statistically insignificant, are suggestive of the view that activist interventions with a payout objective tend to result in OMRs at times when the firm’s cash and valuation environment are more suitable for a share repurchase. Finally, in unreported analysis, we conduct calendar-time portfolio regressions to estimate alphas of Failed Payout 13Ds. Using this sample, firms enter the calendar-time portfolios the month after the 13D filing and are held for 12-, 24-, or 36-months. We find no evidence of significant alphas. For comparison, we perform an identical analysis for firms in OMR Payout 13Ds whereby each firm enters the month after the 13D filing. For the 24-month holding period, which overlaps the 6-month post-OMR period for a majority of OMR Payout sample firms, the monthly alpha equals 0.64% (t = 1.88). This evidence indicates that Payout 13Ds tend to have better stock price outcomes if they are followed by OMRs. Overall, shareholder activism that targets firm payout seems to have better outcomes when the intended action successfully takes place.

8. Conclusion Prior work establishes that shareholder activism is associated with increases in firm value (e.g., Gillan and Starks, 2007; Bebchuk et al., 2015; Denes et al., 2016). Moreover, a long-held view in the literature is that corporate share repurchases signal stock undervaluation and reduce agency costs associated with excess cash. This is evidenced by favorable reactions to repurchase announcements (e.g., Dann, 1981; Vermaelen, 1981; Comment and Jarrell, 1991), positive post-announcement abnormal stock performance (e.g., Ikenberry et al., 1995; Peyer and Vermaelen, 2009), survey evidence that managers state undervaluation as a motivation for share repurchases (Brav et al., 2005), and more favorable market reactions to repurchase announcements by firms more likely to overinvest (Grullon and Michaely, 2004). Nevertheless, recently investment professionals and media outlets have criticized activist shareholders for pressuring firms into open market share repurchases to benefit short-term objectives at the expense of investing in long-term value-adding projects. To date, there is little empirical evidence to support or refute these claims. We fill this gap by directly examining activist-involved share repurchases. We study the impact of shareholder activism on firms’ open market share repurchases using hand-collected activism data from 1997 to 2015. The findings indicate that OMR firms subject to an activist 13D filing, and in particular to an activist that specifically states the intention of increased shareholder payout, use repurchases to distribute excess cash and capitalize on underpriced shares. These firms have higher levels of cash holdings and are more undervalued than average repurchasing firms. Moreover, they exhibit positive abnormal stock returns in the months after the OMR announcement, and the abnormal returns do not revert in subsequent years. These activist-involved firms repurchase larger percentages of outstanding shares, but there is no evidence that this comes at the expense of long-term operating performance or investment. To facilitate a causal interpretation of our findings, we examine (i) activists who take only a passive role and (ii) firms who announce OMRs both with and without an activist presence. The results support our main tests. Overall, the findings suggest that, on average, OMRs by activist-targeted firms are not suboptimal corporate decisions with myopic motives. The presence of an activist is associated with improved timing of OMR announcements. Our study complements other recent articles showing the beneficial effects of shareholder activism through various other channels; i.e. debt restructuring (Lim, 2015), ownership changes (Brav et al., 2015), and takeover bids (Boyson et al., 2017).

D.M. Autore, N. Clarke and B. Liu / Journal of Banking and Finance 107 (2019) 105614

15

Table 12 Expanded sample of 13D filings. This table presents analysis for an expanded sample of Schedule 13Ds filed between 2001 and 2013. Using Bloomberg’s Document Search tool, we identify 605 13Ds filed between 2001 and 2013 that meet our Payout criteria. Of these, 101 are in our original Payout OMRs sample (OMR Payout 13Ds). Out of the additional 504, 49 are followed by an increase in dividends (47) or a tender-offer repurchase (2) within the subsequent two years (Dividend and Tender Offer Payout 13Ds). We define an increase in dividends as the payment of a special dividend (CRSP code 1262 or 1272) or an increase of at least 10% in the average dividend yield (dividends per share divided by share price) from the four quarters prior to the eight quarters after the 13D filing. The remaining 455 Schedule 13Ds are not followed by any increase in payout in the subsequent two years (Failed Payout 13Ds). Panels A and B replicate the cash holdings analysis from Table 4, and Panels C and D replicate the market-to-book decomposition from Table 5. However, in Panels A and B Quarter 0 represents the quarter of the 13D filing, and in Panels C and D we decompose the market-to-book ratio relative to the quarter of the 13D filing. Variable definitions are provided in Appendix B. Panel A: evolution of cash holdings Industry-adjusted cash-to-assets (IND_ADJ_CAT) Quarter

−8 −7 −6 −5 −4 −3 −2 −1 0 +1 +2 +3

All payout 13Ds (n = 605)

OMR Payout 13Ds (n = 101)

Dividend and tender offer payout 13Ds (n = 49)

Failed payout 13Ds (n = 455)

Mean (1)

t (2)

Mean (3)

t (4)

Mean (6)

t (7)

t(6–1) (8)

Mean (9)

t (10)

t(9–1) (11)

6.99 6.89 6.81 6.73 6.77 6.38 6.88 6.98 6.44 6.95 6.83 6.29

8.74 8.76 8.54 8.59 8.75 8.48 9.03 9.09 7.75 7.78 7.56 6.70

9.40 8.76 8.66 9.17 9.07 8.29 9.06 9.58 7.80 8.39 8.22 8.26

5.00 4.91 4.72 5.18 5.27 5.20 5.47 5.68 4.78 5.31 5.35 5.02

7.43 9.39 9.32 9.40 8.69 7.87 8.61 8.35 8.18 9.55 8.60 9.06

2.47 2.91 3.11 2.81 2.91 2.73 2.91 2.76 2.80 3.03 2.80 2.79

−0.56 0.17 0.19 0.06 −0.11 −0.13 −0.13 −0.35 0.11 0.33 0.11 0.22

6.41 6.17 6.11 5.86 6.02 5.74 6.16 6.20 5.68 5.90 5.89 4.97

6.95 6.84 6.63 6.57 6.70 6.48 6.91 6.94 5.60 5.26 5.08 4.20

−1.43 −1.30 −1.24 −1.67 −1.57 −1.40 −1.54 −1.77 −1.10 −1.28 −1.21 −1.62

Panel B: reasons for excess cash Quarter(s)

All payout 13Ds

OMR Payout 13Ds

Dividend and tender offer payout 13Ds

Failed payout 13Ds

Mean (1)

Mean (3)

t (4)

Mean (6)

t (7)

t(6–1) (8)

Mean (9)

t (10)

t(9–1) (11)

2.60 2.52 2.42

8.55 11.44 12.24

3.56 3.50 3.30

5.82 6.28 6.93

1.40 1.63 1.70

3.27 2.90 3.01

16.67 20.08 15.61

1.86 1.66 2.13

0.17 0.85 1.84

3.07 5.49 6.45

0.42 1.21 1.57

0.24 1.01 2.04

11.37 17.21 19.28

2.45 3.74 3.69

t (2)

Operating cash flow volatility (CF_VOL) −5 3.19 19.40 −1 2.94 24.18 +3 2.90 20.08

Number of quarters with negative operating cash flows (NEG_CF) 0.22 12.39 0.14 4.02 −1 −4 to −1 0.94 19.45 0.64 7.98 −8 to −1 1.91 21.71 1.33 8.26 Panel C: market-to-book decomposition prior to schedule 13D filing Component

ln (MB) Firm misvaluation Sector misvaluation Total misvaluation Growth

All payout 13Ds (n = 517)

OMR Payout 13Ds (n = 92)

Dividend and tender offer payout 13Ds (n = 44)

Failed payout 13Ds (n = 381)

Mean (1)

t (2)

Mean (3)

t (4)

Mean (6)

t (7)

t(6–1) (8)

Mean (9)

t (10)

t(9–1) (11)

0.519 0.011 −0.050 −0.039 0.559

14.21 0.33 −5.38 −1.22 20.41

0.391 −0.045 −0.045 −0.090 0.481

5.24 −0.65 −2.35 −1.24 7.48

0.500 0.062 −0.062 0.000 0.500

4.20 0.63 −1.53 0.00 5.08

0.78 0.89 −0.38 0.76 0.16

0.552 0.018 −0.050 −0.032 0.584

12.55 0.48 −4.62 −0.82 18.40

1.87 0.80 −0.25 0.71 1.44

Panel D: market-to-book decomposition two years after schedule 13D filing Component

ln (MB) Firm misvaluation Sector misvaluation Total misvaluation Growth

All payout 13Ds (n = 294)

OMR Payout 13Ds (n = 82)

Dividend and tender offer payout 13Ds (n = 44)

Failed payout 13Ds (n = 168)

Mean (1)

t (2)

Mean (3)

t (4)

Mean (6)

t (7)

t(6–1) (8)

Mean (9)

t (10)

t(9–1) (11)

0.447 0.011 −0.006 0.005 0.442

8.35 0.25 −0.41 0.11 11.30

0.436 0.027 −0.040 −0.013 0.449

5.39 0.44 −1.98 −0.19 6.90

0.295 0.013 −0.038 −0.025 0.320

2.14 0.11 −0.94 −0.22 2.47

−0.88 −0.11 0.06 −0.09 −0.89

0.493 0.002 0.020 0.022 0.471

6.40 0.03 1.03 0.33 9.35

0.51 −0.29 2.15 0.36 0.27

Appendix A. Payout 13D Examples Below we provide excerpts from two Schedule 13Ds that are part of our Payout subsample. The excerpts are from the section ‘Item 4: Purpose of Transaction.’ Example 1 Schedule 13D filed by: Westcap Investors, LLC Subject Firm: ValueVision Media, Inc. Filing Date: June 28, 2005

Item 4 Excerpt: “The Reporting Person originally acquired the securities of the Issuer reported on this Schedule 13-D for investment purposes and continues to do so, but has become disappointed in the Issuer’s results of operations. Consistent with its investment purpose, and to seek to increase shareholder value, the reporting Person has decided to attempt to influence the Issuer’s board of directors and management with a goal to enhance shareholder value. The Reporting person intends to engage in direct discussions with the

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Issuer’s management and directors. The Reporting Person intends to suggest that the Issuer take some or all of the following steps which the Reporting Person considers consistent with the Reporting Person’s investment purpose: (1) re-evaluate the issuer’s strategic direction, (2) hire an investment banker to evaluate whether the Issuer should remain independent or should seek to become a merger or acquisition candidate and (3) distribute cash not needed for operations through repurchasing a significant portion of its outstanding shares. The Reporting Person has no current plans to seek or propose, but may in the future consider, after the results of conversations with the Issuer’s management and directors are known, other alternatives for its investment in the Issuer including pursuing or advancing: (a) an extraordinary corporate transaction, such as a merger or liquidation, involving the Issuer; (b) a sale or transfer of a material amount of assets of the Issuer; (c) changes in the composition of the Issuer’s board of directors or committees thereof, (d) a change in the present dividend policy of the Issuer as an alternative to a stock repurchase; (e) other material changes in the Issuer’s business or corporate structure; or (f) actions similar to those enumerated above. The Reporting Person does not intend to propose, and presently would expect to oppose, changes in the Issuer’s charter or other actions which may impede the acquisition of control of the Issuer by a third party.” Example 2 Schedule 13D filed by: Trian Fund Management, LP Subject Firm: Family Dollar Stores, Inc. Filing Date: July 28, 2010 Item 4 Excerpt: “The Filing Persons acquired the Shares and Options (collectively, “Issuer Securities") because they believe that the Shares are currently undervalued in the market place and represent an attractive investment opportunity. The Trian Group has met with Howard R. Levine, Chairman of the Board and Chief Executive Officer of the Issuer and members of senior management of the Issuer to discuss the Issuer’s business and strategies to enhance value for the Issuer’s shareholders. During these discussions, the Trian Group communicated its view that there is an opportunity to enhance shareholder value by improving the Issuer’s operational performance. The Filing Persons look forward to working with the Issuer on operating initiatives such as increasing sales per square foot to peer levels, improving the Issuer’s operating leverage and optimizing the number of new store openings. The Trian Group also discussed how the Issuer could utilize its capital structure and significant free-cash flow, including by considering the use of prudent amounts of leverage to increase the size of the Issuer’s stock repurchase program. In addition, the Trian Group provided examples of previous investments they (and/or entities affiliated with them) made in which they had helped create significant value by working together with management teams and boards of directors to improve operations and cash flows and enhance shareholder value.”

Appendix B. Variable definitions Unless otherwise noted, variables are constructed using data from CRSP and Compustat and are measured as of the quarter prior to the repurchase announcement. All accounting variables are winsorized at the 1st and 99th percentiles.

3_DAY_CAR:

11_DAY_CAR:

28_DAY_CAR:

ABN_ACC:

ACC_QUAL:

Cumulative abnormal returns measured as the sum of abnormal returns over the 3 days centered on the event, where abnormal returns are based on a market adjustment using the CRSP value-weighted index Cumulative abnormal returns measured as the sum of abnormal returns over the 11 days centered on the event, where abnormal returns are based a market adjustment using the CRSP value-weighted index Cumulative abnormal returns measured as the sum of abnormal returns over days –22 through +5 (where day 0 is the event), where abnormal returns are based on a market adjustment using the CRSP value-weighted index Abnormal accruals; measured as the industry- and performance-matched residuals from the model of Gong et al. (2008). In particular, we conduct industry-quarter regressions in which we regress total accruals against fiscal quarter dummies, change in sales, current property/plant/equipment, one-quarter lag of total accruals, and current total assets. We then adjust firms’ individual residuals by subtracting the median residual of a performance- and industry-matched portfolio. For each repurchase observation, the variable ABN_ACC is the average of the adjusted residual from the quarter of and immediately prior to the announcement. Accruals quality; measured as the standard deviation of a firm’s residuals following a modified Dechow and Dichev (2002) model similar to Lee and Masulis (2009) and Billett and Yu (2016). In particular, we run industry-quarter regressions of total current accruals onto the prior quarter’s operating cash flow, the current quarter’s operating cash flow, next quarter’s operating cash flow, change in sales, and current property/plant/equipment using five quarters of data. ACC_QUAL is measured as of the fiscal quarter prior to the OMR announcement.

ACTIVIST_SHARES: Reported percentage of shares owned by Schedule 13D filer ACTUAL_REP: Actual repurchases; following Fama and French (2001) and Skinner (2008), measured as the Change in Treasury Stock. If Treasury Stock is 0 for the announcement and prior quarter, then Net Repurchases (Stock Purchases - Stock Issuances) is used. If both are negative or missing, repurchases are set to 0. Actual repurchases are then the sum of actual repurchases in the quarters of and four following the announcement, scaled by the market capitalization at the beginning of the announcement quarter. AT: Total assets AVG_TURN: Average turnover; average daily trading volume over a 90 trading-day window ending 10 trading-days prior to the OMR announcement, scaled by common shares outstanding on the last day of the measurement window Cash-to-assets; cash and short-term investment, scaled CAT: by book value of total assets CF_VOL: Operating cash flow volatility; the standard deviation of operating cash flows over the prior 12 quarters (minimum of 8 required); operating cash flows are from Statement of Cash Flows and adjusted by the industry median IND_ADJ_CAT: CAT, adjusted by the industry median IND_ADJ_INV: INV, adjusted by the industry median IND_ADJ_LEV: LEV, adjusted by the industry median IND_ADJ_OP: OP, adjusted by the industry median INST_OWN: Institutional ownership; number of shares owned by institutions (from Thomson Reuters Financial Holdings database) scaled by shares outstanding INV: Investment; sum of research and development expense and capital expenditures, scaled by book value of total assets, averaged over the current and three prior quarters; if research and development expense is missing, we set it equal to 0 LEV: Leverage; sum of current liabilities and long-term debt, scaled by book value of total assets MB: Market-to-book ratio; market value of common equity plus book value of debt, scaled by book value of total assets (continued on next page)

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NEG_CF:

OP:

PERC_SOUGHT:

RET6:

RET_VOL:

Number of quarters with negative operating cash flows, where operating cash flows are taken from Statement of Cash Flows Operating performance; operating income before depreciation scaled by book value of total assets, averaged over the current and three prior quarters Percent sought in repurchase; number of shares (if any) reported by SDC the firm seeks to repurchase, scaled by common shares outstanding on the day of the announcement; if number of shares is missing, we instead use value sought reported by SDC, scaled by market capitalization five trading days prior to the OMR announcement; if both are missing, PERC is set to missing 6-month market-adjusted return, net of the value-weighted CRSP index, ending the month prior to the OMR announcement Return volatility; standard deviation of daily returns over a 90 trading-day window ending 10 trading-days prior to the OMR announcement

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