Investor Heterogeneity, Investor-Management Disagreement and Share Repurchases

Abstract

This paper develops and tests a new theoretical explanation for stock repurchases. Investors may disagree with the manager about the firm's investment projects. A repurchase causes a change in the investor base as investors who are most likely to disagree with the manager tender their shares. Therefore, a firm is more likely to buy back shares when the level of investor-management agreement is lower, and agreement improves as a consequence. Moreover, dispersion of opinion among investors cannot explain repurchase activity once the stock price and investor-management agreement are controlled for. Overall, the evidence is consistent with firms strategically using repurchases to improve alignment between management and shareholders. (JEL G30, G35)For helpful comments, we thank Laura Starks (editor), an anonymous referee,

The market valuation of share repurchases in Europe

“…Our results imply that bad firms do not refrain from announcing their intention to repurchase shares regardless of the fact that they may be scrutinized 1 , as share repurchases trigger a moderate market reaction confined only to the announcement date. The relatively weak market reaction around share repurchases announcements in our countries is also not consistent with Huang and Thakor (2013) who argue that firms buy back their stocks to improve their investor-management disagreements, and/or the Banerjee et al (2013) overconfident managers' excessive optimism.…”

“…Because of its encompassing nature as an investment, share repurchases (among other corporate decisions) have inherent benefits such as signaling of undervaluation, mitigation of agency costs, more tax-efficient payout to shareholders, and debtholder expropriation, resulting in positive excess stock returns on the announcement day and in the post-event period. However, since open market repurchases are not firm commitments, 4 unlike cash dividends or tender offer buybacks, 5 they are costless signals (Huang and Thakor, 2013). On the other hand, Bhattacharya and Dittmar (2003) argue that such announcements attract the market's scrutiny and lead to a positive market reaction, because bad firms will not mimic this action to avoid being discovered.…”

“…However, the empirical evidence provided to date on the impact of each of these factors is mixed, and although the information asymmetry/signaling hypothesis has long been viewed as a popular explanation, it does not necessarily hold in the context of open market and privately negotiated repurchases (Huang and Thakor, 2013). This is partly because most studies focus on a single country, where share repurchases have the same treatment, even though some regulatory changes may occur through time.…”

Payout policy, financial flexibility, and agency costs of free cash flow

“…Buffa and Nicodano (2008) focus on agency problems in the form of wealth transfers under mispricing that open market repurchases engender, abstracting from free cash waste. Huang and Thakor (2013) consider share repurchases as a mechanism 4 We do not consider tender offers in this paper. Of all stock repurchases, more than 90% are performed through open-market programs (see, e.g., Banyi, Dyl, & Kahle, 2008).…”

The Lock-In Effect and the Corporate Payout Puzzle

“…In addition to Stulz (1988) and Bagwell (1991), Barclay and Smith (1988), Chowdhry and Nanda (1994), and Huang and Thakor (2013) all highlight the positive relationship between share repurchases and stock prices. This relationship is attributable to higher bid-ask spreads in Barclay and Smith (1988), the information content of share repurchases in Chowdhry and Nanda (1994), and the reduction in shareholder-manager disagreement in Huang and Thakor (2013). The current paper differs from these studies for reasons similar to those above: the current paper assumes complete information and perfect rationality.…”