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Economic shock and share repurchases
North American Journal of Economics and Finance 44 (2018) 254–264
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Economic shock and share repurchases☆ a
b
Hsuan-Chi Chen , Joel T. Harper , Subramanian R. Iyer a b
a,⁎
T
FITE Department, Anderson School of Management, University of New Mexico, Albuquerque, NM 87131, United States School of Finance, Operations Management, and International Business, The University of Tulsa, Tulsa, OK 74104, United States
AB S T R A CT Using the most recent financial crisis as a natural experiment, we examine firm valuation, capital structure adjustment, and takeover deterrence as motives for share repurchases. We find that both overvalued firms and low levered firms are more likely to announce share repurchase programs and buy back more shares following the repurchase announcements. Potential target firms are more likely to announce larger share repurchase programs, but there is no significantly positive relation between the takeover probability and the completion rate. We also find that the decision to announce share repurchase and the decision to actually buy back shares following the repurchase announcement are separate to some extent.
1. Introduction A considerable volume of financial research has identified various motives for open market share repurchases (OMR) and has examined actual share acquisition, given that announcing firms are not obligated to buy back the number of shares announced in repurchase programs (Dittmar, 2000; Stephens & Weisbach, 1998). Dittmar (2000) examines share repurchases for the period 1977–1996, allowing the significance of each motive to change over time. She argues that for most firms, motives may be applicable only in certain time periods. Given time-varying motives for share repurchases, in this study we use an exogenous negative economic shock to all firms, namely, the financial crisis in 2008, as an explicit control for certain time periods to examine some motives for OMRs. The empirical results may improve our understanding about the motives for share repurchase announcements and actual share buybacks under difficult economic conditions. Firms still have discretion on the extent of actual share acquisition after they announce OMR programs. Therefore, the decision to announce share repurchase and the decision to repurchase the specific number of shares following the OMR announcement may have different determinants. That is, these two decisions are separate to some extent (see Cragg (1971) for analyzing the decisions on whether to purchase durable goods and the amount spent and Haushalter (2000) for studying the decisions to hedge production and the fraction of production to hedge). We also investigate this subtle issue which has not been addressed in the OMR literature. The financial crisis of 2008–2009 represents a period associated with a negative macroeconomic shock. Fig. 1 shows the performance of stock indices such as the S&P 500 index and Dow Jones U.S. Financials Index which is one of Dow Jones Sector Indices around the event. The financial crisis was caused by the serious credit crunch and financial distress simultaneously experienced in the financial industry, beyond the control of industrial firms. Thus, it was an exogenous negative liquidity shock to industrial firms, as shown in Fig. 1. Furthermore, the share repurchase authorization values in Fig. 2 also support the abrupt shift in economic regimes. The share repurchase authorization values dropped considerably during the financial crisis. Therefore, the period of financial crisis
☆ The authors thank an anonymous reviewer and conference participants at the 2016 annual meetings of the Southwestern Finance Association for their helpful comments. Hsuan-Chi Chen gratefully acknowledges support from the Anderson School of Management at the University of New Mexico. ⁎ Corresponding author. E-mail addresses: [email protected] (H.-C. Chen), [email protected] (J.T. Harper), [email protected] (S.R. Iyer).
https://doi.org/10.1016/j.najef.2018.01.006 Received 1 September 2017; Received in revised form 4 January 2018; Accepted 17 January 2018 1062-9408/ © 2018 Elsevier Inc. All rights reserved.
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Fig. 1. Number of Announcements This Figure provides the number of share repurchases per month from 2006 through 2010. The left-hand axis is the Dow-Jones Industrial average and S&P 500 index. The right-hand axis is the number of share repurchase announcements per month (numann).
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Fig. 2. Size of Share Repurchase Programs This figure provides the size of share repurchase programs in terms of authorization value per month from 2006 to 2010. The left-hand axis is the Dow-Jones Industrial average and S&P 500 index. The right-hand axis is the authorization value of share repurchase announcements per month (in billions).
provides the context to examine how the theories on the motivations for share repurchases work in an exogenous market condition. One motive for share repurchases is the information asymmetry between the firm and outside investors: firm insiders believe that their stock is undervalued because they disagree with market valuation for their firms (Ikenberry, Lakonishok, & Vermaelen, 1995) or because the market underestimates the firm’s prospects (Chen, Chen, Huang, & Schatzberg, 2014; Lie, 2005). Thus, when firms announce share repurchase programs, the market tends to perceive the announcement as a signal of undervaluation and reacts positively to the announcement (Comment & Jarrell, 1991; Dann, 1981; Vermaelen, 1981). Sudden price drops during the financial crisis may motivate firms to announce share repurchase programs to provide support for their own shares and to simultaneously send a signal to the market that their stocks were undervalued. Repurchasing stock reduces equity and increases leverage. Therefore, firms may repurchase shares to adjust their capital structure, particularly when their leverage ratios are below their target levels. Thus, a period of financial crisis presents a golden opportunity for firms to repurchase shares at lower valuations to adjust their capital structure. Furthermore, depressed stock prices during the financial crisis could attract unsolicited takeover attempts and cause unwanted distraction of managers’ attention and resources. Therefore, firms can repurchase shares to raise the acquisition price and deter unwanted takeover attempts (Bagwell, 1991). Billett and Xue (2007) model pre-purchase takeover probability and examine its impact on the decision to repurchase shares. They find a very strong positive relation between takeover probability and share repurchase, supporting the takeover deterrence hypothesis. The literature suggests that firms may buy back shares for different reasons, which may be interrelated even during the financial crisis. Using the variables designed to capture the effects of the above motives of share repurchases and following Haushalter (2000), we employ probit and cross-sectional OLS regressions to examine the likelihood of announcing an OMR program and the extent of actual share buyback following the repurchase announcement. These regressions simultaneously address the issue that the decision to announce an OMR program and the decision to actually buy back shares may have different determinants, which has not been addressed in the OMR literature. Another difference from the extant literature is that we use an exogenous liquidity shock, namely, the financial crisis of 2008, common to all industrial firms to examine the above motives of share repurchases, rather than using annual periods (such as in Dittmar (2000)) or long samples that may mask the effect of such difficult economic periods. In this paper we examine several issues related to share repurchase motives. First, using probit regressions to analyze the likelihood of share repurchase announcements, we find that firms with higher cash flows, lower leverage, and that pay smaller or no dividends or are more attractive takeover targets are more likely to announce share repurchase programs during the financial crisis. Second, we do not find consistent or robust repurchase motives that potentially explain the size of an OMR program. Third, when 255
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examining actual repurchases made within one year after the OMR announcement1, we find that overvalued firms prior to the financial crisis and firms with lower leverage tend to buy back more shares following the OMR announcements. However, we do not find a significantly positive relation between the takeover probability and the completion rate following the OMR announcement. Fourth, our empirical evidence supports the idea that the decision to announce an OMR program and the decision to actually buy back shares have different determinants. These two decisions are indeed separate to some extent. We note that this research issue has not been addressed in the OMR literature. The paper proceeds as follows. Section 2 discusses some motives of share repurchases and accordingly develops testable hypotheses in the context of financial crisis as a natural experiment. Section 3 provides the background. Section 4 presents methodology and empirical results. Section 5 concludes the study. 2. Hypothesis development Miller and Modigliani (1961) proposed the dividend irrelevance theory: in a perfect world, a firm’s payout policy should not matter. However, markets are imperfect, and the mode of payout surely influences corporate and investor decision-making. Consequently, the firm’s payout policy provides the opportunity to pose various interesting questions with respect to shareholder payout policy in general and share repurchases in particular. One important question is what factors influence firms’ repurchase behavior. Share repurchase behavior is not limited to share repurchase announcements. Extant literature has examined the cumulative abnormal returns surrounding announcements (Andriosopoulos & Lasfer, 2015), the size of share repurchase programs (Babenko et al., 2012), actual repurchases following announcements (Banyi, Dyl, & Kahle, 2008; Ginglinger & Hamon, 2007; Haw, Ho, Hu, & Zhang, 2011), the share repurchase completion (Andriosopoulos, Andriosopoulos, & Hoque, 2013; Stephens & Weisbach, 1998), and operating performance and long-run buy-and-hold abnormal returns following share repurchase announcements (Lie, 2005; Zhang, 2005). Collectively, we address these aspects of share repurchases as share repurchase behavior. Firms may have multiple independent or joint motives to repurchase shares. Dittmar (2000) tests some of the theories in a single framework, and Voss (2012) elucidates upon these theories. In this section, we develop several testable hypotheses in the context of financial crisis as a natural experiment. 2.1. Undervaluation One of the most popular theories of share repurchases is the undervaluation hypothesis, which is also interpreted as the signaling hypothesis. Information asymmetry between firm insiders and outsiders forms the basis of this theory. Firm insiders believe that the stock is undervalued with respect to their previous reference valuations. Therefore, firms announce a repurchase program, and the market perceives the announcement as a signal of undervaluation. Following the announcement, the share price reacts positively. Prior research finds 2% to 3% abnormal returns coinciding with the announcement of OMR programs (Jagannathan & Stephens, 2003). Survey evidence by Brav, Graham, Harvey, and Michaely (2005) also confirms that signaling undervaluation remains the most popular reason for repurchasing shares. Ikenberry et al. (1995) find that average buy-and-hold abnormal return (BHAR) after the initial share repurchase announcement is 12.1%. Chan, Ikenberry, and Lee (2004) use long-run stock returns to find abnormal compounded returns of 6.7% in the first year and 23.6% abnormal compounded returns four years post-announcement. Sudden price drops during the financial crisis could motivate firms to announce share repurchase programs to provide support for their own shares and to simultaneously send a signal to the market that their stocks were undervalued. Therefore, we test the following hypotheses based on the undervaluation motive for share repurchases. H2.1.1: More undervalued firms are more likely to announce OMR programs. H2.1.2: More undervalued firms tend to announce larger OMR programs. H2.1.3: More undervalued firms tend to buy back a higher percentage of the announced shares within a specific period following their OMR announcements. 2.2. Capital structure Excess cash returned to shareholders through share repurchase reduces equity, thus increasing in leverage. A firm could resort to share repurchases when its leverage ratio is below its target. This has prompted many to argue that firms repurchase shares to adjust their capital structure. Hovakimian, Opler, and Titman (2001) find that capital structure choices enjoy great significance when firms decide between repurchasing shares and raising additional debt. Employee stock options also affect capital structure. Leverage decreases when employees exercise stock options to own shares of the company. In addition, as the number of shares outstanding increases when options are exercised, the earnings per share are potentially diluted. Brav et al. (2005) find that 68% of the survey respondents consider equity dilution an important determinant to repurchasing shares because equity dilution further results in EPS dilution. Corporate executives are motivated to increase the earnings per share (EPS) if their compensation is linked to the EPS. Share repurchases offer a relatively quick and easy way to offset the effect of employee stock option exercises and to increase earnings per share. 1 We examine OMR announcements during the financial crisis. If a firm announces an OMR program on Sep 19, 2009 then we examine the actual repurchases until Sep 2010.
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The survey by Brav et al. (2005) finds evidence that a desire to increase the EPS could be one of the strong motivations to repurchase shares. Bens, Nagar, Skinner, and Franco Wong (2003) find that firms increase repurchases when the dilutive effect of employee stock options on EPS increases. In support of the equity dilution and EPS hypothesis, Fenn and Liang (2001) find a negative relationship between dividends and management stock options and a positive relationship between share repurchases and management stock options, which is also supported by Cuny, Martin, and Puthenpurackal (2009). A period of economic crisis presents good opportunities for firms to adjust capital structure through share repurchases because of relatively low stock prices than before. Furthermore, it is relatively difficult for low leverage firms to change capital structure via issuing bonds or borrowing bank loans during the financial crisis. The financial crisis could have presented a windfall opportunity. The special circumstance make share repurchases a more viable tool for adjusting capital structure during the crisis period if low leverage firms believe that their capital structure is below target levels. Based on the capital structure adjustment motive for share repurchases, we accordingly posit the following hypotheses. H2.2.1: Low leverage firms are more likely to announce OMR programs. H2.2.2: Low leverage firms tend to announce larger OMR programs. H2.2.3: Low leverage firms tend to buy back a higher percentage of the announced shares within a specific period following their OMR announcements. 2.3. Takeover deterrence Poor operating performance depresses stock prices. Such depressed stock prices could attract unsolicited takeover attempts causing unwanted distraction for managers’ attention and resources. Therefore, the firm may repurchase shares to provide support to sagging stock prices and thereby deter unwanted takeover attempts (Bagwell, 1991). Billett and Xue (2007) model pre-purchase takeover probability and examine its impact on the decision to repurchase shares. They find a strong positive relation between takeover probability and the decision to repurchase shares. Based on takeover deterrence argument, we expect that depressed stock prices during the financial crisis could attract unsolicited takeover attempts. Therefore, we develop the following hypotheses. H2.3.1: Takeover target firms are more likely to announce OMR programs. H2.3.2: Takeover target firms tend to announce larger OMR programs. H2.3.3: Takeover target firms tend to buy back a higher percentage of the announced shares within a specific period following their OMR announcements. 3. Background Literature shows that the undervaluation, excess cash flow, and stock option exercise and equity dilution hypotheses have dominated as the most important motivations for share repurchases. These same motivations are potentially even stronger during a period of depressed stock valuations. Stock valuations can trend lower due to firm-specific or macroeconomic reasons. Focusing on the macroeconomic causes, managers who are cognizant of the opportunities presented by the depressed stock valuations may announce stock repurchase plans. One such macroeconomic event in the recent past is the financial crisis of 2008–2009. According to the Financial Crisis Inquiry Commission, the recession officially started in December 2007. By December 2009, the economy had lost 8.3 million jobs, and the underemployment rate soared to 17.4%. Households nearly lost $17 trillion in household net wealth, and their debt levels remained near historic highs. The S&P 500 lost a third of its value in 2008 before recovering in 2009. However, by December 2010, the S&P 500 was still 13% lower than at the start of 2008. Worldwide, stock prices plummeted by more than 40% before rebounding in 2009. The credit crunch was so debilitating for firms and individuals that consumer confidence fell to its lowest point since late 1992. Given the magnitude of such a crisis, a shrewd manager could have easily profited from this opportunity by announcing new programs or by repurchasing shares for previously announced programs. However, business financing dried up during the crisis. Firms in need of financing could not rely on the financial markets; instead, they had to draw down cash reserves or pay a hefty premium to use conventional channels such as bank lending. Therefore, the need to conserve cash and the opportunity to repurchase shares are competing arguments to some extent. 4. Methodology and empirical results 4.1. Variables Undervaluation is the primary motive for share repurchases. Hence, it is critical to measure the extent of undervaluation for a firm. The early literature, such as Dittmar (2000) and Ikenberry et al. (1995), uses past stock returns as proxies for undervaluation. The recent literature has used mispricing measures, as proposed in Rhodes-Kropf, Robinson, and Viswanathan (2005) (RRV), as a proxy for undervaluation. We follow Fu, Lin, and Officer (2013) to calculate the RRV mispricing measures. Note that the RRV mispricing measure estimates the ratio of market value of equity to intrinsic value of equity, which is calculated as follows:
M RRV = Ln ⎛ ⎞ ⎝ V ⎠i
(1)
where M is the market value of equity and V is the unobservable intrinsic value of equity as specified in Appendix 3. Hence, the 257
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Table 1 Summary Statistics This table provides the summary statistics. Appendix 1 offers variable definitions. OMR Firms Variable RRV CASH CASHFLOW LEVERAGE TAKEOVERPROB M/B SIZE SAINDEX DIVIDENDS OPTIONS
Non-OMR Firms Mean 0.1698 0.2317 0.1327 0.4150 0.2190 5.0223 6.2418 −3.6603 0.0105 0.0290
Std Dev 0.6126 0.2134 0.1085 0.2139 0.0969 42.7034 2.0375 0.8385 0.0329 0.0556
N 1050 1057 1057 1049 993 1057 1057 1066 1057 606
Median 0.1469 0.1563 0.1316 0.4101 0.2276 2.4195 6.2292 −3.5544 0.0000 0.0212
Mean 0.0671 0.1973 0.0507 0.4566 0.1273 4.2772 5.4614 −3.1244 0.0176 8.2411
Std Dev 1.6876 0.2327 0.2675 0.2203 0.1017 31.7637 2.6806 1.2997 0.0754 179.1634
N 8226 8714 8714 8702 7469 8714 8714 9504 8714 2353
Median 0.0834 0.0970 0.1023 0.4600 0.1539 2.0694 5.5455 −3.2543 0.0000 0.0159
T-Test
Median Test **
1.9563 4.5824*** 9.8695*** −5.8035*** 26.8355*** 0.6907 9.1497*** −13.1565*** −2.9982*** −1.1282
3.472*** 8.353*** 11.236*** −5.843*** 26.970*** 7.215*** 8.715*** −14.098*** −3.127*** 5.237***
relatively large positive values of RRV measure indicate overvaluation, and the negative values of RRV measure suggest undervaluation. We follow Dittmar (2000) and measure the excess cash using two variables. CASH is measured as cash and cash equivalents, and CASHFLOW is measured as operating income before depreciation as in Ang et al. (2014). Following Dittmar (2000) and Ikenberry, Lakonishok, and Vermaelen (2000), we measure investment opportunities by the market-to-book ratio, M/B, which is defined as the ratio of market value of equity divided by book value of equity. Market value of equity is calculated as the product of fiscal year ending price and number of common shares outstanding. The market-to-book ratio also can indicate potential undervaluation. The optimal capital structure hypothesis assumes that firms repurchase shares to attain a target leverage ratio. We include LEVERAGE, which is measured as the ratio of total liabilities to total assets. Furthermore, firms may repurchase shares to offset the equity dilution due to employees’ option exercise. To measure the impact of options exercise, we include the variable OPTIONS, as in Cuny et al. (2009). As financial constraints can influence share repurchases, we include SAINDEX as calculated in Hadlock and Pierce (2010). Dividends could act as a deterrent for share repurchases, so we include DIVIDENDS, which are calculated as the annual cash dividends. Appendix 1 provides a summary of variable definitions.
4.2. Sample and summary statistics Our data comes from multiple sources. We use SDC Platinum to identify the repurchase program announcement dates and obtain mergers and acquisitions data for estimating takeover probabilities. SEC 10 K and 10Q filings are used to collect the actual repurchase data. We use COMPUSTAT to find firm-level information on most accounting variables. We also use CRSP to collect stock price information. Employee options data come from EXECUCOMP. We follow prior literature and exclude financial firms. Table 1 reports the summary statistics for both OMR firms that announced open market repurchases programs and non-OMR firms that did not announce share buyback programs during the financial crisis. The variables are all lagged one year. The average and median RRV measure for OMR firms are positive and larger than those for non-OMR firms, suggesting that OMR firms tend to be overvalued before the financial crisis. It is plausible that these firms could have experienced large negative returns during the financial crisis, leading firm managers to perceive undervaluation and resulting in the announcement of an OMR program2. The mean cash ratio for OMR firms is 23%, which is significantly higher than 20% for other firms. The median cash ratio for OMR firms is 16%, which is 6% higher than that of other firms. The average and median cash flow for OMR firms are also significantly higher than those of other firms. Such evidence suggests that OMR firms are in better shape than other firms in terms of liquidity. The mean and median leverage of OMR firms are significantly lower than those of other firms, consistent with the idea that low leverage firms may announce share repurchase programs to adjust their capital structure during the financial crisis. Furthermore, the average and median takeover probability of OMR firms are significantly higher than those of non-OMR firms, indicating that potential target firms tend to announce share repurchase programs to deter takeover attempts. To categorize the announcement decisions, we use calendar time-period. For example, a firm that announces an OMR program in December 2008 is categorized as an announcement in 2008 (financial crisis year). One of the perils of working with share repurchases data is that share repurchases have no predictable pattern as opposed to dividends. Firms may announce multiple programs during a given year. Firms may reauthorize an old announcement without increasing the authorization value. Firms may even reauthorize an old announcement with additional value commitment. Therefore, in many cases it is difficult to trace actual repurchases to their respective announcements. To avoid that problem, in our sample we include only new announcements as well as those reauthorizations with additional money. We strictly trace all the actual repurchases in the next twelve months to the current announcement. For example, if a firm announces a repurchase program in August 2008, all repurchases before September 2009 is traced and assigned to the announcement made in August 2008. A firm may also announce multiple share repurchase programs. For example, a firm may 2 We calculated one-year buy-and-hold abnormal returns for the first year of the financial crisis and found that both OMR and non-OMR firms suffered an almost identical 30% decline in stock returns.
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Table 2 Share Repurchase Activity This table provides the summary statistics of the SHARES AUTHORIZED, SHARES REPURCHASED, COMPLETION RATE, and number of OMR announcements during the period 2008–2009. Appendix 1 offers variable definitions. 2008
2009
Variable
Mean
Median
Mean
Median
SHARES AUTHORIZED SHARES REPURCHASED COMPLETION RATE NUMBER OF OMR ANNOUNCEMENTS
0.0846 0.0440 0.6126 803
0.0674 0.0321 0.5059
0.0774 0.0426 0.7381 263
0.0606 0.0306 0.4988
announce a share repurchase program in August 2008 and another one in April 2009. All repurchases before April 2009 is traced and assigned to August 2008 announcement and all repurchases before May 2010 are traced and assigned to April 2009 announcement. Table 2 presents a summary of share repurchase activity during the financial crisis period. In 2008, there were 803 OMR announcements, and the number of announcements was reduced to one third of that level or 263 in 2009. The ratio of the number of shares authorized to be bought back to the number of shares outstanding is around 8% for both years. In contrast, the ratio of the number of shares that is actually bought back following their announcements to the number of shares outstanding is 4% on average for both years. In terms of completion rate, the average is 61% for 2008 and 74% for 2009; while the median completion rates are around 50% for both years. 4.3. Multivariate models and empirical results One of the most important questions asked in the OMR literature is why do firms announce share repurchase programs. Studies such as Dittmar (2000) have performed a long-run test spanning different economic periods to answer this question. The motivations during the financial crisis period could be entirely different than longer sample periods. Considerations during the financial crisis were unique because firms could have been in a conservative mode. To examine the motives behind share repurchase announcements, we perform probit regressions as follows:
ANNi = αi + β1 RRVi + β2 CASHi + β3 CASHFLOWi + β4 LEVERAGEi + β5 TAKEOVERPROBi + β6 M / Bi + β7 SIZEi + β8 SAINDEXi + β9 DIVIDENDSi + β10 OPTIONSi + εi,
(2)
where ANN is a dummy variable that takes the value of 1 if the firm announced a share repurchase program, and 0 otherwise. We present the empirical results in Table 3. The RRV mispricing measure is positively related to the likelihood of announcing a Table 3 Why Do Firms Announce Share Repurchase Programs? The table provides the results of probit regression models with ANN as the dependent variable. Robust Zstatistics are reported in the parenthesis. Coefficients significant at the 1%, 5%, and 10% level are marked by ***, **, and *, respectively. Industry fixed effects are included in all models. Please refer to Appendix 1 for variable definitions. VARIABLES RRV CASH
(1)
(2) ***
0.1753 (4.8769) 0.0595 (0.5579)
(3) ***
0.1299 (3.4817)
−0.9733*** (−7.1803) 4.5402*** (18.2862) 0.0003 (0.7510) −0.0540*** (−3.5071) −0.3197*** (−9.6011) −2.4047*** (−2.6375)
1.3985*** (9.4562) −0.7603*** (−5.7039) 4.6143*** (18.4958) 0.0006 (1.4452) −0.0791*** (−5.0094) −0.2716*** (−7.8652) −3.3452*** (−3.2671)
Constant
−2.2427*** (−16.5962)
Wald Chi-Sq Observations
677*** 8128
CASHFLOW LEVERAGE TAKEOVERPROB M/B SIZE SAINDEX DIVIDENDS
(4) **
0.1432 (2.1777) −0.0514 (−0.2650)
0.1081 (1.5934)
−2.1536*** (−16.7626)
−1.0140*** (−4.6663) 4.8096*** (14.0512) 0.0039 (0.6886) 0.0043 (0.1566) −0.0639 (−1.1862) −2.2231* (−1.9314) −0.0003 (−0.3886) −1.2550*** (−5.1504)
1.3392*** (4.5005) −0.7506*** (−3.5129) 4.8337*** (14.1993) 0.0019 (0.2349) −0.0156 (−0.5603) −0.0695 (−1.2828) −3.1709** (−2.4352) −0.0018 (−0.2391) −1.4472*** (−6.3307)
698*** 8128
314*** 2555
307*** 2555
OPTIONS
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Table 4 Number of Shares Authorized This table provides the regression results with SHARES AUTHORIZED as the dependent variable. Robust t-statistics are reported in the parenthesis. Coefficients significant at the 1%, 5%, and 10% level are marked by ***, **, and *, respectively. Industry fixed effects are included in all models. Please refer to Appendix 1 for variable definitions. VARIABLES
(1)
(2)
RRV
−0.0133 (−2.5810) 0.0283** (2.5175)
**
CASH CASHFLOW
(3)
−0.0119 (−2.4725) **
0.0719*** (4.9331) 0.0351 970
0.0774 559
0.0872 559
Constant
0.0576*** (3.5780)
Adj R-Squared Observations
0.0380 970
M/B SIZE SAINDEX DIVIDENDS
−0.0183** (−2.2198)
0.0654*** (3.0513) 0.0703** (2.2560) −0.0003 (−0.9788) 0.0001 (0.0306) 0.0015 (0.2929) −0.1407 (−1.2865) 0.2245*** (3.9391) 0.0275 (1.1813)
0.0577*** (3.4596) 0.0494* (1.8787) 0.0001*** (2.9705) −0.0013 (−0.6815) 0.0031 (0.8049) 0.0646 (0.4767)
TAKEOVERPROB
−0.0158 (−1.9400) 0.0402** (2.1963)
0.1118** (2.1738) 0.0719*** (2.8870) 0.0766** (2.4345) 0.0001 (0.3717) −0.0016 (−0.5401) 0.0034 (0.6757) −0.2397** (−2.0657) 0.2323*** (4.2737) 0.0310 (1.3850)
0.0311 (1.0462) 0.0491*** (3.1297) 0.0567** (2.1478) 0.0001*** (2.8080) −0.0020 (−1.0548) 0.0051 (1.2622) 0.0492 (0.3758)
LEVERAGE
(4) *
OPTIONS
share repurchase program during the financial crisis. The result suggests that overvalued firms prior to the financial crisis are more likely to announce share repurchase programs. The result is consistent with the idea that the prior overvalued firms could experience large negative returns during the financial crisis, and thus lead the managers to perceive their firms as undervalued. If this is the case, it is more likely for these firms to announce share repurchase programs. Also, firms with higher cash flows were more likely to announce a repurchase program during the financial crisis period. Consistent with hypothesis H2.2.1, lower leverage firms are more likely to announce share repurchase programs. Furthermore, we find that higher takeover probability prompts firms to announce share repurchase programs, supporting the hypothesis H2.3.1. We also find that dividend paying firms are less likely to announce share repurchase programs across all specifications. The number of share authorized to be bought back (normalized by the number of shares outstanding), which represents the size of the announced share repurchase program conveys a signal and a larger repurchase program conveys a stronger signal (Chan, Ikenberry, Lee, & Wang, 2010; Comment & Jarrell, 1991). It is plausible that the motives mentioned earlier could explain the size of the repurchase program. To test this hypothesis, we run cross-sectional regressions of the following form:
AUTHSHAREi = αi + β1 RRVi + β2 CASHi + β3 CASHFLOWi + β4 LEVERAGEi + β5 TAKEOVERPROBi + β6 M / Bi + β7 SIZEi + β8 SAINDEXi + β9 DIVIDENDSi + β10 OPTIONSi + εi.,
(3)
where AUTHSHARE is the number of share to be bought back in the OMR announcement, normalized by the number of shares outstanding in the secondary market. We report the empirical results in Table 4. Across all specifications, the significantly negative coefficients on the RRV mispricing measure suggest that less overvalued or even undervalued firms tend to announce larger share repurchase programs. The evidence is consistent with hypothesis H2.1.2. However, the significantly positive coefficients on leverage do not support hypothesis H2.2.2, which posits that low leverage firms would announce larger share repurchase programs, implying a significantly negative coefficient on leverage. Theegative coefficient on TAKEOVERPROB suggests that higher takeover probability prompts firms to announce larger share repurchase programs, supporting hypothesis H2.3.2. Banyi et al. (2008) report the flaws in the dollar values of share repurchases calculated by many researchers using standard data sources. They recommend using the quarterly and annual statements to assimilate share repurchases, which can be defined as actual repurchases (Ben-Rephael, Oded, & Wohl, 2013; Bonaimé, 2012; Ginglinger & Hamon, 2007). Firms have been publishing data on actual repurchases on a quarterly basis since 2004. Bonaimé (2012) uses actual share repurchase data to confirm that the completion rate is approximately 73%. We run the following cross-sectional regression model to examine which motive of share repurchases could explain the completion rate (COMPLETION RATE) defined as the ratio of the number of shares bought back within one year following the OMR announcement to the number of shares authorized in the OMR announcement.
COMPLETIONRATEi = αi + β1 RRVi + β2 CASHi + β3 CASHFLOWi + β4 LEVERAGEi + β5 TAKEOVERPROBi + β6 M / Bi + β7 SIZEi + β8 SAINDEXi + β9 DIVIDENDSi + β10 OPTIONSi + εi, 260
(4)
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Table 5 Repurchase Completion This table provides the regressions results with COMPLETION RATE as the dependent variable. Robust t-statistics are reported in the parenthesis. Coefficients significant at the 1%, 5%, and 10% level are marked by ***, **, and *, respectively. Industry fixed effects are included in all models. Please refer to Appendix 1 for variable definitions. VARIABLES
(1)
(2) **
**
0.1405 (2.0947) 0.0388 (0.2474) −0.2824* (−1.6797) −0.6484** (−2.2180) −0.0002 (−0.6954) 0.0371* (1.9250) 0.0104 (0.2382) −1.1680** (−2.2268) 0.1405** (2.0947)
0.1330 (2.1676)
Constant
0.8181*** (3.2455)
Adj R-Squared Observations
0.0238 900
RRV CASH CASHFLOW LEVERAGE TAKEOVERPROB M/B SIZE SAINDEX DIVIDENDS
−0.2607* (−1.7303) −0.6351** (−2.1386) −0.0002 (−0.7464) 0.0342* (1.7948) 0.0189 (0.4306) −1.3142** (−2.3537) 0.1330** (2.1676)
(3)
(4)
0.1492 (1.4238) −0.1926 (−0.9434)
0.1435 (1.3815)
0.8282*** (3.6657)
−0.4172 (−1.8569) −0.5667* (−1.7479) 0.0008 (0.2490) 0.0735*** (2.9701) 0.0405 (0.6631) −2.4117 (−1.4300) 0.7367 (1.4928) 0.7749** (2.3105)
−0.1948 (−0.6346) −0.3787* (−1.7709) −0.6007* (−1.8625) −0.0003 (−0.0911) 0.0784*** (3.2193) 0.0321 (0.5244) −2.2286 (−1.3295) 0.7232 (1.4993) 0.6996** (2.3460)
0.0249 900
0.0402 546
0.0395 546
OPTIONS
*
Table 5 reports the empirical results for the completion rate. Models (1) and (2) show that the RRV mispricing measure is positively related to the completion rate during the financial crisis. That is, potentially overvalued firms prior to the financial crisis tend to buy back more shares. The result does not support hypothesis H2.1.3. However, we cannot exclude the possibility that overvalued firms may experience large negative returns during the financial crisis, the managers perceive their firms are undervalued, and they accordingly decide to buy back relatively more shares following the OMR announcements. We also find that leverage is significant and negatively related to completion rate across all specifications. This result supports hypothesis H2.2.3, which posits that low leverage firms tend to buy back a higher percentage of share repurchase programs following their OMR announcements. We also examine the coefficients on the takeover probability. However, the results do not support hypothesis H2.3.3, which posits that potential target firms tend to buy back a higher percentage of share repurchase programs following their OMR announcements. We consider the results from both Tables 3 and 5 to examine whether the motives to announce a share repurchase program can simultaneously explain the decision to buy back more shares following the OMR announcement. Our results support neither the hypothesis that more undervalued firms are more likely to announce share repurchase programs (H2.1.1) nor the hypothesis that more undervalued firms buy back a higher percentage of share repurchase programs following their OMR announcements. However, our test may be subject to a problem of error-in-variable because our mispricing measure is lagged one year. It is possible that the prior overvalued firms tend to experience large negative returns during the financial crisis and the managers perceive their firms as undervalued accordingly. Therefore, these firms are more likely to announce share repurchase programs and buy back more shares following their announcements. If this is the case, we then find a common factor, namely, recent stock price declines simultaneously explain the decision to announce a share repurchase program and the decision to buy back more shares following the OMR announcement. We next turn to the motive of capital structure adjustment. In Table 3, we find that lower leverage firms are more likely to announce share repurchase programs. Furthermore, in Table 5, we find that low leverage firms buy back a higher percentage of share repurchase programs following their OMR announcements. Therefore, firm leverage can simultaneously explain the decision to announce a share repurchase program and the decision to buy back more shares following the OMR announcement. We further examine the takeover deterrence hypothesis. However, we do not find the evidence that takeover deterrence can simultaneously explain the decision to announce share repurchase and the decision to repurchase some number of shares following the OMR announcement. Overall, we conclude that these two decisions are separate to some extent. 5. Conclusion The financial crisis was an unprecedented event in the recent global financial history. In the wake of such an event, we specifically explore three motives behind share repurchase activity in the context of an exogenously negative shock. These motives include undervaluation, capital structure or leverage adjustment, and takeover deterrence. Theories explaining the motivations for share 261
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repurchases are well established. On the one hand, these motives may also explain other aspects of share repurchases such as the size of the share repurchase program and the completion rate for actual share repurchases within a specific period following the OMR announcement. On the other hand, after firms announce share repurchase programs, managers still have discretion on the extent of actual share acquisition. Thus, the decision to announce share repurchase and the decision to buy back a specific number of shares following the OMR announcement may have different determinants. That is, these two decisions are separate to some degree. We also examine this subtle issue which has not been addressed in the OMR literature. Following prior studies, we posit that undervaluation is a primary motive for firms to announce share repurchases. Contrary to popular belief, our results show that overvalued firms prior to the financial crisis are more likely to announce share repurchase programs and buy back more shares following the repurchase announcements. However, we still find that less overvalued or even undervalued firms tend to announce larger share repurchase programs. We find that lower leveraged firms are more likely to announce share repurchase programs and buy back a higher percentage of share repurchase programs following their OMR announcements; however, lower leverage firms tend to announce smaller share repurchase programs. In sum, firm leverage can simultaneously explain the decision to announce a share repurchase program and the decision to buy back more shares following the OMR announcement. Finally, we find that potential target firms are more likely to announce larger share repurchase programs. But, we do not find a significantly positive relation between the takeover probability and the completion rate following the OMR announcement. Furthermore, the combination of the above results implies that takeover deterrence cannot simultaneously explain the decision to announce share repurchase and the decision to repurchase some number of shares following the announcement. Therefore, we conclude that these two decisions are separate to some extent and that we have addressed an issue that was not explored in the OMR literature. Appendix 1. Variable Definitions Variable
Definition
ANN CASH CASHFLOW COMPLETION RATE DIVIDENDS LEVERAGE M/B
Dummy variable that takes value of 1 if a firm announced an open-market share repurchase program Cash and cash equivalents scaled by total assets Operating income before depreciation scaled by total assets The ratio of number of SHARES AUTHORIZED to SHARES REPURCHASED
OPTIONS RRV SHARES AUTHORIZED SHARES REPURCHASED SAINDEX SIZE TAKEOVERPROB
Annual cash dividends scaled by total assets Total debt divided by total assets Market value of equity divided by book value of equity. Market value of equity is calculated as the product of fiscal year ending price and number of common shares outstanding Calculated as the sum of unexercised exercisable options and unexercised unexercisable options scaled by common shares outstanding Undervaluation measure created per Rhodes-Kropf, Robinson, and Swaminathan (2005). The methodology is explained in Appendix 3 Number of shares authorized scaled by total shares outstanding Number of shares repurchased scaled by total shares outstanding Calculated per the equation: −0.737 × Size + 0.043 × Size2 − 0.040 × Age Logarithm of sales Takeover probability estimated as in Billett and Xue (2007). The method used in this paper is reported in Appendix 2
Appendix 2. Takeover Probability Estimation Billett and Xue (2007) estimate a heteroskedasticity corrected probit model of takeover probability by maximum likelihood. They define a takeover attempt based on whether a firm receives a takeover bid, as reported in SDC. The various control variables they use are as follows. ROAIA is defined as the operating income before depreciation scaled by total assets. SIZEEQ is the natural log of common equity. LEVBIA is defined as the two-digit industry median adjusted total debt scaled by total assets. NPPE is the net property, plant, and equipment scaled by total assets. SALEGR is the sales growth over the previous year measured as the natural log of the sales in the current year over the sales in the previous year. MKBK is the market value of common equity to the book value of equity. ITODUM equals 1 if at least one firm in the same industry (same four-digit SIC code) receives a takeover bid. They also include time dummies for different time periods. Because we estimate this model for the beginning of the financial crisis period (2007) and the quantitative easing period (2009), we chose to ignore the time dummies. The results are reported below.
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Intercept ROAIA SIZEEQ LEVBIA MKBK SALEGR NPPE ITODUM
−1.2023∗∗∗ 0.2397∗∗∗ 0.1073∗∗∗ 0.000081∗∗ 0.000121 −0.1478∗∗∗ −0.5374∗∗∗ −4.995
N TODUM WALD CHI-SQ LOG LIKELIHOOD
9978 1624 290.17 −3625.53
Coefficients significant at 1%, 5%, and 10% are indicated by
∗∗∗ ∗∗
,
, and
∗
respectively.
Appendix 3. The mispricing measure of the RRV model Fu, Lin, and Officer (2013) estimate the undervaluation RRV measure as proposed by Rhodes-Kropf, Robinson, and Viswanathan (2005). The basic identity used is
M M V ln ⎛ ⎞ = ln ⎛ ⎞ + ln ⎛ ⎞, ⎝B⎠ ⎝V ⎠ ⎝B⎠
(1)
where M is the market value of equity, B is the book value of equity, and V is the unobservable intrinsic value of equity. The market value of equity M is expressed as the following linear function:
D ln (Mit ) = α 0jt + α1jtln (Bit ) + α2jtln (|NIit |) + α3jt I −ln (|NIit |) + α4jt ⎛ ⎞ + εit , ⎝ V ⎠it
(2)
where |NIit | is the absolute value of net income for firm i at time t. is an indicator variable that equals one for firm-years when net income is negative, and zero otherwise. D is the market leverage ratio and subscript j stands for industry j. We perform cross sectional V regressions of model (2) for each industry using the Fama-French 12-industry classification scheme to estimate the parameters. The parameters are averaged over time for each industry. The mispricing measure of the RRV model is then calculated as follows:
I−
M D ln ⎛ ⎞ = ln (Mit )−α 0j + α1j ln (Bit ) + α2j ln (|NIit |) + α3j I −ln (|NIit |) + α4j ⎛ ⎞ . ⎝V ⎠ ⎝ V ⎠it
(3)
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North American Journal of Economics and Finance journal homepage: www.elsevier.com/locate/najef
Economic shock and share repurchases☆ a
b
Hsuan-Chi Chen , Joel T. Harper , Subramanian R. Iyer a b
a,⁎
T
FITE Department, Anderson School of Management, University of New Mexico, Albuquerque, NM 87131, United States School of Finance, Operations Management, and International Business, The University of Tulsa, Tulsa, OK 74104, United States
AB S T R A CT Using the most recent financial crisis as a natural experiment, we examine firm valuation, capital structure adjustment, and takeover deterrence as motives for share repurchases. We find that both overvalued firms and low levered firms are more likely to announce share repurchase programs and buy back more shares following the repurchase announcements. Potential target firms are more likely to announce larger share repurchase programs, but there is no significantly positive relation between the takeover probability and the completion rate. We also find that the decision to announce share repurchase and the decision to actually buy back shares following the repurchase announcement are separate to some extent.
1. Introduction A considerable volume of financial research has identified various motives for open market share repurchases (OMR) and has examined actual share acquisition, given that announcing firms are not obligated to buy back the number of shares announced in repurchase programs (Dittmar, 2000; Stephens & Weisbach, 1998). Dittmar (2000) examines share repurchases for the period 1977–1996, allowing the significance of each motive to change over time. She argues that for most firms, motives may be applicable only in certain time periods. Given time-varying motives for share repurchases, in this study we use an exogenous negative economic shock to all firms, namely, the financial crisis in 2008, as an explicit control for certain time periods to examine some motives for OMRs. The empirical results may improve our understanding about the motives for share repurchase announcements and actual share buybacks under difficult economic conditions. Firms still have discretion on the extent of actual share acquisition after they announce OMR programs. Therefore, the decision to announce share repurchase and the decision to repurchase the specific number of shares following the OMR announcement may have different determinants. That is, these two decisions are separate to some extent (see Cragg (1971) for analyzing the decisions on whether to purchase durable goods and the amount spent and Haushalter (2000) for studying the decisions to hedge production and the fraction of production to hedge). We also investigate this subtle issue which has not been addressed in the OMR literature. The financial crisis of 2008–2009 represents a period associated with a negative macroeconomic shock. Fig. 1 shows the performance of stock indices such as the S&P 500 index and Dow Jones U.S. Financials Index which is one of Dow Jones Sector Indices around the event. The financial crisis was caused by the serious credit crunch and financial distress simultaneously experienced in the financial industry, beyond the control of industrial firms. Thus, it was an exogenous negative liquidity shock to industrial firms, as shown in Fig. 1. Furthermore, the share repurchase authorization values in Fig. 2 also support the abrupt shift in economic regimes. The share repurchase authorization values dropped considerably during the financial crisis. Therefore, the period of financial crisis
☆ The authors thank an anonymous reviewer and conference participants at the 2016 annual meetings of the Southwestern Finance Association for their helpful comments. Hsuan-Chi Chen gratefully acknowledges support from the Anderson School of Management at the University of New Mexico. ⁎ Corresponding author. E-mail addresses: [email protected] (H.-C. Chen), [email protected] (J.T. Harper), [email protected] (S.R. Iyer).
https://doi.org/10.1016/j.najef.2018.01.006 Received 1 September 2017; Received in revised form 4 January 2018; Accepted 17 January 2018 1062-9408/ © 2018 Elsevier Inc. All rights reserved.
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Number of Share Repurchases Announcement 140
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100 80
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DJFN
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0
numann
Fig. 1. Number of Announcements This Figure provides the number of share repurchases per month from 2006 through 2010. The left-hand axis is the Dow-Jones Industrial average and S&P 500 index. The right-hand axis is the number of share repurchase announcements per month (numann).
Authorization Value of Shares Repurchases 140
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0 2006-04
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authbill
Fig. 2. Size of Share Repurchase Programs This figure provides the size of share repurchase programs in terms of authorization value per month from 2006 to 2010. The left-hand axis is the Dow-Jones Industrial average and S&P 500 index. The right-hand axis is the authorization value of share repurchase announcements per month (in billions).
provides the context to examine how the theories on the motivations for share repurchases work in an exogenous market condition. One motive for share repurchases is the information asymmetry between the firm and outside investors: firm insiders believe that their stock is undervalued because they disagree with market valuation for their firms (Ikenberry, Lakonishok, & Vermaelen, 1995) or because the market underestimates the firm’s prospects (Chen, Chen, Huang, & Schatzberg, 2014; Lie, 2005). Thus, when firms announce share repurchase programs, the market tends to perceive the announcement as a signal of undervaluation and reacts positively to the announcement (Comment & Jarrell, 1991; Dann, 1981; Vermaelen, 1981). Sudden price drops during the financial crisis may motivate firms to announce share repurchase programs to provide support for their own shares and to simultaneously send a signal to the market that their stocks were undervalued. Repurchasing stock reduces equity and increases leverage. Therefore, firms may repurchase shares to adjust their capital structure, particularly when their leverage ratios are below their target levels. Thus, a period of financial crisis presents a golden opportunity for firms to repurchase shares at lower valuations to adjust their capital structure. Furthermore, depressed stock prices during the financial crisis could attract unsolicited takeover attempts and cause unwanted distraction of managers’ attention and resources. Therefore, firms can repurchase shares to raise the acquisition price and deter unwanted takeover attempts (Bagwell, 1991). Billett and Xue (2007) model pre-purchase takeover probability and examine its impact on the decision to repurchase shares. They find a very strong positive relation between takeover probability and share repurchase, supporting the takeover deterrence hypothesis. The literature suggests that firms may buy back shares for different reasons, which may be interrelated even during the financial crisis. Using the variables designed to capture the effects of the above motives of share repurchases and following Haushalter (2000), we employ probit and cross-sectional OLS regressions to examine the likelihood of announcing an OMR program and the extent of actual share buyback following the repurchase announcement. These regressions simultaneously address the issue that the decision to announce an OMR program and the decision to actually buy back shares may have different determinants, which has not been addressed in the OMR literature. Another difference from the extant literature is that we use an exogenous liquidity shock, namely, the financial crisis of 2008, common to all industrial firms to examine the above motives of share repurchases, rather than using annual periods (such as in Dittmar (2000)) or long samples that may mask the effect of such difficult economic periods. In this paper we examine several issues related to share repurchase motives. First, using probit regressions to analyze the likelihood of share repurchase announcements, we find that firms with higher cash flows, lower leverage, and that pay smaller or no dividends or are more attractive takeover targets are more likely to announce share repurchase programs during the financial crisis. Second, we do not find consistent or robust repurchase motives that potentially explain the size of an OMR program. Third, when 255
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examining actual repurchases made within one year after the OMR announcement1, we find that overvalued firms prior to the financial crisis and firms with lower leverage tend to buy back more shares following the OMR announcements. However, we do not find a significantly positive relation between the takeover probability and the completion rate following the OMR announcement. Fourth, our empirical evidence supports the idea that the decision to announce an OMR program and the decision to actually buy back shares have different determinants. These two decisions are indeed separate to some extent. We note that this research issue has not been addressed in the OMR literature. The paper proceeds as follows. Section 2 discusses some motives of share repurchases and accordingly develops testable hypotheses in the context of financial crisis as a natural experiment. Section 3 provides the background. Section 4 presents methodology and empirical results. Section 5 concludes the study. 2. Hypothesis development Miller and Modigliani (1961) proposed the dividend irrelevance theory: in a perfect world, a firm’s payout policy should not matter. However, markets are imperfect, and the mode of payout surely influences corporate and investor decision-making. Consequently, the firm’s payout policy provides the opportunity to pose various interesting questions with respect to shareholder payout policy in general and share repurchases in particular. One important question is what factors influence firms’ repurchase behavior. Share repurchase behavior is not limited to share repurchase announcements. Extant literature has examined the cumulative abnormal returns surrounding announcements (Andriosopoulos & Lasfer, 2015), the size of share repurchase programs (Babenko et al., 2012), actual repurchases following announcements (Banyi, Dyl, & Kahle, 2008; Ginglinger & Hamon, 2007; Haw, Ho, Hu, & Zhang, 2011), the share repurchase completion (Andriosopoulos, Andriosopoulos, & Hoque, 2013; Stephens & Weisbach, 1998), and operating performance and long-run buy-and-hold abnormal returns following share repurchase announcements (Lie, 2005; Zhang, 2005). Collectively, we address these aspects of share repurchases as share repurchase behavior. Firms may have multiple independent or joint motives to repurchase shares. Dittmar (2000) tests some of the theories in a single framework, and Voss (2012) elucidates upon these theories. In this section, we develop several testable hypotheses in the context of financial crisis as a natural experiment. 2.1. Undervaluation One of the most popular theories of share repurchases is the undervaluation hypothesis, which is also interpreted as the signaling hypothesis. Information asymmetry between firm insiders and outsiders forms the basis of this theory. Firm insiders believe that the stock is undervalued with respect to their previous reference valuations. Therefore, firms announce a repurchase program, and the market perceives the announcement as a signal of undervaluation. Following the announcement, the share price reacts positively. Prior research finds 2% to 3% abnormal returns coinciding with the announcement of OMR programs (Jagannathan & Stephens, 2003). Survey evidence by Brav, Graham, Harvey, and Michaely (2005) also confirms that signaling undervaluation remains the most popular reason for repurchasing shares. Ikenberry et al. (1995) find that average buy-and-hold abnormal return (BHAR) after the initial share repurchase announcement is 12.1%. Chan, Ikenberry, and Lee (2004) use long-run stock returns to find abnormal compounded returns of 6.7% in the first year and 23.6% abnormal compounded returns four years post-announcement. Sudden price drops during the financial crisis could motivate firms to announce share repurchase programs to provide support for their own shares and to simultaneously send a signal to the market that their stocks were undervalued. Therefore, we test the following hypotheses based on the undervaluation motive for share repurchases. H2.1.1: More undervalued firms are more likely to announce OMR programs. H2.1.2: More undervalued firms tend to announce larger OMR programs. H2.1.3: More undervalued firms tend to buy back a higher percentage of the announced shares within a specific period following their OMR announcements. 2.2. Capital structure Excess cash returned to shareholders through share repurchase reduces equity, thus increasing in leverage. A firm could resort to share repurchases when its leverage ratio is below its target. This has prompted many to argue that firms repurchase shares to adjust their capital structure. Hovakimian, Opler, and Titman (2001) find that capital structure choices enjoy great significance when firms decide between repurchasing shares and raising additional debt. Employee stock options also affect capital structure. Leverage decreases when employees exercise stock options to own shares of the company. In addition, as the number of shares outstanding increases when options are exercised, the earnings per share are potentially diluted. Brav et al. (2005) find that 68% of the survey respondents consider equity dilution an important determinant to repurchasing shares because equity dilution further results in EPS dilution. Corporate executives are motivated to increase the earnings per share (EPS) if their compensation is linked to the EPS. Share repurchases offer a relatively quick and easy way to offset the effect of employee stock option exercises and to increase earnings per share. 1 We examine OMR announcements during the financial crisis. If a firm announces an OMR program on Sep 19, 2009 then we examine the actual repurchases until Sep 2010.
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The survey by Brav et al. (2005) finds evidence that a desire to increase the EPS could be one of the strong motivations to repurchase shares. Bens, Nagar, Skinner, and Franco Wong (2003) find that firms increase repurchases when the dilutive effect of employee stock options on EPS increases. In support of the equity dilution and EPS hypothesis, Fenn and Liang (2001) find a negative relationship between dividends and management stock options and a positive relationship between share repurchases and management stock options, which is also supported by Cuny, Martin, and Puthenpurackal (2009). A period of economic crisis presents good opportunities for firms to adjust capital structure through share repurchases because of relatively low stock prices than before. Furthermore, it is relatively difficult for low leverage firms to change capital structure via issuing bonds or borrowing bank loans during the financial crisis. The financial crisis could have presented a windfall opportunity. The special circumstance make share repurchases a more viable tool for adjusting capital structure during the crisis period if low leverage firms believe that their capital structure is below target levels. Based on the capital structure adjustment motive for share repurchases, we accordingly posit the following hypotheses. H2.2.1: Low leverage firms are more likely to announce OMR programs. H2.2.2: Low leverage firms tend to announce larger OMR programs. H2.2.3: Low leverage firms tend to buy back a higher percentage of the announced shares within a specific period following their OMR announcements. 2.3. Takeover deterrence Poor operating performance depresses stock prices. Such depressed stock prices could attract unsolicited takeover attempts causing unwanted distraction for managers’ attention and resources. Therefore, the firm may repurchase shares to provide support to sagging stock prices and thereby deter unwanted takeover attempts (Bagwell, 1991). Billett and Xue (2007) model pre-purchase takeover probability and examine its impact on the decision to repurchase shares. They find a strong positive relation between takeover probability and the decision to repurchase shares. Based on takeover deterrence argument, we expect that depressed stock prices during the financial crisis could attract unsolicited takeover attempts. Therefore, we develop the following hypotheses. H2.3.1: Takeover target firms are more likely to announce OMR programs. H2.3.2: Takeover target firms tend to announce larger OMR programs. H2.3.3: Takeover target firms tend to buy back a higher percentage of the announced shares within a specific period following their OMR announcements. 3. Background Literature shows that the undervaluation, excess cash flow, and stock option exercise and equity dilution hypotheses have dominated as the most important motivations for share repurchases. These same motivations are potentially even stronger during a period of depressed stock valuations. Stock valuations can trend lower due to firm-specific or macroeconomic reasons. Focusing on the macroeconomic causes, managers who are cognizant of the opportunities presented by the depressed stock valuations may announce stock repurchase plans. One such macroeconomic event in the recent past is the financial crisis of 2008–2009. According to the Financial Crisis Inquiry Commission, the recession officially started in December 2007. By December 2009, the economy had lost 8.3 million jobs, and the underemployment rate soared to 17.4%. Households nearly lost $17 trillion in household net wealth, and their debt levels remained near historic highs. The S&P 500 lost a third of its value in 2008 before recovering in 2009. However, by December 2010, the S&P 500 was still 13% lower than at the start of 2008. Worldwide, stock prices plummeted by more than 40% before rebounding in 2009. The credit crunch was so debilitating for firms and individuals that consumer confidence fell to its lowest point since late 1992. Given the magnitude of such a crisis, a shrewd manager could have easily profited from this opportunity by announcing new programs or by repurchasing shares for previously announced programs. However, business financing dried up during the crisis. Firms in need of financing could not rely on the financial markets; instead, they had to draw down cash reserves or pay a hefty premium to use conventional channels such as bank lending. Therefore, the need to conserve cash and the opportunity to repurchase shares are competing arguments to some extent. 4. Methodology and empirical results 4.1. Variables Undervaluation is the primary motive for share repurchases. Hence, it is critical to measure the extent of undervaluation for a firm. The early literature, such as Dittmar (2000) and Ikenberry et al. (1995), uses past stock returns as proxies for undervaluation. The recent literature has used mispricing measures, as proposed in Rhodes-Kropf, Robinson, and Viswanathan (2005) (RRV), as a proxy for undervaluation. We follow Fu, Lin, and Officer (2013) to calculate the RRV mispricing measures. Note that the RRV mispricing measure estimates the ratio of market value of equity to intrinsic value of equity, which is calculated as follows:
M RRV = Ln ⎛ ⎞ ⎝ V ⎠i
(1)
where M is the market value of equity and V is the unobservable intrinsic value of equity as specified in Appendix 3. Hence, the 257
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Table 1 Summary Statistics This table provides the summary statistics. Appendix 1 offers variable definitions. OMR Firms Variable RRV CASH CASHFLOW LEVERAGE TAKEOVERPROB M/B SIZE SAINDEX DIVIDENDS OPTIONS
Non-OMR Firms Mean 0.1698 0.2317 0.1327 0.4150 0.2190 5.0223 6.2418 −3.6603 0.0105 0.0290
Std Dev 0.6126 0.2134 0.1085 0.2139 0.0969 42.7034 2.0375 0.8385 0.0329 0.0556
N 1050 1057 1057 1049 993 1057 1057 1066 1057 606
Median 0.1469 0.1563 0.1316 0.4101 0.2276 2.4195 6.2292 −3.5544 0.0000 0.0212
Mean 0.0671 0.1973 0.0507 0.4566 0.1273 4.2772 5.4614 −3.1244 0.0176 8.2411
Std Dev 1.6876 0.2327 0.2675 0.2203 0.1017 31.7637 2.6806 1.2997 0.0754 179.1634
N 8226 8714 8714 8702 7469 8714 8714 9504 8714 2353
Median 0.0834 0.0970 0.1023 0.4600 0.1539 2.0694 5.5455 −3.2543 0.0000 0.0159
T-Test
Median Test **
1.9563 4.5824*** 9.8695*** −5.8035*** 26.8355*** 0.6907 9.1497*** −13.1565*** −2.9982*** −1.1282
3.472*** 8.353*** 11.236*** −5.843*** 26.970*** 7.215*** 8.715*** −14.098*** −3.127*** 5.237***
relatively large positive values of RRV measure indicate overvaluation, and the negative values of RRV measure suggest undervaluation. We follow Dittmar (2000) and measure the excess cash using two variables. CASH is measured as cash and cash equivalents, and CASHFLOW is measured as operating income before depreciation as in Ang et al. (2014). Following Dittmar (2000) and Ikenberry, Lakonishok, and Vermaelen (2000), we measure investment opportunities by the market-to-book ratio, M/B, which is defined as the ratio of market value of equity divided by book value of equity. Market value of equity is calculated as the product of fiscal year ending price and number of common shares outstanding. The market-to-book ratio also can indicate potential undervaluation. The optimal capital structure hypothesis assumes that firms repurchase shares to attain a target leverage ratio. We include LEVERAGE, which is measured as the ratio of total liabilities to total assets. Furthermore, firms may repurchase shares to offset the equity dilution due to employees’ option exercise. To measure the impact of options exercise, we include the variable OPTIONS, as in Cuny et al. (2009). As financial constraints can influence share repurchases, we include SAINDEX as calculated in Hadlock and Pierce (2010). Dividends could act as a deterrent for share repurchases, so we include DIVIDENDS, which are calculated as the annual cash dividends. Appendix 1 provides a summary of variable definitions.
4.2. Sample and summary statistics Our data comes from multiple sources. We use SDC Platinum to identify the repurchase program announcement dates and obtain mergers and acquisitions data for estimating takeover probabilities. SEC 10 K and 10Q filings are used to collect the actual repurchase data. We use COMPUSTAT to find firm-level information on most accounting variables. We also use CRSP to collect stock price information. Employee options data come from EXECUCOMP. We follow prior literature and exclude financial firms. Table 1 reports the summary statistics for both OMR firms that announced open market repurchases programs and non-OMR firms that did not announce share buyback programs during the financial crisis. The variables are all lagged one year. The average and median RRV measure for OMR firms are positive and larger than those for non-OMR firms, suggesting that OMR firms tend to be overvalued before the financial crisis. It is plausible that these firms could have experienced large negative returns during the financial crisis, leading firm managers to perceive undervaluation and resulting in the announcement of an OMR program2. The mean cash ratio for OMR firms is 23%, which is significantly higher than 20% for other firms. The median cash ratio for OMR firms is 16%, which is 6% higher than that of other firms. The average and median cash flow for OMR firms are also significantly higher than those of other firms. Such evidence suggests that OMR firms are in better shape than other firms in terms of liquidity. The mean and median leverage of OMR firms are significantly lower than those of other firms, consistent with the idea that low leverage firms may announce share repurchase programs to adjust their capital structure during the financial crisis. Furthermore, the average and median takeover probability of OMR firms are significantly higher than those of non-OMR firms, indicating that potential target firms tend to announce share repurchase programs to deter takeover attempts. To categorize the announcement decisions, we use calendar time-period. For example, a firm that announces an OMR program in December 2008 is categorized as an announcement in 2008 (financial crisis year). One of the perils of working with share repurchases data is that share repurchases have no predictable pattern as opposed to dividends. Firms may announce multiple programs during a given year. Firms may reauthorize an old announcement without increasing the authorization value. Firms may even reauthorize an old announcement with additional value commitment. Therefore, in many cases it is difficult to trace actual repurchases to their respective announcements. To avoid that problem, in our sample we include only new announcements as well as those reauthorizations with additional money. We strictly trace all the actual repurchases in the next twelve months to the current announcement. For example, if a firm announces a repurchase program in August 2008, all repurchases before September 2009 is traced and assigned to the announcement made in August 2008. A firm may also announce multiple share repurchase programs. For example, a firm may 2 We calculated one-year buy-and-hold abnormal returns for the first year of the financial crisis and found that both OMR and non-OMR firms suffered an almost identical 30% decline in stock returns.
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Table 2 Share Repurchase Activity This table provides the summary statistics of the SHARES AUTHORIZED, SHARES REPURCHASED, COMPLETION RATE, and number of OMR announcements during the period 2008–2009. Appendix 1 offers variable definitions. 2008
2009
Variable
Mean
Median
Mean
Median
SHARES AUTHORIZED SHARES REPURCHASED COMPLETION RATE NUMBER OF OMR ANNOUNCEMENTS
0.0846 0.0440 0.6126 803
0.0674 0.0321 0.5059
0.0774 0.0426 0.7381 263
0.0606 0.0306 0.4988
announce a share repurchase program in August 2008 and another one in April 2009. All repurchases before April 2009 is traced and assigned to August 2008 announcement and all repurchases before May 2010 are traced and assigned to April 2009 announcement. Table 2 presents a summary of share repurchase activity during the financial crisis period. In 2008, there were 803 OMR announcements, and the number of announcements was reduced to one third of that level or 263 in 2009. The ratio of the number of shares authorized to be bought back to the number of shares outstanding is around 8% for both years. In contrast, the ratio of the number of shares that is actually bought back following their announcements to the number of shares outstanding is 4% on average for both years. In terms of completion rate, the average is 61% for 2008 and 74% for 2009; while the median completion rates are around 50% for both years. 4.3. Multivariate models and empirical results One of the most important questions asked in the OMR literature is why do firms announce share repurchase programs. Studies such as Dittmar (2000) have performed a long-run test spanning different economic periods to answer this question. The motivations during the financial crisis period could be entirely different than longer sample periods. Considerations during the financial crisis were unique because firms could have been in a conservative mode. To examine the motives behind share repurchase announcements, we perform probit regressions as follows:
ANNi = αi + β1 RRVi + β2 CASHi + β3 CASHFLOWi + β4 LEVERAGEi + β5 TAKEOVERPROBi + β6 M / Bi + β7 SIZEi + β8 SAINDEXi + β9 DIVIDENDSi + β10 OPTIONSi + εi,
(2)
where ANN is a dummy variable that takes the value of 1 if the firm announced a share repurchase program, and 0 otherwise. We present the empirical results in Table 3. The RRV mispricing measure is positively related to the likelihood of announcing a Table 3 Why Do Firms Announce Share Repurchase Programs? The table provides the results of probit regression models with ANN as the dependent variable. Robust Zstatistics are reported in the parenthesis. Coefficients significant at the 1%, 5%, and 10% level are marked by ***, **, and *, respectively. Industry fixed effects are included in all models. Please refer to Appendix 1 for variable definitions. VARIABLES RRV CASH
(1)
(2) ***
0.1753 (4.8769) 0.0595 (0.5579)
(3) ***
0.1299 (3.4817)
−0.9733*** (−7.1803) 4.5402*** (18.2862) 0.0003 (0.7510) −0.0540*** (−3.5071) −0.3197*** (−9.6011) −2.4047*** (−2.6375)
1.3985*** (9.4562) −0.7603*** (−5.7039) 4.6143*** (18.4958) 0.0006 (1.4452) −0.0791*** (−5.0094) −0.2716*** (−7.8652) −3.3452*** (−3.2671)
Constant
−2.2427*** (−16.5962)
Wald Chi-Sq Observations
677*** 8128
CASHFLOW LEVERAGE TAKEOVERPROB M/B SIZE SAINDEX DIVIDENDS
(4) **
0.1432 (2.1777) −0.0514 (−0.2650)
0.1081 (1.5934)
−2.1536*** (−16.7626)
−1.0140*** (−4.6663) 4.8096*** (14.0512) 0.0039 (0.6886) 0.0043 (0.1566) −0.0639 (−1.1862) −2.2231* (−1.9314) −0.0003 (−0.3886) −1.2550*** (−5.1504)
1.3392*** (4.5005) −0.7506*** (−3.5129) 4.8337*** (14.1993) 0.0019 (0.2349) −0.0156 (−0.5603) −0.0695 (−1.2828) −3.1709** (−2.4352) −0.0018 (−0.2391) −1.4472*** (−6.3307)
698*** 8128
314*** 2555
307*** 2555
OPTIONS
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Table 4 Number of Shares Authorized This table provides the regression results with SHARES AUTHORIZED as the dependent variable. Robust t-statistics are reported in the parenthesis. Coefficients significant at the 1%, 5%, and 10% level are marked by ***, **, and *, respectively. Industry fixed effects are included in all models. Please refer to Appendix 1 for variable definitions. VARIABLES
(1)
(2)
RRV
−0.0133 (−2.5810) 0.0283** (2.5175)
**
CASH CASHFLOW
(3)
−0.0119 (−2.4725) **
0.0719*** (4.9331) 0.0351 970
0.0774 559
0.0872 559
Constant
0.0576*** (3.5780)
Adj R-Squared Observations
0.0380 970
M/B SIZE SAINDEX DIVIDENDS
−0.0183** (−2.2198)
0.0654*** (3.0513) 0.0703** (2.2560) −0.0003 (−0.9788) 0.0001 (0.0306) 0.0015 (0.2929) −0.1407 (−1.2865) 0.2245*** (3.9391) 0.0275 (1.1813)
0.0577*** (3.4596) 0.0494* (1.8787) 0.0001*** (2.9705) −0.0013 (−0.6815) 0.0031 (0.8049) 0.0646 (0.4767)
TAKEOVERPROB
−0.0158 (−1.9400) 0.0402** (2.1963)
0.1118** (2.1738) 0.0719*** (2.8870) 0.0766** (2.4345) 0.0001 (0.3717) −0.0016 (−0.5401) 0.0034 (0.6757) −0.2397** (−2.0657) 0.2323*** (4.2737) 0.0310 (1.3850)
0.0311 (1.0462) 0.0491*** (3.1297) 0.0567** (2.1478) 0.0001*** (2.8080) −0.0020 (−1.0548) 0.0051 (1.2622) 0.0492 (0.3758)
LEVERAGE
(4) *
OPTIONS
share repurchase program during the financial crisis. The result suggests that overvalued firms prior to the financial crisis are more likely to announce share repurchase programs. The result is consistent with the idea that the prior overvalued firms could experience large negative returns during the financial crisis, and thus lead the managers to perceive their firms as undervalued. If this is the case, it is more likely for these firms to announce share repurchase programs. Also, firms with higher cash flows were more likely to announce a repurchase program during the financial crisis period. Consistent with hypothesis H2.2.1, lower leverage firms are more likely to announce share repurchase programs. Furthermore, we find that higher takeover probability prompts firms to announce share repurchase programs, supporting the hypothesis H2.3.1. We also find that dividend paying firms are less likely to announce share repurchase programs across all specifications. The number of share authorized to be bought back (normalized by the number of shares outstanding), which represents the size of the announced share repurchase program conveys a signal and a larger repurchase program conveys a stronger signal (Chan, Ikenberry, Lee, & Wang, 2010; Comment & Jarrell, 1991). It is plausible that the motives mentioned earlier could explain the size of the repurchase program. To test this hypothesis, we run cross-sectional regressions of the following form:
AUTHSHAREi = αi + β1 RRVi + β2 CASHi + β3 CASHFLOWi + β4 LEVERAGEi + β5 TAKEOVERPROBi + β6 M / Bi + β7 SIZEi + β8 SAINDEXi + β9 DIVIDENDSi + β10 OPTIONSi + εi.,
(3)
where AUTHSHARE is the number of share to be bought back in the OMR announcement, normalized by the number of shares outstanding in the secondary market. We report the empirical results in Table 4. Across all specifications, the significantly negative coefficients on the RRV mispricing measure suggest that less overvalued or even undervalued firms tend to announce larger share repurchase programs. The evidence is consistent with hypothesis H2.1.2. However, the significantly positive coefficients on leverage do not support hypothesis H2.2.2, which posits that low leverage firms would announce larger share repurchase programs, implying a significantly negative coefficient on leverage. Theegative coefficient on TAKEOVERPROB suggests that higher takeover probability prompts firms to announce larger share repurchase programs, supporting hypothesis H2.3.2. Banyi et al. (2008) report the flaws in the dollar values of share repurchases calculated by many researchers using standard data sources. They recommend using the quarterly and annual statements to assimilate share repurchases, which can be defined as actual repurchases (Ben-Rephael, Oded, & Wohl, 2013; Bonaimé, 2012; Ginglinger & Hamon, 2007). Firms have been publishing data on actual repurchases on a quarterly basis since 2004. Bonaimé (2012) uses actual share repurchase data to confirm that the completion rate is approximately 73%. We run the following cross-sectional regression model to examine which motive of share repurchases could explain the completion rate (COMPLETION RATE) defined as the ratio of the number of shares bought back within one year following the OMR announcement to the number of shares authorized in the OMR announcement.
COMPLETIONRATEi = αi + β1 RRVi + β2 CASHi + β3 CASHFLOWi + β4 LEVERAGEi + β5 TAKEOVERPROBi + β6 M / Bi + β7 SIZEi + β8 SAINDEXi + β9 DIVIDENDSi + β10 OPTIONSi + εi, 260
(4)
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Table 5 Repurchase Completion This table provides the regressions results with COMPLETION RATE as the dependent variable. Robust t-statistics are reported in the parenthesis. Coefficients significant at the 1%, 5%, and 10% level are marked by ***, **, and *, respectively. Industry fixed effects are included in all models. Please refer to Appendix 1 for variable definitions. VARIABLES
(1)
(2) **
**
0.1405 (2.0947) 0.0388 (0.2474) −0.2824* (−1.6797) −0.6484** (−2.2180) −0.0002 (−0.6954) 0.0371* (1.9250) 0.0104 (0.2382) −1.1680** (−2.2268) 0.1405** (2.0947)
0.1330 (2.1676)
Constant
0.8181*** (3.2455)
Adj R-Squared Observations
0.0238 900
RRV CASH CASHFLOW LEVERAGE TAKEOVERPROB M/B SIZE SAINDEX DIVIDENDS
−0.2607* (−1.7303) −0.6351** (−2.1386) −0.0002 (−0.7464) 0.0342* (1.7948) 0.0189 (0.4306) −1.3142** (−2.3537) 0.1330** (2.1676)
(3)
(4)
0.1492 (1.4238) −0.1926 (−0.9434)
0.1435 (1.3815)
0.8282*** (3.6657)
−0.4172 (−1.8569) −0.5667* (−1.7479) 0.0008 (0.2490) 0.0735*** (2.9701) 0.0405 (0.6631) −2.4117 (−1.4300) 0.7367 (1.4928) 0.7749** (2.3105)
−0.1948 (−0.6346) −0.3787* (−1.7709) −0.6007* (−1.8625) −0.0003 (−0.0911) 0.0784*** (3.2193) 0.0321 (0.5244) −2.2286 (−1.3295) 0.7232 (1.4993) 0.6996** (2.3460)
0.0249 900
0.0402 546
0.0395 546
OPTIONS
*
Table 5 reports the empirical results for the completion rate. Models (1) and (2) show that the RRV mispricing measure is positively related to the completion rate during the financial crisis. That is, potentially overvalued firms prior to the financial crisis tend to buy back more shares. The result does not support hypothesis H2.1.3. However, we cannot exclude the possibility that overvalued firms may experience large negative returns during the financial crisis, the managers perceive their firms are undervalued, and they accordingly decide to buy back relatively more shares following the OMR announcements. We also find that leverage is significant and negatively related to completion rate across all specifications. This result supports hypothesis H2.2.3, which posits that low leverage firms tend to buy back a higher percentage of share repurchase programs following their OMR announcements. We also examine the coefficients on the takeover probability. However, the results do not support hypothesis H2.3.3, which posits that potential target firms tend to buy back a higher percentage of share repurchase programs following their OMR announcements. We consider the results from both Tables 3 and 5 to examine whether the motives to announce a share repurchase program can simultaneously explain the decision to buy back more shares following the OMR announcement. Our results support neither the hypothesis that more undervalued firms are more likely to announce share repurchase programs (H2.1.1) nor the hypothesis that more undervalued firms buy back a higher percentage of share repurchase programs following their OMR announcements. However, our test may be subject to a problem of error-in-variable because our mispricing measure is lagged one year. It is possible that the prior overvalued firms tend to experience large negative returns during the financial crisis and the managers perceive their firms as undervalued accordingly. Therefore, these firms are more likely to announce share repurchase programs and buy back more shares following their announcements. If this is the case, we then find a common factor, namely, recent stock price declines simultaneously explain the decision to announce a share repurchase program and the decision to buy back more shares following the OMR announcement. We next turn to the motive of capital structure adjustment. In Table 3, we find that lower leverage firms are more likely to announce share repurchase programs. Furthermore, in Table 5, we find that low leverage firms buy back a higher percentage of share repurchase programs following their OMR announcements. Therefore, firm leverage can simultaneously explain the decision to announce a share repurchase program and the decision to buy back more shares following the OMR announcement. We further examine the takeover deterrence hypothesis. However, we do not find the evidence that takeover deterrence can simultaneously explain the decision to announce share repurchase and the decision to repurchase some number of shares following the OMR announcement. Overall, we conclude that these two decisions are separate to some extent. 5. Conclusion The financial crisis was an unprecedented event in the recent global financial history. In the wake of such an event, we specifically explore three motives behind share repurchase activity in the context of an exogenously negative shock. These motives include undervaluation, capital structure or leverage adjustment, and takeover deterrence. Theories explaining the motivations for share 261
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repurchases are well established. On the one hand, these motives may also explain other aspects of share repurchases such as the size of the share repurchase program and the completion rate for actual share repurchases within a specific period following the OMR announcement. On the other hand, after firms announce share repurchase programs, managers still have discretion on the extent of actual share acquisition. Thus, the decision to announce share repurchase and the decision to buy back a specific number of shares following the OMR announcement may have different determinants. That is, these two decisions are separate to some degree. We also examine this subtle issue which has not been addressed in the OMR literature. Following prior studies, we posit that undervaluation is a primary motive for firms to announce share repurchases. Contrary to popular belief, our results show that overvalued firms prior to the financial crisis are more likely to announce share repurchase programs and buy back more shares following the repurchase announcements. However, we still find that less overvalued or even undervalued firms tend to announce larger share repurchase programs. We find that lower leveraged firms are more likely to announce share repurchase programs and buy back a higher percentage of share repurchase programs following their OMR announcements; however, lower leverage firms tend to announce smaller share repurchase programs. In sum, firm leverage can simultaneously explain the decision to announce a share repurchase program and the decision to buy back more shares following the OMR announcement. Finally, we find that potential target firms are more likely to announce larger share repurchase programs. But, we do not find a significantly positive relation between the takeover probability and the completion rate following the OMR announcement. Furthermore, the combination of the above results implies that takeover deterrence cannot simultaneously explain the decision to announce share repurchase and the decision to repurchase some number of shares following the announcement. Therefore, we conclude that these two decisions are separate to some extent and that we have addressed an issue that was not explored in the OMR literature. Appendix 1. Variable Definitions Variable
Definition
ANN CASH CASHFLOW COMPLETION RATE DIVIDENDS LEVERAGE M/B
Dummy variable that takes value of 1 if a firm announced an open-market share repurchase program Cash and cash equivalents scaled by total assets Operating income before depreciation scaled by total assets The ratio of number of SHARES AUTHORIZED to SHARES REPURCHASED
OPTIONS RRV SHARES AUTHORIZED SHARES REPURCHASED SAINDEX SIZE TAKEOVERPROB
Annual cash dividends scaled by total assets Total debt divided by total assets Market value of equity divided by book value of equity. Market value of equity is calculated as the product of fiscal year ending price and number of common shares outstanding Calculated as the sum of unexercised exercisable options and unexercised unexercisable options scaled by common shares outstanding Undervaluation measure created per Rhodes-Kropf, Robinson, and Swaminathan (2005). The methodology is explained in Appendix 3 Number of shares authorized scaled by total shares outstanding Number of shares repurchased scaled by total shares outstanding Calculated per the equation: −0.737 × Size + 0.043 × Size2 − 0.040 × Age Logarithm of sales Takeover probability estimated as in Billett and Xue (2007). The method used in this paper is reported in Appendix 2
Appendix 2. Takeover Probability Estimation Billett and Xue (2007) estimate a heteroskedasticity corrected probit model of takeover probability by maximum likelihood. They define a takeover attempt based on whether a firm receives a takeover bid, as reported in SDC. The various control variables they use are as follows. ROAIA is defined as the operating income before depreciation scaled by total assets. SIZEEQ is the natural log of common equity. LEVBIA is defined as the two-digit industry median adjusted total debt scaled by total assets. NPPE is the net property, plant, and equipment scaled by total assets. SALEGR is the sales growth over the previous year measured as the natural log of the sales in the current year over the sales in the previous year. MKBK is the market value of common equity to the book value of equity. ITODUM equals 1 if at least one firm in the same industry (same four-digit SIC code) receives a takeover bid. They also include time dummies for different time periods. Because we estimate this model for the beginning of the financial crisis period (2007) and the quantitative easing period (2009), we chose to ignore the time dummies. The results are reported below.
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Intercept ROAIA SIZEEQ LEVBIA MKBK SALEGR NPPE ITODUM
−1.2023∗∗∗ 0.2397∗∗∗ 0.1073∗∗∗ 0.000081∗∗ 0.000121 −0.1478∗∗∗ −0.5374∗∗∗ −4.995
N TODUM WALD CHI-SQ LOG LIKELIHOOD
9978 1624 290.17 −3625.53
Coefficients significant at 1%, 5%, and 10% are indicated by
∗∗∗ ∗∗
,
, and
∗
respectively.
Appendix 3. The mispricing measure of the RRV model Fu, Lin, and Officer (2013) estimate the undervaluation RRV measure as proposed by Rhodes-Kropf, Robinson, and Viswanathan (2005). The basic identity used is
M M V ln ⎛ ⎞ = ln ⎛ ⎞ + ln ⎛ ⎞, ⎝B⎠ ⎝V ⎠ ⎝B⎠
(1)
where M is the market value of equity, B is the book value of equity, and V is the unobservable intrinsic value of equity. The market value of equity M is expressed as the following linear function:
D ln (Mit ) = α 0jt + α1jtln (Bit ) + α2jtln (|NIit |) + α3jt I −ln (|NIit |) + α4jt ⎛ ⎞ + εit , ⎝ V ⎠it
(2)
where |NIit | is the absolute value of net income for firm i at time t. is an indicator variable that equals one for firm-years when net income is negative, and zero otherwise. D is the market leverage ratio and subscript j stands for industry j. We perform cross sectional V regressions of model (2) for each industry using the Fama-French 12-industry classification scheme to estimate the parameters. The parameters are averaged over time for each industry. The mispricing measure of the RRV model is then calculated as follows:
I−
M D ln ⎛ ⎞ = ln (Mit )−α 0j + α1j ln (Bit ) + α2j ln (|NIit |) + α3j I −ln (|NIit |) + α4j ⎛ ⎞ . ⎝V ⎠ ⎝ V ⎠it
(3)
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