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Corporate payout policy
aseannoun do no; ariseti dividends for m
Table 1 Total dollar payout to shareholders by New York 1983
19
of distibution
firms, by 1985
19
Avg.
a 2.82 82.77 4.17 Open-market repurchases Dollar payout of ftrm!P of Satyr
4.65 4.81 0.35
Mra-firm tender offers Dollar payout 46of firmSE of equityb
1.27 0*47 0.10
3.70 0.93 0.24
2.99 0.79 0.18
2.30 ;:
3.74 3.29 0.24
:*G 622
4.40 2.79 0.23
3.51 2.81 0.21
0.59 2.27 0.04
0.29 2.10 0.02
0.39
0.17 2.20 0.01
0.34 2.22 0.02
Targeted repurchases Dollar payout % of firn& % of cquityb
I.15 3.46 0.76 0.21
Special dividends 2.31 0.02
dividends d-uringour sample period, these magnitudes appear high in relation to historical averages.’ The rem&g three methods are used much less often. Existing financial theory does not predkt this ovewhelming rebnce 01) cash dividends. In most analyses of corporate payout policy, cash dividends et repurchases are equivalent mechanisms.2 Where the forrr;of ear to make repurchases more advanta‘Dann (1981) and Vermaelen (1981) document that open-market share repurchases acre relatively infrequ,ent during the period covered by their stwdies. For example, Vermaelen finds 243 open-market repurchase announcements between 1976 and 1978. He also finds 131 intrafirm tender-offer announcements by NYSE firms between 1962 and 1977. These frequencies are noticeably lower than in our 1983-1986 period, even though their studies nc!Jded the period of wage and price controls when cash dividends were restricted. Black and Scholes (1974) find regular cash dividend yields on all NYSE firms from 1951 to 197Q averaged 4.36% per year, a number virtually the same as OK 1983-l%% average. g=n.iu (1961) for the basic equivalence proof. See also the analyses of of manager-shareholder agency s [Rozeff (1982) n-_-r.... \A rlnoC\I. Dti&.lC&J ‘“JJJ, bo&hc!der agency problems 982)j; signaling [Bhattacharya (197 r and Bock (1985),
To date, the only published expl dividends is offered by Shefrin pay cash dividends because indi unrelated to taxes or transaction costs. es nonstandard assumptions about the shape of ere is a previously unrecugnized cost associat the secondary market by better info read, reduces the more trading by info_med managers iucreases l he bid-as liquidity of the Grm’s shares, ~!n_d+&c&y bcreases the and reduces its market value. In contrast, payment of cash dividends does not us, our affect the liquidity of the secondary market for the Grm’s shares. explanation for why firms do not substitut dividends is based on costs arising from managers and shareholders, and not on s preferences.4
‘Although the 1986 change in the tax code reduces =&.eappaent tax advantage of sh are not ..xed under &her repurchases, it does sot income or estate taxes. I
dividend irrelevancy proposition as a special case.
64
ofstockrclpwhw
M.J. Barclayand C. W. Smith, Jr., Costs
program
In our analysis, we take the level and frequency of the payouts as given. us, we do not attempt to explain why dividends are highly predictable from d we do not address why the most common payout frequency e also restrict our analysis to the set of observed distribution ts have strong incentives to devise efficient distriAlchian (1950) and Stigler (195S)]. Moreover, the effiution method depends on relative costs and it is difIicult to assess costs of unobserved policies. n section 2 we analyze the effects of an open-market repurchase program ty of the firm% shares and on the &m’s cost of capital. We also other forms of corporate distributions, including intrafirm tender offers and privately negotiated repurchases. Although these alternate repurchase mechanisms appear to offer tax advantages similar to those offered by open-market repurchases, they involve a different set of costs than those on we focus. In section 3, we 4Er some empirical evidence on the change in share liquidity arottnd the announcement of open-market repurchases. In section 4, we present our conclusions_
ative costs of alternate.pijjou3 pilicks 2.1. Open-market repurchases and the cost of capital Open-market repurchases and infomtatior~asymztry. If management has no better information about the value of the 6rm than other market participants, the increased market activity from a repurchase program will have no predictable adverse effects. In ftict, regular colTorate repurchases would, in &%ct, provide competition fcr the firm’s market-maker. By placing limit orders ?LQ~ which it is willing to buy shares, the firm could establish a lower bound on the bid price at which the specialist can buy shares. To the extent thi? reduces the bid-ask spre it will make the market for the Crm’s shares more liquid and increase their value. e label this the compPtin?-market-maker hypothesis. The insider-tradin.g analyses by Jaffe (1374) and Seyhun (1986), how,rer, provide strong evidence that managers have information that other market articipan ; do non have. We assume that each manager acts in his own &interest within a sc;i of or@&.aiiu*id ~.yii~&j.k;*;:.~ %us it coi$Orace olicies give managers an opportunity to benefit at shareholders’ expense, we
5Myersand ajluf (1984) discuss the kq_&x.Gotmof several alternate assumptions about management’s objectives under asymmetic inFo~~&on. Aitkough they do not judge the realism of these assumptions, they suggest that the available empirical evidence is most consistent with the LW~npion that managers act in the interests of c nt shareholders who have passive buy-andhold strategies. In e cases examined hzre and in rs and Majluf~ the managers’ interests an the interests of the passive buy-and-hold sh~&d&zz coincide. To distinguish between the hypotheses, one must examine events where tbeir interests diverge.
h&J. Barclayaed C.W Smith, Jr., Cmts of stock
their shares to the order-rn~a~er
con
charter provisions, bankers to be parti
program by employing an investment b
program. Shareholders will monitor only if the expected net private benefits are lower ownership concentrapositive. Thus there will be less monitoring tion because any one stoc-kholdcr bears the cost, whereas the bencfits are shared by all. Since rirms publish fmancial reports only quarterly, monitoring intraquarter transactions is difbcult. Thus managers have considerable discretion over the within-quarter timing of transactions and can mlerate or delay the repurchase to take advantage of perceived differences between their estimate of value and market prices. Hn addition to timing their purchases, managers can alter the normal flow of information to the marke release of good news until after a repurchase and accelerating bad news so that it is available before a repurchase. Although information to the market continuously, managers have considerable discretion over the timing and detail of the releases; for exam@ withhold information when its release might be d Cvc position. The real decisions of the firm c pattern of information disclosure fixed,. Therefore, it is extremely against using their insi
“!kx fhith and
Watts (1982) ktor a des
‘In fact, corporate officers appear
stock for the lowest price possible, and open-market purchases allowed it to time its purchases carefully.’
66
M.J. Barclayand C. W. Smith,Jr., Costsof stock repurchaseprogram
The costs of increased trading activity by managers are born ultimately bj the corporation’s shareholders (as expected with most corporate policies in an e now examine the mechanisms throu cient, competitive which these costs @~-~arket repurchases and bid-ask spreads. Hf a fi
substitutes regular es for cash dividend payments, its man marktt for its &ares. rs through dividends at a rate that ue $0 their shareh e firm% equity per year, and the turnover the number of shares traded to the number of shares by the New York Stock Exchange to be 49% per year.) directly affected by the introduction of a large, informed p‘ .;ehaser into the secondary market for a firm’s securities is likely to the specialist adjusts price to equate supply and id and ask prices at which he is willing to buy buy and sell orders do not always arrive simultaneously, the specialist absorbs short-run fluctuations in his inventory. AS noted by Treynor grom (1985), and Easley and O’Hara (1987), the informed traders who observe his quotes and trade earn abnormal returns. What the specialist loses to , he recovers from uninformed or ‘liquidity’ traders in the ains between the price at which he buys and the price at which traders (like the corporation’s managers) enter that he no longer is covering the opportunity d invested capital at the current bid-ask spread. In a he will widen the bid-ask spread until he again earns a (see the adyendix). arket ~epu~c~~@sand the cost of capital. The market price of a
security reflects investors’ required rate of return on assets with similar Investors, however, are interested in net returns
costs they bear in tra
M.J. Barclay and C.
Smith, Jr.,
Castsof stock repurchase progr~~~~
2.2. Out-of-pocket expenses of
value of the check.
The firm faces scale the repurchase; however, t timing of the transactions. trades sa.;ggests that -he effec; of a ~43 us the repurchase strat the purchases are sp
agency costs discus Out-of-pocket expenses iimpos uted on a pro-rata basis whereas the latter are u
67
J. Barclay and C. W. Smith, Jr., Costs of stock repurchase programs
68
2.3. Costs of altetnate distribution mechanisms Although o;en-market repurchases are by far the most common mechanism any can also acquire its s
strate that they are more efficient with these options, we offer the following limited
ost of the costs of open-market repurchases through the announcement of an intram uiring managers to announce the tiiie and allowing all shareholders to participate on a pro-rata basis reduces the information disparity between managers and LJe of managers’ i&de information. shareholders and thus reduces the V+ A&bough the information-disparity costs appear smaller with tender offers than with open-market repurchases, tender ogers still give managers an advantage of unusual situations by altering the flow of rmation to the market or the timing of real investment decisions. In an shareholders on average will not be fooled by this behavior. et, real resource costs would be incurred by investors to protect themselves st potential opportunistic behavior. By establishing a policy of distribg regular self-tenders, the firm redxes these costs. ore importantly, intraCrm tender offers imply a different set of transaction and regulatory costs than open-market repurchases. Firms that wish to tender typically must hire an investment banker to handle the gal and accounting fees to register the offer with the . Although we do not have a direct ses, Smith (1977) suggests that the g services are relatively large. average cost of underwriting a new issue of equity ranges issue (for issues up to $10 million) er compensation alone av-,, -ging from 5.5 to 10% of et costs are in addition to the shareholder-borne if the offer is priced at a
8
irical evidewe on specially designated dividends.
rcluy aad C. W. Smith, Jr,, Costs of stock repurchasepr~~r~~
large fraction of the c
f2Y wheE firms reeurchase sh pothesis, which predicts that spre ses empirically. Using spread data instead of re
data to test our
tion about the fo payouts afkcts the stock price, it is stock-return data. on about the level of the oreover, a repurchase will a about the program first becomes public. critically on correct identification of this
critica! in tests u
9Asnoted above, the I owever we
eo Vermaelen for providi
6
.T. Barclay and C. W. Smith, Jr., Costs of stock repurchase programs
70
announceme
tes that the firm plans to repurchase over a period of approximately one year. SE stocks are obtained from Fitch’s Stock e spread variable used is the avera ads from 1960 to 1979 announcements, 153 had correspon ne year prior to through one year following ments with spread data from event-year data from event-year - 5 to
+5. sents a time series of our data. For each year we provide the lurchase announce_ments~ as well as the average spread and variance for the sample Erms that repurchased shares in the open entire population of Grms for whicn we have data, and for the for which we ave continuous data for each year between 1970
Evidence. In fig. I, we present the average bid-ask spread for the subsamples with data from event-years -1 to + 1, -2 to -G, and -5 to +5. Thegeneral picture in fig. 1 suggests that the spread is relatively constant in years -5 - 1, rises from - 1 to + 1, falls from =t 1 to + 3: sn? _c r&tiveIy fiat r. Standard t-tests suggest that both the increase from - 1 to 4 1 and ecrease from + 1 to + 3 are significant. Given th.at our spread data are averages of beginnin d ending-year spreads, this is consistent with the redictions of our Year -1 averages two spreads prior to the anouncement, year averages one preannouncement spread and one postannouncement spread, and year -i-l averages two postannouncement spreads. reover, if the average repurchase is expected to last one year, then year + 2 erage one spread while the repurchase is continuing with one after its in interpreting this evidence. The competer hypothesis and the information-asymmetry hypothesis are ests measure the sum of lement repurchases volun th our estimates. In a well-functioning vate incentives to maximize firm value imply that Crms et repurchases should have larger benefits er effec!s and lower costs from the info us our estimates of the effect of a repu
5. Barclay and C. W. Smith, Jr., Costs of stock repurchaseprograms
71
Table 2 ‘Xime series of the number of share repurchases, average bid-ask variances from 1970 to 1978 (sample size in p Number of repurchase announcements
With spread data”
Average spread in percent
Year
Total
1970
2
1
1.48% (1238)
1971
4
1
1.43 (1274)
fillUS
042)
1.204 (2621)
1.067 (1799)
0.973 (1799)
1.38 (1468) 1.50 (1423)
1.Cil (2557) 0.765 (2501) c.!? (2428)
3.860 (1799) --
(149) 0.326 (147) 0.468 034) _._.-
1.70
1.46
1.51
1.080
0.965
0.602
1974
49
27
2.44 (1475)
1975
1%
10
2.39 (1470)
1976
16
12
1.66 (i&51)
153
0.711 (Zf99)
1.325 (1799)
1.63 (1425)
244
0.775 (23”0-jA\ 0,662 (2494)
1.519 (2609j
68
Total or average
0.715 (142)
1.438 (1799)
112
6
0.965 (1799)
1.697 (2636)
1973
15
1.053 (2249)
2.25 (153) 1.99 (153) 1.29 (150) 1.07 (143) 1.31 (13fi)
1.29 (1365)
1978
sample
All
2.05 (897) 1.94 (897) 1.36 (893 1.19 (897) 1.31 (8973
13
15
fifIllS
Firms with continuous return data (1970-78)
1.15 (146) 1.58 (152)
18
17
Repurchase sampleb
Average variance x 10’
1.40% (897) 1.29 (8971 1.17 (897) 1.46 0x!?\. ,Uiij
1972
1977
Firrix with continuous spread data (1970-78)
, and average retu
1.511 (128) 1.29 (133)
0.617 (1799)
0.726 (1799)
0.822 (1501 0.983 (150) 0.750 (150)
“Annual spread data are available for at least event-years - 1 through -I-1. bThe repurchase sample consists of the 153 repurchase announcements where spread data are available for at least event-years - 1 through + 1.
73-
M.J. Barclayand C. bK Smith,Jr., Costsoi stockre~w~&s~program 2.3-l
!.O!
!
-5
I
-4
-3 Year
--** -
l l
*
I
I
-2
-I
in Relation
I
0
I
I
I
I
2
3
to tiepurchase
a 4
1
5
h?nsvnCement
Sample wiih daia from eveni-yea; Sample with data from event-year Sample with data from event-year
‘I to +I ‘2 to +2
‘5 to +5
Fig. 1. Average bid-ask spreads for New York Stock Exchmge firms that annouuced open-market share repurchase progrm between 1970 and 1978. There are 153 announcements with spread data from event-years - 1 to +l, 133 with dara irum -2 iu +2, ant! 58 with 4&a from - 5 to +5.
first specification issue is raised by an examination e greatest frequency of repurchase announcements 1974. This raises the when the repurchases are
ssion of actual
n, we estimate a stmtural e run a pooled time-series, cross-sectional all NYSE Crms on the covariance of daily and eleven dummy for firms with openin average spreads dur-
id-ask
spreads by Benston and rice-level variable we use is the
J. Barclay and C.
Variable
Smith, Jr., C&s of stack rep~rc~~e ~r~~Q~~
estimate
kercept Return variance Return auto-
73
estimate
1.145 14.261
0.018 0.161
0.002
COVtianCe
level Trading volume D - 5’ D - 4a D - 3a D - 2’= D-l* Deb D+lf” D + 2c D433sd D -I-4d D + Sd Price
Adjusted R* Nwnber of observations
0.010 0.030 0.277 0.207 0.292 0.254 0.167 0.015 a.243 0.128 - 0.115 - 0.110 - 0.011
-
-
0.114 0.107 0.104 0.101 0.100 0.096 n,:J-”AA? 0.098 0.106 0.109 0.115
- 0.131 - 0.222 -0.255 - 0.10; 0.093 0.423 - 0.037 - 0.184 -0.138
0.437
13,369
-D-2-D-l cannot be rejected (F,=O.25, aThe hypothesis that D-S=D-4=D-3 p = 0.908 without calendar-year dummies and I$ = 0.44, p = 0.776 with calendar-year dummies). bThe hypothesis that D - 1 = D + 1 can be rejected at the 0.01 level of significance withwt calendar-year dummies ( FI = 9.23, p = 0.002) and at the 0.10 level with calendar-year d ( FI = 2.80, p = 0.094). ‘The hypothesis that D + 1 = D + 3 can be rejected at the 0.01 level of significance without calendar-year dummies ( FI = 6.60, p = 0.010) and at the 0.05 level with calendar-year d ( fi = 4.86, p = 0.027). “The hypothesis that D + 3 = D + 4 = D + 5 cannot be rejected ( F2= 0.38, p = 0.681 wi calendar-year d&es and F2 = 0.41, p = 0.663 wi
A4.J. Barclay and C. W. Smith, Jr., Costs cfstock repurchaseprograms
74
Table 4
Estimated regression coefficients for pooled time-series, cross-sectional regressions of the percentage bid-ask spread on daiIy return variance, daiIy market-adjusted return variance, and daily return serial covariance for 13,160 observations from 1965 to 1979 (t-statistics in parentheses). Daily return VarianCe
Mixketadjusted return VtiaoCe
Regression
Intercept
1
0.72 (59.79)
13.45 (91.92)
2
0.72 (59.88)
13.44 (91.81)
3
0.70 (61.54)
15.26 (99.76)
4
0.70 (61.63)
15.25 (99.76)
5
1.51 (l41 .OS)
Daily return serial covariauce
Adjusted R2
0.39 0.02 (3.14)
0.39 0.43
0.02 (3.24)
0.43 G.001
(Z)
from + 1 to + 3 is signScantly negative, as in fig. 1. Also, we cannot reject the $F&&sr_ ‘c ?hat the &imiG& L.FJzvGnt-years - 5 through - 1 and + 3 through + 5 are equal. ur theory makes predictions only about changes in the event-year dums, not about their level. The negative dummy variables for event-years - 5 - 1 and + 3 through +5 suggest that these firms have lower than average bid-ask spreads during years in which they are not repurchasing s have greater than average liquidity in the secondary market for their shares, this sttggests a reason why they have a comparative advantage in repurchasing shares. Nowever, we are reluctant to push speculation along these lines too far. t is unfortunate that our spread data are only annual. T’o better understand t,hs tie series o,f changes in liquidity around the rep-urchase annotrincements, we examine several roxies for the monthly bid-ask spread. proposes an indirect easure of the bid-ask spread based o cov&arrce of common stock returns that has been used in piace of direct e in several enryilic Two elements, however, are reflected in ead: information asymmetries among traders, and specialists inventory costs. These two factors have different implications tra~sa~t~o~ costs induce negative serial. covariance lthou ect an U&kSPd esti order being a sale or a purchase. s, the bid and ask prices are functi size, and transaction prices can he serially dependent.
asley and s of trade
J. Barclay and C.
-5
-4
-3
Smith, Jr., Costs of stock
-2
-I
0
I
re~~c~~e prog~a
i
3
4
75
s
Year in Relation to Repurchase ~nnouncerne~~ Fig. 2. AMWI estimated bid-ask spreads for New York Stock Exchmge firms &&atannotmced open-r~ar~ef share-repurchase programsbetween1970 and 1978. Spreads are estimated from the table 4 reg~%ati of bid-ask spreads on the variance of market-adjusted commor~ stock returns.
our analysis prydrcts that ~tic~pated oven-m~ket repurchases the gross spread oy exacerbating the information-asymmetry effect on the transaction-cost component is ambiguous. Thus, if a firm engages in anticipated open-m the change in the sprea be reflected in The larger bid-ask spread, variance. Therefore, we employ several regression spreads using daily return variance, d daily return serial covariance. Table 4 reports these results. In each regression, the average of ning- and end-of-year bid-ask spread is regre cross-sectional regressio rm years az excluded
96 3 E
2.3
8
2.2
L $
2.1
$j I
2.0
g
1.9
t 9
1.8
Ji Q) zr &
I.7
b
I.5
12 month average
1.6
-12
-10
-8
-6
-4
-2
onth in Religion to
0
2
4
epurchase
6
8
IO
I2
Announcement
examine the ability of
rn4e: to estimate bid-ask spreads, we average bid-ask spread for our repurchase sample in eve~t-~~~~~ - 5 to 9 5. e estimated spreads, reported in fig. 2, depict the e estimated spreads as the actual spreads presented :A tig. 1. -1 to +l,faCl 0
*he auerage estimated bid-ask spread in each eve&month urchase announcement until one year after the antly higher in the year e average estimated spread is
t to explain why firms e two most frequently used forms,
alternate payout nwchanisms. occur with self-tenders because registering with the Securities an expenses incurred wi out-of-pocket costs of &-tenders are ins there will be sign&ant ec~~oti~2s of distribution, the more ated repurchases increase the utions are mole to be regular cash
“4Thisresult is streqthened b
dividend.
observation haLL m
78
AU. Barclayand C. W. Smith,Jr*, Castsof stock repurchaseprograms
structure literature with asset-pricing model that suggest
ge, no other extant analysis of an
return variances, not returns.
appendix, a formal mooel illustrates the relation between share e model modifies and s and the corporation’s cost of capital. e Glosten and Milgrom (1985) model of bid and ask prices with sly informed traders assume +&at specialists trading on the floor of the stock exchange operate in a competitive environment with no transaction costs. The assumption of zero transaction costs is not essential to the m&d, but helps to focus ;rt*ention on arket characteristics in which we are most interested. The specialist set and ask prices and stands ready to buy one unit of stock at the bid price or sell one unit at the ask price. The specialist is free to change d ask prices at any tune. The shares of the firm being traded are etual cash flow with d, representing the random cash flow at ers include ‘informed’ investors and ‘liquidity’ traders. The may or may not be corporate insiders. At each period t, insiders receive a signal Sp that is correlated with LI,+~ Let H, denote the ation set of the uninformed traders at time t. Ht includes the time series ast tr~sact~~~ prices and cash flows as well as the current bid a.113ask te the information set of the informed traders. G* includes on in hi plus 8% signal St. The specialist is assumed to have the same information as the uninformed traders. et one at a time (randomly and anonymously) unit or leave without trading.15 Let c+ denote o arrives at the m et at time t (i.e., F, = H, md, and Ft = Gt if he is informed). Each to shares of stock, X, and current consumparameter of the individual investor’s utility
the market at a latez.
M.J. Barclay and C.
function (for t
Smith, Jr., Costs of stock repurchase program
),
2z-d
In eqs (1) the value
iscounted at 2 m iscount rate r represen at which investors are
exceptions: (1) The Glosten an ours has an infinite horizon. (2) Glosten an structure on the Wowof information.
not know when he sets nis bi informed or uninformed. ask prices will satisfy A,= @WV
Ptm4;;1-41~
If additional. informed tr shares) are introduced to t lasses at this current bid-ask sprea specialist will widen his b P _.
,a__. r_ _ IId ._ 5_ UP&L JLIG
79
M.J. Barclayand C. W. Smith,Jr., Costsof stockrepurchaseprogram
80
ectly from Glosten and
ilgrom’s Proposition 5 and is
licitly defined by the
(1 +i)‘=E
d'i(l+i)P-(i-"+
(4
1
tion of the competitive net rate of return i endogeation’s cost of capital, r. Because this security t, a wider bid-ask spread would imply a smaller current firm value to provide investors with the competitive net rate of return. r@?pss&WI 2. &en the assumptions above, the discount rate (opportunity cost of capital) r u--plied to the jbn ‘s cash fiw increase when ere is an increase in the precision of hiders’
(9
(ti)
information or e ratio aj*the informed to uninformed arrival rates is increased.
Proof.
e zero profit condition for the specialist [eqs. (2) and (3~1implies
at
(5)
t
y from eq. (1) an8 assumed martingak property of the cash
‘j 1
(1
*
r),Tl
(7)
Smith, Jr., Costs
of s
Akhian, A-en, 1950, Wmtainty, evohaion, and economic thgory,JO 58,211-221. Amihud, Yakov and Haim ndehon, 1986, Asset pd and the bid-as Fhmcial Ecmoinics 17,223-249. Barclay, Michael, 1985, Why do firms pay dividends? A repeated principal-qent expl~atio~, UnpublishedmaUSC@t (Uti~tity of Rochester,R&es&, XT. Benston, George and Robert Hagerman, 1974, Deterruinants of bid-ask spreads in e over&ecounter market, JoumaJ of Financial Economics 1,353-364. Bhattacharya, Sudipto, 1979, Imperfect information, divideud policy, and “the bird-in-the-hand’ fallacy, Bell Journal of Economics 10,259-270. Black, Fischer and Myron Scholes, 1974, The effects of dividend yield and dividend poliq on aucial Economics l, l-22. common stock prices and returns, 1983, The wealth effects of targeted share Bradley, Michael and L. Macdonal repurchases, Journal of Financial Branch, Ren and Walter Freed, 1977, Bid-ask spreads ou the Ah&RX and the big tmard, .Jo~~~ of Finance 32,159-163. Breafey, Richard and Stewart Myers, 1984, Principles of corporate finance,2nd ed. ( New York, NY). Brickley, Jmcs, 1983. Shareholder wealth, information signaling, and the specially designated dividend: An empirical study, Journal of Financial Econoruics 12,187-299. Brown, Stephen J. and Jerold B. Warner, 1985, Using da@ stock returns: The case of event studies, Journal of Financial Economics 14,3-32. Dann, Larry, 1981. Common stock repurchases: An analysis of returns to bondholders and stockholders, JourrA of Financial Economics 9,113-138. Easley, David and Muueen O’Hara, 1987, Price, trade sir?, and fo~a~o~ in securities tuarkets, Journal of Financial Economics P9,69-90. :eric Easterbrook, Frank H., 1984, Two agency-cost explanations of dividen Review 74,650-659. Feenberg, Daniel, 1981, Does the inves dends?, Journal of Financial
JafTe, Jeffrey, 1974, Jensen, Michael, 19 Econotic Re-view
82
M.J. Barday and C. W. Smith, Jr., Costs of stock repurchase programs
K&y, Avner, 1982, Stockholdee-bondholder conflict and dividend constraints, Journal of Financial Economics 10,211-233. Linuer, John, 1956, Distribution of incomes of corporations among dividends, retained earnings, and taxes, Ametican Economic Review 46,97-113. Miller, Merton and France Modigliani, 1961, Dividend policy, growth, and the valuation of shares, Journal of Business 34,235-264. Miller, Merton and Kevin Rock, 1985, Dividend policy under asymmetric information, Journal of Finance 40,1031-1051. Miller, Merton and Myron Scholes, 1978, Dividends and taxes, Journal of Pinancial Economics 6, 333-364. Myers, Stewart and Nicholas Majluf, 1984, Corporate financing and investment decisions when firms have information that investors do Got have, Journal of Financial Economics 13, 187-221. Peterson, Pamela P., David R Peterson, and James S. Ang, 1985, Direct evidence on the marginal rate of taxation on dividend income, Journal of Financial Pconomics 14,267-282. Roll, Richard, 1984, A simple implitit measure of the effective bid-ask spread in an efficient market, Journal of Finance 39,1127-1139. RozefI’, Michael S., 1982, Growth, beta, and agency costs as determinants of dividend payout ratios, Journal of Financial Research 5249-259. Seyhun, I-L Nejat, 1986, Insiders’ profits, cost of trading, and market efficiency, Journal of Financial Economics 16,189-212. Shefrin, Her& M. and Meir Statman, 1984, Explaining investor preference for cash dividends, Journal of Pinancial &onomi~ 13,253-282. S&h, Clifford W., 1977, Alternative methods for m&g capital: Rights versus underwritten offerings Journal of Financial Economics 5,273-307. Smith, Clifford W., 1986, litvestment banking and the capital aquisition process, Journal of Financial Economics 15,3-29. Smith, Clifford W. and Jerold Warner, 1979, On financial contracting: An analysis of bond covenants, Journal of Financial Economics 7.117-161. Sti&, Clifford W. and Ross Watts, 1982, Incentive and tax effects of U.S. executive compensaticn plans, Australian Journal of Management 7,139-157. Stigler, Gee 1958, The economics of scale, Journal of Law and Economics 1.54-71. R-E. Whaley, 1983, Transaction costs imd the small Rrm effect, Journal of Stall, 1i.R. Financial Economics 12, 57-79. Treynor, J.L., 19X. ?&_Bonly gaa;-~+I town, Finantial Analysts Journal 27,12-14. Vermaelen, Theo, 1981, Common stock repurchases and market signalhng, Journal of Financial Economics 9.139-183.
Table 1 Total dollar payout to shareholders by New York 1983
19
of distibution
firms, by 1985
19
Avg.
a 2.82 82.77 4.17 Open-market repurchases Dollar payout of ftrm!P of Satyr
4.65 4.81 0.35
Mra-firm tender offers Dollar payout 46of firmSE of equityb
1.27 0*47 0.10
3.70 0.93 0.24
2.99 0.79 0.18
2.30 ;:
3.74 3.29 0.24
:*G 622
4.40 2.79 0.23
3.51 2.81 0.21
0.59 2.27 0.04
0.29 2.10 0.02
0.39
0.17 2.20 0.01
0.34 2.22 0.02
Targeted repurchases Dollar payout % of firn& % of cquityb
I.15 3.46 0.76 0.21
Special dividends 2.31 0.02
dividends d-uringour sample period, these magnitudes appear high in relation to historical averages.’ The rem&g three methods are used much less often. Existing financial theory does not predkt this ovewhelming rebnce 01) cash dividends. In most analyses of corporate payout policy, cash dividends et repurchases are equivalent mechanisms.2 Where the forrr;of ear to make repurchases more advanta‘Dann (1981) and Vermaelen (1981) document that open-market share repurchases acre relatively infrequ,ent during the period covered by their stwdies. For example, Vermaelen finds 243 open-market repurchase announcements between 1976 and 1978. He also finds 131 intrafirm tender-offer announcements by NYSE firms between 1962 and 1977. These frequencies are noticeably lower than in our 1983-1986 period, even though their studies nc!Jded the period of wage and price controls when cash dividends were restricted. Black and Scholes (1974) find regular cash dividend yields on all NYSE firms from 1951 to 197Q averaged 4.36% per year, a number virtually the same as OK 1983-l%% average. g=n.iu (1961) for the basic equivalence proof. See also the analyses of of manager-shareholder agency s [Rozeff (1982) n-_-r.... \A rlnoC\I. Dti&.lC&J ‘“JJJ, bo&hc!der agency problems 982)j; signaling [Bhattacharya (197 r and Bock (1985),
To date, the only published expl dividends is offered by Shefrin pay cash dividends because indi unrelated to taxes or transaction costs. es nonstandard assumptions about the shape of ere is a previously unrecugnized cost associat the secondary market by better info read, reduces the more trading by info_med managers iucreases l he bid-as liquidity of the Grm’s shares, ~!n_d+&c&y bcreases the and reduces its market value. In contrast, payment of cash dividends does not us, our affect the liquidity of the secondary market for the Grm’s shares. explanation for why firms do not substitut dividends is based on costs arising from managers and shareholders, and not on s preferences.4
‘Although the 1986 change in the tax code reduces =&.eappaent tax advantage of sh are not ..xed under &her repurchases, it does sot income or estate taxes. I
dividend irrelevancy proposition as a special case.
64
ofstockrclpwhw
M.J. Barclayand C. W. Smith, Jr., Costs
program
In our analysis, we take the level and frequency of the payouts as given. us, we do not attempt to explain why dividends are highly predictable from d we do not address why the most common payout frequency e also restrict our analysis to the set of observed distribution ts have strong incentives to devise efficient distriAlchian (1950) and Stigler (195S)]. Moreover, the effiution method depends on relative costs and it is difIicult to assess costs of unobserved policies. n section 2 we analyze the effects of an open-market repurchase program ty of the firm% shares and on the &m’s cost of capital. We also other forms of corporate distributions, including intrafirm tender offers and privately negotiated repurchases. Although these alternate repurchase mechanisms appear to offer tax advantages similar to those offered by open-market repurchases, they involve a different set of costs than those on we focus. In section 3, we 4Er some empirical evidence on the change in share liquidity arottnd the announcement of open-market repurchases. In section 4, we present our conclusions_
ative costs of alternate.pijjou3 pilicks 2.1. Open-market repurchases and the cost of capital Open-market repurchases and infomtatior~asymztry. If management has no better information about the value of the 6rm than other market participants, the increased market activity from a repurchase program will have no predictable adverse effects. In ftict, regular colTorate repurchases would, in &%ct, provide competition fcr the firm’s market-maker. By placing limit orders ?LQ~ which it is willing to buy shares, the firm could establish a lower bound on the bid price at which the specialist can buy shares. To the extent thi? reduces the bid-ask spre it will make the market for the Crm’s shares more liquid and increase their value. e label this the compPtin?-market-maker hypothesis. The insider-tradin.g analyses by Jaffe (1374) and Seyhun (1986), how,rer, provide strong evidence that managers have information that other market articipan ; do non have. We assume that each manager acts in his own &interest within a sc;i of or@&.aiiu*id ~.yii~&j.k;*;:.~ %us it coi$Orace olicies give managers an opportunity to benefit at shareholders’ expense, we
5Myersand ajluf (1984) discuss the kq_&x.Gotmof several alternate assumptions about management’s objectives under asymmetic inFo~~&on. Aitkough they do not judge the realism of these assumptions, they suggest that the available empirical evidence is most consistent with the LW~npion that managers act in the interests of c nt shareholders who have passive buy-andhold strategies. In e cases examined hzre and in rs and Majluf~ the managers’ interests an the interests of the passive buy-and-hold sh~&d&zz coincide. To distinguish between the hypotheses, one must examine events where tbeir interests diverge.
h&J. Barclayaed C.W Smith, Jr., Cmts of stock
their shares to the order-rn~a~er
con
charter provisions, bankers to be parti
program by employing an investment b
program. Shareholders will monitor only if the expected net private benefits are lower ownership concentrapositive. Thus there will be less monitoring tion because any one stoc-kholdcr bears the cost, whereas the bencfits are shared by all. Since rirms publish fmancial reports only quarterly, monitoring intraquarter transactions is difbcult. Thus managers have considerable discretion over the within-quarter timing of transactions and can mlerate or delay the repurchase to take advantage of perceived differences between their estimate of value and market prices. Hn addition to timing their purchases, managers can alter the normal flow of information to the marke release of good news until after a repurchase and accelerating bad news so that it is available before a repurchase. Although information to the market continuously, managers have considerable discretion over the timing and detail of the releases; for exam@ withhold information when its release might be d Cvc position. The real decisions of the firm c pattern of information disclosure fixed,. Therefore, it is extremely against using their insi
“!kx fhith and
Watts (1982) ktor a des
‘In fact, corporate officers appear
stock for the lowest price possible, and open-market purchases allowed it to time its purchases carefully.’
66
M.J. Barclayand C. W. Smith,Jr., Costsof stock repurchaseprogram
The costs of increased trading activity by managers are born ultimately bj the corporation’s shareholders (as expected with most corporate policies in an e now examine the mechanisms throu cient, competitive which these costs @~-~arket repurchases and bid-ask spreads. Hf a fi
substitutes regular es for cash dividend payments, its man marktt for its &ares. rs through dividends at a rate that ue $0 their shareh e firm% equity per year, and the turnover the number of shares traded to the number of shares by the New York Stock Exchange to be 49% per year.) directly affected by the introduction of a large, informed p‘ .;ehaser into the secondary market for a firm’s securities is likely to the specialist adjusts price to equate supply and id and ask prices at which he is willing to buy buy and sell orders do not always arrive simultaneously, the specialist absorbs short-run fluctuations in his inventory. AS noted by Treynor grom (1985), and Easley and O’Hara (1987), the informed traders who observe his quotes and trade earn abnormal returns. What the specialist loses to , he recovers from uninformed or ‘liquidity’ traders in the ains between the price at which he buys and the price at which traders (like the corporation’s managers) enter that he no longer is covering the opportunity d invested capital at the current bid-ask spread. In a he will widen the bid-ask spread until he again earns a (see the adyendix). arket ~epu~c~~@sand the cost of capital. The market price of a
security reflects investors’ required rate of return on assets with similar Investors, however, are interested in net returns
costs they bear in tra
M.J. Barclay and C.
Smith, Jr.,
Castsof stock repurchase progr~~~~
2.2. Out-of-pocket expenses of
value of the check.
The firm faces scale the repurchase; however, t timing of the transactions. trades sa.;ggests that -he effec; of a ~43 us the repurchase strat the purchases are sp
agency costs discus Out-of-pocket expenses iimpos uted on a pro-rata basis whereas the latter are u
67
J. Barclay and C. W. Smith, Jr., Costs of stock repurchase programs
68
2.3. Costs of altetnate distribution mechanisms Although o;en-market repurchases are by far the most common mechanism any can also acquire its s
strate that they are more efficient with these options, we offer the following limited
ost of the costs of open-market repurchases through the announcement of an intram uiring managers to announce the tiiie and allowing all shareholders to participate on a pro-rata basis reduces the information disparity between managers and LJe of managers’ i&de information. shareholders and thus reduces the V+ A&bough the information-disparity costs appear smaller with tender offers than with open-market repurchases, tender ogers still give managers an advantage of unusual situations by altering the flow of rmation to the market or the timing of real investment decisions. In an shareholders on average will not be fooled by this behavior. et, real resource costs would be incurred by investors to protect themselves st potential opportunistic behavior. By establishing a policy of distribg regular self-tenders, the firm redxes these costs. ore importantly, intraCrm tender offers imply a different set of transaction and regulatory costs than open-market repurchases. Firms that wish to tender typically must hire an investment banker to handle the gal and accounting fees to register the offer with the . Although we do not have a direct ses, Smith (1977) suggests that the g services are relatively large. average cost of underwriting a new issue of equity ranges issue (for issues up to $10 million) er compensation alone av-,, -ging from 5.5 to 10% of et costs are in addition to the shareholder-borne if the offer is priced at a
8
irical evidewe on specially designated dividends.
rcluy aad C. W. Smith, Jr,, Costs of stock repurchasepr~~r~~
large fraction of the c
f2Y wheE firms reeurchase sh pothesis, which predicts that spre ses empirically. Using spread data instead of re
data to test our
tion about the fo payouts afkcts the stock price, it is stock-return data. on about the level of the oreover, a repurchase will a about the program first becomes public. critically on correct identification of this
critica! in tests u
9Asnoted above, the I owever we
eo Vermaelen for providi
6
.T. Barclay and C. W. Smith, Jr., Costs of stock repurchase programs
70
announceme
tes that the firm plans to repurchase over a period of approximately one year. SE stocks are obtained from Fitch’s Stock e spread variable used is the avera ads from 1960 to 1979 announcements, 153 had correspon ne year prior to through one year following ments with spread data from event-year data from event-year - 5 to
+5. sents a time series of our data. For each year we provide the lurchase announce_ments~ as well as the average spread and variance for the sample Erms that repurchased shares in the open entire population of Grms for whicn we have data, and for the for which we ave continuous data for each year between 1970
Evidence. In fig. I, we present the average bid-ask spread for the subsamples with data from event-years -1 to + 1, -2 to -G, and -5 to +5. Thegeneral picture in fig. 1 suggests that the spread is relatively constant in years -5 - 1, rises from - 1 to + 1, falls from =t 1 to + 3: sn? _c r&tiveIy fiat r. Standard t-tests suggest that both the increase from - 1 to 4 1 and ecrease from + 1 to + 3 are significant. Given th.at our spread data are averages of beginnin d ending-year spreads, this is consistent with the redictions of our Year -1 averages two spreads prior to the anouncement, year averages one preannouncement spread and one postannouncement spread, and year -i-l averages two postannouncement spreads. reover, if the average repurchase is expected to last one year, then year + 2 erage one spread while the repurchase is continuing with one after its in interpreting this evidence. The competer hypothesis and the information-asymmetry hypothesis are ests measure the sum of lement repurchases volun th our estimates. In a well-functioning vate incentives to maximize firm value imply that Crms et repurchases should have larger benefits er effec!s and lower costs from the info us our estimates of the effect of a repu
5. Barclay and C. W. Smith, Jr., Costs of stock repurchaseprograms
71
Table 2 ‘Xime series of the number of share repurchases, average bid-ask variances from 1970 to 1978 (sample size in p Number of repurchase announcements
With spread data”
Average spread in percent
Year
Total
1970
2
1
1.48% (1238)
1971
4
1
1.43 (1274)
fillUS
042)
1.204 (2621)
1.067 (1799)
0.973 (1799)
1.38 (1468) 1.50 (1423)
1.Cil (2557) 0.765 (2501) c.!? (2428)
3.860 (1799) --
(149) 0.326 (147) 0.468 034) _._.-
1.70
1.46
1.51
1.080
0.965
0.602
1974
49
27
2.44 (1475)
1975
1%
10
2.39 (1470)
1976
16
12
1.66 (i&51)
153
0.711 (Zf99)
1.325 (1799)
1.63 (1425)
244
0.775 (23”0-jA\ 0,662 (2494)
1.519 (2609j
68
Total or average
0.715 (142)
1.438 (1799)
112
6
0.965 (1799)
1.697 (2636)
1973
15
1.053 (2249)
2.25 (153) 1.99 (153) 1.29 (150) 1.07 (143) 1.31 (13fi)
1.29 (1365)
1978
sample
All
2.05 (897) 1.94 (897) 1.36 (893 1.19 (897) 1.31 (8973
13
15
fifIllS
Firms with continuous return data (1970-78)
1.15 (146) 1.58 (152)
18
17
Repurchase sampleb
Average variance x 10’
1.40% (897) 1.29 (8971 1.17 (897) 1.46 0x!?\. ,Uiij
1972
1977
Firrix with continuous spread data (1970-78)
, and average retu
1.511 (128) 1.29 (133)
0.617 (1799)
0.726 (1799)
0.822 (1501 0.983 (150) 0.750 (150)
“Annual spread data are available for at least event-years - 1 through -I-1. bThe repurchase sample consists of the 153 repurchase announcements where spread data are available for at least event-years - 1 through + 1.
73-
M.J. Barclayand C. bK Smith,Jr., Costsoi stockre~w~&s~program 2.3-l
!.O!
!
-5
I
-4
-3 Year
--** -
l l
*
I
I
-2
-I
in Relation
I
0
I
I
I
I
2
3
to tiepurchase
a 4
1
5
h?nsvnCement
Sample wiih daia from eveni-yea; Sample with data from event-year Sample with data from event-year
‘I to +I ‘2 to +2
‘5 to +5
Fig. 1. Average bid-ask spreads for New York Stock Exchmge firms that annouuced open-market share repurchase progrm between 1970 and 1978. There are 153 announcements with spread data from event-years - 1 to +l, 133 with dara irum -2 iu +2, ant! 58 with 4&a from - 5 to +5.
first specification issue is raised by an examination e greatest frequency of repurchase announcements 1974. This raises the when the repurchases are
ssion of actual
n, we estimate a stmtural e run a pooled time-series, cross-sectional all NYSE Crms on the covariance of daily and eleven dummy for firms with openin average spreads dur-
id-ask
spreads by Benston and rice-level variable we use is the
J. Barclay and C.
Variable
Smith, Jr., C&s of stack rep~rc~~e ~r~~Q~~
estimate
kercept Return variance Return auto-
73
estimate
1.145 14.261
0.018 0.161
0.002
COVtianCe
level Trading volume D - 5’ D - 4a D - 3a D - 2’= D-l* Deb D+lf” D + 2c D433sd D -I-4d D + Sd Price
Adjusted R* Nwnber of observations
0.010 0.030 0.277 0.207 0.292 0.254 0.167 0.015 a.243 0.128 - 0.115 - 0.110 - 0.011
-
-
0.114 0.107 0.104 0.101 0.100 0.096 n,:J-”AA? 0.098 0.106 0.109 0.115
- 0.131 - 0.222 -0.255 - 0.10; 0.093 0.423 - 0.037 - 0.184 -0.138
0.437
13,369
-D-2-D-l cannot be rejected (F,=O.25, aThe hypothesis that D-S=D-4=D-3 p = 0.908 without calendar-year dummies and I$ = 0.44, p = 0.776 with calendar-year dummies). bThe hypothesis that D - 1 = D + 1 can be rejected at the 0.01 level of significance withwt calendar-year dummies ( FI = 9.23, p = 0.002) and at the 0.10 level with calendar-year d ( FI = 2.80, p = 0.094). ‘The hypothesis that D + 1 = D + 3 can be rejected at the 0.01 level of significance without calendar-year dummies ( FI = 6.60, p = 0.010) and at the 0.05 level with calendar-year d ( fi = 4.86, p = 0.027). “The hypothesis that D + 3 = D + 4 = D + 5 cannot be rejected ( F2= 0.38, p = 0.681 wi calendar-year d&es and F2 = 0.41, p = 0.663 wi
A4.J. Barclay and C. W. Smith, Jr., Costs cfstock repurchaseprograms
74
Table 4
Estimated regression coefficients for pooled time-series, cross-sectional regressions of the percentage bid-ask spread on daiIy return variance, daiIy market-adjusted return variance, and daily return serial covariance for 13,160 observations from 1965 to 1979 (t-statistics in parentheses). Daily return VarianCe
Mixketadjusted return VtiaoCe
Regression
Intercept
1
0.72 (59.79)
13.45 (91.92)
2
0.72 (59.88)
13.44 (91.81)
3
0.70 (61.54)
15.26 (99.76)
4
0.70 (61.63)
15.25 (99.76)
5
1.51 (l41 .OS)
Daily return serial covariauce
Adjusted R2
0.39 0.02 (3.14)
0.39 0.43
0.02 (3.24)
0.43 G.001
(Z)
from + 1 to + 3 is signScantly negative, as in fig. 1. Also, we cannot reject the $F&&sr_ ‘c ?hat the &imiG& L.FJzvGnt-years - 5 through - 1 and + 3 through + 5 are equal. ur theory makes predictions only about changes in the event-year dums, not about their level. The negative dummy variables for event-years - 5 - 1 and + 3 through +5 suggest that these firms have lower than average bid-ask spreads during years in which they are not repurchasing s have greater than average liquidity in the secondary market for their shares, this sttggests a reason why they have a comparative advantage in repurchasing shares. Nowever, we are reluctant to push speculation along these lines too far. t is unfortunate that our spread data are only annual. T’o better understand t,hs tie series o,f changes in liquidity around the rep-urchase annotrincements, we examine several roxies for the monthly bid-ask spread. proposes an indirect easure of the bid-ask spread based o cov&arrce of common stock returns that has been used in piace of direct e in several enryilic Two elements, however, are reflected in ead: information asymmetries among traders, and specialists inventory costs. These two factors have different implications tra~sa~t~o~ costs induce negative serial. covariance lthou ect an U&kSPd esti order being a sale or a purchase. s, the bid and ask prices are functi size, and transaction prices can he serially dependent.
asley and s of trade
J. Barclay and C.
-5
-4
-3
Smith, Jr., Costs of stock
-2
-I
0
I
re~~c~~e prog~a
i
3
4
75
s
Year in Relation to Repurchase ~nnouncerne~~ Fig. 2. AMWI estimated bid-ask spreads for New York Stock Exchmge firms &&atannotmced open-r~ar~ef share-repurchase programsbetween1970 and 1978. Spreads are estimated from the table 4 reg~%ati of bid-ask spreads on the variance of market-adjusted commor~ stock returns.
our analysis prydrcts that ~tic~pated oven-m~ket repurchases the gross spread oy exacerbating the information-asymmetry effect on the transaction-cost component is ambiguous. Thus, if a firm engages in anticipated open-m the change in the sprea be reflected in The larger bid-ask spread, variance. Therefore, we employ several regression spreads using daily return variance, d daily return serial covariance. Table 4 reports these results. In each regression, the average of ning- and end-of-year bid-ask spread is regre cross-sectional regressio rm years az excluded
96 3 E
2.3
8
2.2
L $
2.1
$j I
2.0
g
1.9
t 9
1.8
Ji Q) zr &
I.7
b
I.5
12 month average
1.6
-12
-10
-8
-6
-4
-2
onth in Religion to
0
2
4
epurchase
6
8
IO
I2
Announcement
examine the ability of
rn4e: to estimate bid-ask spreads, we average bid-ask spread for our repurchase sample in eve~t-~~~~~ - 5 to 9 5. e estimated spreads, reported in fig. 2, depict the e estimated spreads as the actual spreads presented :A tig. 1. -1 to +l,faCl 0
*he auerage estimated bid-ask spread in each eve&month urchase announcement until one year after the antly higher in the year e average estimated spread is
t to explain why firms e two most frequently used forms,
alternate payout nwchanisms. occur with self-tenders because registering with the Securities an expenses incurred wi out-of-pocket costs of &-tenders are ins there will be sign&ant ec~~oti~2s of distribution, the more ated repurchases increase the utions are mole to be regular cash
“4Thisresult is streqthened b
dividend.
observation haLL m
78
AU. Barclayand C. W. Smith,Jr*, Castsof stock repurchaseprograms
structure literature with asset-pricing model that suggest
ge, no other extant analysis of an
return variances, not returns.
appendix, a formal mooel illustrates the relation between share e model modifies and s and the corporation’s cost of capital. e Glosten and Milgrom (1985) model of bid and ask prices with sly informed traders assume +&at specialists trading on the floor of the stock exchange operate in a competitive environment with no transaction costs. The assumption of zero transaction costs is not essential to the m&d, but helps to focus ;rt*ention on arket characteristics in which we are most interested. The specialist set and ask prices and stands ready to buy one unit of stock at the bid price or sell one unit at the ask price. The specialist is free to change d ask prices at any tune. The shares of the firm being traded are etual cash flow with d, representing the random cash flow at ers include ‘informed’ investors and ‘liquidity’ traders. The may or may not be corporate insiders. At each period t, insiders receive a signal Sp that is correlated with LI,+~ Let H, denote the ation set of the uninformed traders at time t. Ht includes the time series ast tr~sact~~~ prices and cash flows as well as the current bid a.113ask te the information set of the informed traders. G* includes on in hi plus 8% signal St. The specialist is assumed to have the same information as the uninformed traders. et one at a time (randomly and anonymously) unit or leave without trading.15 Let c+ denote o arrives at the m et at time t (i.e., F, = H, md, and Ft = Gt if he is informed). Each to shares of stock, X, and current consumparameter of the individual investor’s utility
the market at a latez.
M.J. Barclay and C.
function (for t
Smith, Jr., Costs of stock repurchase program
),
2z-d
In eqs (1) the value
iscounted at 2 m iscount rate r represen at which investors are
exceptions: (1) The Glosten an ours has an infinite horizon. (2) Glosten an structure on the Wowof information.
not know when he sets nis bi informed or uninformed. ask prices will satisfy A,= @WV
Ptm4;;1-41~
If additional. informed tr shares) are introduced to t lasses at this current bid-ask sprea specialist will widen his b P _.
,a__. r_ _ IId ._ 5_ UP&L JLIG
79
M.J. Barclayand C. W. Smith,Jr., Costsof stockrepurchaseprogram
80
ectly from Glosten and
ilgrom’s Proposition 5 and is
licitly defined by the
(1 +i)‘=E
d'i(l+i)P-(i-"+
(4
1
tion of the competitive net rate of return i endogeation’s cost of capital, r. Because this security t, a wider bid-ask spread would imply a smaller current firm value to provide investors with the competitive net rate of return. r@?pss&WI 2. &en the assumptions above, the discount rate (opportunity cost of capital) r u--plied to the jbn ‘s cash fiw increase when ere is an increase in the precision of hiders’
(9
(ti)
information or e ratio aj*the informed to uninformed arrival rates is increased.
Proof.
e zero profit condition for the specialist [eqs. (2) and (3~1implies
at
(5)
t
y from eq. (1) an8 assumed martingak property of the cash
‘j 1
(1
*
r),Tl
(7)
Smith, Jr., Costs
of s
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