File Name: the nature and persistence of buyback anomalies .zip
Our results provide corroborative evidence for the accruals anomaly, i. On the other hand, we do not find corroborative evidence for the SUE anomaly.
The BIS hosts nine international organisations engaged in standard setting and the pursuit of financial stability through the Basel Process. In the light of the economic toll of the Covid pandemic, a natural question is whether the substantial amount of buybacks conducted in recent years has undermined corporate resilience and increased the need for public support.
Buybacks are a means to distribute cash to shareholders. They are of concern for two reasons: first, managers could use them to artificially increase stock prices in order to boost performance pay; second, they could be a tool to raise leverage to excessive levels. There is some evidence that managers use buybacks opportunistically, but little indication of detrimental effects on long-term company value.
However, buybacks appear instrumental in meeting leverage targets. Therefore, the main policy issue is leverage, and buybacks are of concern mostly in their role as leverage management tools.
Policymakers across the world committed large sums to support private business through the Covid pandemic. This came on the heels of a steady increase in buybacks, also known as share repurchases.
Was there a link between substantial buybacks and the need for public assistance? This feature focuses mainly on US non-financial corporates and highlights that repurchases mostly served the purpose of leverage targeting. Thus, buybacks appear of concern to the extent that leverage is. Overall corporate payouts rose substantially in recent years. Net repurchases amounted on average to about 1. Stock buybacks can be a double-edged sword from investors' perspective.
They can support a firm's market price by signalling undervaluation, achieving tax efficiency gains relative to dividends or helping avoid wasteful expenditures by managers. Still, they could be detrimental to longer-run firm value if executives use them simply to increase their performance pay. However, there is only limited evidence for this. In addition, buybacks are instrumental in meeting leverage targets.
If investors failed to measure properly financial distress costs or shifted these costs to creditors or the public purse, these targets would be too high. Excessive leverage is a financial stability concern. The remainder of the feature describes recent trends in buybacks, before exploring the reasons for repurchases. It then investigates how past buybacks affected returns during the initial pandemic shock, and links buybacks to the broader discussion on the financial stability implications of corporate leverage.
While share buybacks are conceptually similar to dividends, the two forms of disbursement to shareholders have evolved differently over time. As a powerful tool for leverage management, buybacks complement and reinforce the effect of debt issuance on firms' capital structure. In a stock buyback, a company returns capital to shareholders by repurchasing its own shares. Equity decreases and leverage rises, more rapidly so when funds are obtained by issuing debt.
Like dividends, buybacks are a form of capital distribution. In the example above, the firm could also disburse funds through dividends, with similar effects on leverage.
There are three important differences between dividends and buybacks. First, firms are reluctant to cut the former, because investors value smooth dependable income, but use the latter more flexibly, for instance to disburse one-off cash windfalls. Second, while managers could use buybacks to artificially inflate earnings per share EPS and stock prices, dividends have no effect on EPS and mechanically reduce stock prices on ex dividend dates. Third, dividends are paid mostly by mature firms, while buybacks are common among high-growth firms as well Farre-Mensa et al Net buybacks can turn negative, and they did during the GFC, as firms issued equity to shore up their balance sheets.
Dividends had been somewhat higher than net buybacks until , when the latter surged just before the GFC and dropped precipitously thereafter second panel. Underscoring the structural differences between dividends and buybacks, the former were remarkably smooth, while the latter proved procyclical and co-moved with equity valuations grey bars. Similar trends could be observed globally. While this total was only a fraction of US buybacks, it quadrupled relative to The rest of this feature zooms in on US data on non-financial corporates' buybacks.
Given the substantial size and longer history of share repurchases in the United States, these data offer rich information on time trends and cross-company patterns. The determinants and effects of buybacks appear similar in most countries Manconi et al While repurchases have risen in dollar terms, they have remained stable relative to company size.
It was also broadly stable over time, albeit with some year-on-year variation fourth panel. Scaling net buybacks by book assets yields similar patterns. Repurchases were partly funded with external finance. Virtually all companies that undertook buybacks in a given year also raised funds from investors during the same period, often through a mix of equity and debt Graph 2 , left-hand panel.
Repurchasing shares while also issuing equity might appear counterintuitive. However, it can occur when companies seek to offset the issuance of stock for employees' compensation. In addition, periodic equity issuance subjects firms to the scrutiny of financial markets, irrespective of planned buybacks. While more repurchasers issued debt only, buybacks were not the main reason for rising debt issuance. As illustrated in the example at the beginning of this section, this trend has contributed to a faster rise in leverage.
However, starting in buybacks represented a progressively smaller share of debt issuance, trending down towards early s levels centre panel. This indicates that buybacks were not the main cause of the post-GFC rise in corporate debt.
After , internally generated funds became more important in financing buybacks. For one, economic growth resulted in rising profitability.
In addition, firms exhibited a higher propensity to distribute available income. Kahle and Stulz find that cumulative corporate payouts from to were higher than those from to and that two thirds of the increase was due to this higher propensity.
The propensity to distribute cash has differed across company size. The decision to buy back equity can reflect a variety of motives, and an extensive academic literature allows us to classify these motives based on whether the likely effect on firm value is positive, negative or uncertain.
In a number of cases, repurchases improve a firm's market value. For instance, if managers perceive equity as undervalued, they can credibly signal their assessment to investors through buybacks.
In addition, using repurchases to disburse funds when capital gains are taxed less than dividends increases net distributions, all else equal. Furthermore, by substituting equity with debt, firms can lower funding costs when debt risk premia are relatively low, especially in the presence of search for yield.
And, by reducing funds that managers can invest at their discretion, repurchases lessen the risk of wasteful expenditures. However, buybacks can be detrimental when they reflect conflicts of interest. Executive compensation linked to stock prices or EPS targets can lead managers to repurchase equity with the narrow objective of boosting their pay.
Managers would not bear the full costs of this action: the resulting increase in leverage increases the likelihood of financial distress, but it is likely to materialise well after managers have received their compensation. Effectively, managers would shift risks to shareholders. In these circumstances, buybacks would be excessive from investors' longer-term perspective. Finally, buybacks can be used to fine-tune the capital structure.
Since repurchases always affect leverage, all else equal, they are a powerful tool to achieve a specific leverage target. Used for this purpose, they seek to bring in benefits for shareholders such as higher return-on-equity, but their net impact on long-term company value is not clear-cut.
To assess this impact, it is necessary to also consider financial distress costs, such as weaker pricing power or higher bankruptcy risk. Importantly, leverage can have positive effects on company value but still be excessive from the perspective of society as a whole.
Such is the case when some financial distress costs are shifted to creditors or the public purse, with financial stability implications. Findings in the academic literature suggest that misalignment of managers' and investors' incentives was not a major driver of buybacks.
One indication in this direction is that sub-par corporate governance appears to have limited effects on post-repurchase performance. Before , opportunistic buybacks - in which managers repurchase stock largely for private benefit - were more likely in companies with poor corporate governance Caton et al These firms would experience weaker post-repurchase growth in terms of both stock returns and operating income.
Studies indicate that the importance of governance for performance after buybacks decreased after , probably due to enhanced regulations and disclosures. In addition, incentives linked to executive pay seem to have had a weak influence on repurchase patterns. To be sure, available evidence suggests that companies prefer to pay out with buybacks, rather than with dividends, when managers hold more stock options Fenn and Liang The effect, however, is largely confined to the choice of capital distribution method, rather than the amount distributed Kahle That is, managers would decide to distribute persistent excess cash flows with buybacks, even if, in the absence of stock options, they would have used dividends.
Importantly, they would generally not distribute more funds through buybacks than they would have through dividends. Compensation practices have also evolved. Executive stock options have become relatively less popular, in favour of arrangements whereby executive performance pay is not negatively affected by dividend payments. Still, bonuses linked to EPS, which increase with buybacks, increase the likelihood of repurchases when EPS targets are about to be missed by small amounts Almeida et al Ultimately, if repurchases mainly reflected managerial opportunism and were thus detrimental to investors, they would entice negative market reactions over the long run.
There is little evidence that this has been the case. After accounting for broad risk factors, long-term stock returns are typically positive following buyback announcements and higher than for non-repurchasers Peyer and Vermaelen , Dittmar and Field Even in the presence of substantial executive stock options, buybacks do not cause negative reactions Kahle Firms with executive bonuses tied to EPS targets also experience long-term returns in line with those of comparable firms that did not repurchase stock Cheng et al Corporate assets grew faster than equity over the past decade.
The increase in leverage was similar for the more leveraged firms, namely those at the 90th percentile of the cross-sectional distribution of leverage ratios in a given year. Capital distributions supported the increase in leverage.
Given historical debt dynamics, adding repurchases and dividends back to company assets would have substantially dampened the increase in leverage Graph 3 , second panel, dotted lines. Importantly, the effect of adding back share repurchases difference between solid and dashed lines would have been much greater than that of adding back dividends difference between dotted and dashed lines.
Being an important leverage management tool, buybacks were concentrated in firms that sought to keep up with the leverage of their peers.
We find that market reactions to earnings announcements can be predictable. Four-factor abnormal returns to earnings announcements that follow buyback announcements are higher by 5. The magnitude is large and economically and statistically significant. The drift in these returns is unrelated and distinct from the post-earnings announcement drift. For example, we find positive drift for firms making buyback announcements even when they exhibit negative earnings surprises and find negative drift for firms issuing equity even when they show positive earnings surprises.
Skip to search form Skip to main content You are currently offline. Some features of the site may not work correctly. DOI: Using recent data, we reject the hypothesis that the buyback anomalies first reported by Lakonishok and Vermaelen , Journal of Finance and Ikenberry, Lakonishok, and Vermaelen , Journal of Financial Economics have disappeared over time. View PDF.
Using recent data, we reject the hypothesis that the buyback anomalies first reported by Lakonishok and Vermaelen , Journal of Finance —77 and Ikenberry, Lakonishok, and Vermaelen , Journal of Financial Economics — have disappeared over time. We find evidence consistent with the hypothesis that open market repurchases are a response to a market overreaction to bad news: significant analyst downgrades, combined with overly pessimistic forecasts of long-term earnings. Stock prices after tender offers are set as if all investors tender their shares, but empirically they do not. Thus, the arbitrage opportunity persists because the market sets prices as if the average, not the marginal investor, determines the stock price.
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Using recent data, we reject the hypothesis that the buyback anomalies first reported by Lakonishok and Vermaelen , Journal of Finance —77 and Ikenberry, Lakonishok, and Vermaelen , Journal of Financial Economics — have disappeared over time. We find evidence consistent with the hypothesis that open market repurchases are a response to a market overreaction to bad news: significant analyst downgrades, combined with overly pessimistic forecasts of long-term earnings.
It is worth mentioning that a great deal of financial liberalization, privatization and internationalization policies in emerging economies have significantly increased the corporate restructuring activities like mergers, acquisitions, share repurchases, and stock splits, among others. More deeply, this paper will answer the research question—does a share repurchase offer abnormal returns around the announcement? Thus, it is performed in one of the Asian emerging markets—India. It is found that stock performance does not adequate, and notices lower as well as negative earnings during post-buyback period. In addition, we show some interesting results that derived from industrial and services sectors. The outcome of this paper would help financial analysts, financial advisors, corporate enterprises and regulatory bodies in designing policies on earnings distribution, managerial incentives, takeovers, and so forth of regulatory aspects. Baker, H.
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Corporate Finance Corporate Governance. Journal of financial Economics 1 , , The Review of Financial Studies 22 4 , , Journal of Financial Economics 59 3 , , Journal of Financial Economics 75 2 , , Journal of Empirical Legal Studies 5 4 , ,
The BIS hosts nine international organisations engaged in standard setting and the pursuit of financial stability through the Basel Process. In the light of the economic toll of the Covid pandemic, a natural question is whether the substantial amount of buybacks conducted in recent years has undermined corporate resilience and increased the need for public support. Buybacks are a means to distribute cash to shareholders. They are of concern for two reasons: first, managers could use them to artificially increase stock prices in order to boost performance pay; second, they could be a tool to raise leverage to excessive levels. There is some evidence that managers use buybacks opportunistically, but little indication of detrimental effects on long-term company value.
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PDF | Using recent data, we reject the hypothesis that the buyback anomalies first reported by Lakonishok and Vermaelen (, Journal of.