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Stock Repurchases: Types, Reasons, and Planning

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  1. Topics • What do we know about stock repurchases? G. Grullon and D. L. Ikenberry Hu - Financing Decision I

  2. What do we know about stock repurchases?Types • Fixed-price tender offer • Large scale (15% shares), high premium 16% • Announcement effect: 15% • Dutch-auction tender offer • Open market repurchase program • 5% shares, lasting 2 to 3 years • Announcement effect: 4% Hu - Financing Decision I

  3. What do we know about stock repurchases?Types Hu - Financing Decision I

  4. What do we know about stock repurchases?Why? • Increase EPS • If the drop in earnings is less than the drop in the number of shares • Can it increase stock price? • Is it due to a better use of asset or stock repurchase? Hu - Financing Decision I

  5. What do we know about stock repurchases?Why? • Signal future cash flow • Information revealing needs to be credible • Stock repurchase is credible because lying is costly • Fixed price tender offer: • More credible, observe earnings improvement • Open market repurchase • Observe earnings decline Hu - Financing Decision I

  6. What do we know about stock repurchases?Why? • Exploit market undervaluation • Observe: Four year abnormal return is 12.14% • Concentrates on value stocks (high book-to-market value), four year return is 45.29% Hu - Financing Decision I

  7. What do we know about stock repurchases?Why? • Reduce agency costs of free cash flows • Managers can pursue their personal interests • Observation 1: • Tender offer firms have higher levels of cash • Announcement effect is higher when excess cash is higher • Observation 2: • Announcement effect is higher when operating return on investment is lower Hu - Financing Decision I

  8. What do we know about stock repurchases?Why? • Reallocate investment among companies • Shareholders can reallocate investment more efficiently • Observation • After repurchase, asset is less and capital expenditure is less Hu - Financing Decision I

  9. What do we know about stock repurchases?Why? • Substitute cash dividend • Personal dividend income tax or capital gains tax? • To maintain stock price (cash dividend will cause the stock price to drop) Hu - Financing Decision I

  10. What do we know about stock repurchases?Why? • Adjust capital structure • To offset share increase from stock options Hu - Financing Decision I

  11. What do we know about stock repurchases?Planning an open market repurchase • Repurchase and stock liquidity • Increase informed traders • Increase depth • Observation • Spread declines for less liquid stocks • Volatility drops • Price drops less with market Hu - Financing Decision I

  12. What do we know about stock repurchases?Planning an open market repurchase • Flexibility and completion rate • Will firms mislead the market and repurchase very few shares? • Disclosure • US does not disclose • Canada disclose • Observation • Price increases the most for companies that do not repurchase • Announcement effect is higher when flexibility is more valuable (stock is more volatile) Hu - Financing Decision I

  13. What do we know about stock repurchases?Planning an open market repurchase • Transaction limitations • SEC rule 10b-18 in 1982 • Made through only one broker • Not executed at the opening or during the last half hour of trading • Not done at a price exceeding the highest bid • Not exceed 25%of average daily volume • Black-out dates: prohibit insider trading Hu - Financing Decision I

  14. What do we know about stock repurchases?Planning an open market repurchase • Alternatives • Buy stocks • Buy call options • When price is higher, exercise call • When price is lower, buy stocks on open market • Sell put Hu - Financing Decision I

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