Open-Market Repurchase Announcements and Stock Price Behavior in Inefficient Markets

Abstract

JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide range of content in a trusted digital archive. We use information technology and tools to increase productivity and facilitate new forms of scholarship. For more information about JSTOR, please contact support@jstor.org.. Wiley and Financial Management Association International are collaborating with JSTOR to digitize, preserve and extend access to Financial Management. I ask why a firm would choose to buy back its outstanding shares after the stock price goes up in response to an open-market repurchase announcement. I introduce the subject of market inefficiency and establish a signaling equilibrium that does not assume that an announcement of open-market repurchase represents a commitment. Since the firm can earn capital gains by buying its outstanding shares at a bargain price, it has a strong incentive to execute stock repurchases even after it announces repurchase intention. Empirically, my model predicts positive long-run stock return performance and positive announcement effects following open-market repurchase announcements. (2000) report that open-market stock repurchasing has been the most popular method for firms to repurchase stock. Many empirical studies report that stock prices go up in response to open-market repurchase announcements.' That is, open-market repurchase announcements are good news for the stock market. This is known as the signaling hypothesis for open-market stock repurchases. Stock repurchases have become an important financial policy for listing firms over the last 20 years. Bagwell and Shoven (1989) and Grullon and MichaelyIn addition to the positive announcement effect, Ikenberry, Lakonishok, and Vermaelen (1995) find that stock prices further appreciate following announcements of open-market repurchases. They report that, on average, announcing firms experience a significant positive stock price increase of about 12% over the subsequent four years. This phenomenon suggests that, for an announcing firm, purchase of its outstanding shares constitutes a profitable investment opportunity even after the stock price rises in response to the announcement of an open-market repurchase. In fact, although firms do not necessarily need to obey their announcements, Stephens and Weisbach (1998) report that most firms do follow through with such announcements.As pointed out by Ikenberry et al. (1995), if the market evaluates the worth of the stock price of a firm based on the fundamentals, then repurchase of outstanding shares will not be profitable immediately following the market reaction to the announcement. Thus, in an efficient market, it is difficult to explain by the signaling hypothesis why a firm would actually buy back its outstanding shares after announcing its intention to repurchase shares. In this paper, I reexamine corporate open-market stock repurchase strategy and stock price behavior when there exists both informational asymmetry and market inefficiency.I int...

Share Repurchases, the Clustering Problem, and the Free Cash Flow Hypothesis

“…First, we test the statistical significance of abnormal returns around the announcements of actual repurchases using Zellner's (1962) seemingly unrelated regression (SUR). However, it is still unclear as to why firms actually purchase their shares even after the initial repurchase announcements have increased share prices, except in an inefficient market as shown theoretically by Isagawa (2002). This is an important research design issue as failing to account for cross-sectional correlations and heteroskedasticity in estimating abnormal returns and associated standard errors can invalidate evidence of the market's reaction to actual repurchases.…”

The Conditional Performance of REIT Stock Repurchases

“…We examine a longer payoff period than many earlier studies because managers may not be able to credibly convey their information directly to investors in the short run (Isagawa, 2002). Furthermore, repurchase programs take time to execute, making it unlikely that firms repurchase before near-term events.…”

“…This issue of asymmetric information of REIT managers has been studied previously with respect to initial public offerings (Akhigbe et al, Earlier repurchase studies typically examine company stock returns close to their repurchase announcements. 1 But Isagawa (2002) suggests that managers_ private information is likely to be impounded into stock prices over longer periods. Simply announcing a repurchase is unlikely to immediately resolve information asymmetry between managers and outsiders.…”

The Impact of a Firm's Payout Policy on Stock Prices and Shareholders' Wealth in an Inefficient Market

“…Closest to our theoretical approach is the work by Isagawa (2002). He shows that for open market repurchases not only informational effects in the announcement date may have an impact on the share price.…”

“…Similar to Isagawa (2002) and in contrast to the previous mentioned asymmetric information theories, we build a model based on market inefficiency resulting from the existence of non-smart Investors and (not explicitly modeled) limits of arbitrage. Limits of arbitrage may result from on the lack of perfect Substitutes (see Wurgler and Zhuravskaya (2002)) or the risk aversion of potential arbitrageurs (see Vishny (1997) andDe Long et al (1990)).…”