Share Repurchase

In an article on Journal of Financial Economics, David Ikenberry, Josef Lakonishok and Theo Vermaelen stated that companies which announced share repurchases tend to have abnormal return. But the market seems to errs because response to these announcement was not adequate.

There are many reason for a company to repurchase their stocks. One of the most popular reason that managers claim is undervaluation of their stocks – signaling . Other reasons include capital structure adjustment, takeover defense, excess cash, substitution for dividends… But no matter what reason underlies their decision, the market seems to have inadequate response. Because theoretically, if the stocks are undervalued, the price should be adjusted right after the announcement and managers no longer have the motivation to buy back companies' share. But in reality, the price correction didn't happen , the managers didn't have to cancel their repurchase program. The question is whether the market already incorporate the repurchase into the stock price, or the managers really know what they are doing .

In this article, the authors examine a sample of 1239 share repurchase announcement from January 1980 to December 1990. Combining with the result of other research, they saw that the average response from the market was only 3.5%. That means the market nearly ignored the information about share repurchasing.

The methodology used by authors are cumulative abnormal returns ( CARs) and buy and hold approach. For CARs approach, abnormal returns were calculated each month and aggregated over time while for buy and hold approach, return will be calculated after 1 year. 4 benchmarks used in both methods are the CRSP equal , value-weighted indices of NYSE and ASE firms, size based, size and book to market based, work of Fama and French.

The result show in short term the average reaction of the market is 3.54%. There's a clear difference between firms of different size. Firm with smaller size tend to have higher abnormal return than bigger firms. People tend to think that firm with high book to market ratio will be more likely to be undervalued and tend to have higher abnormal return .However the research show that abnormal return are the same no matter how book to market ratio is.

For long term, all firms announced share repurchase also performed well with positive abnormal return. The abnormal return increase by year but seem to disappear after year 4, the average difference in performance is 12.14%. But in the long run, the difference in size and book to market ratio didn't have much impact in the abnormal return. This is because bigger firms tend to perform better in the long run.

Another finding is that the underlying motivation for high book to market ratio firm to repurchase share is undervaluation but this may not be true for low book to market ratio firms. So what