Editor's Note: The following post comes to us from Thomas Chemmanur, Professor of Finance at Boston College, and Yingzhen Li of The Brattle Group.

In recent years, the number of firms undertaking stock repurchases has increased dramatically, while the proportion of firms distributing value through cash dividends has declined. The popularity of share repurchases has not been mitigated even after the passage of the Jobs and Growth Tax Relief Act of 2003. In our paper, The Role of Institutional Investors in Open-Market Share Repurchase Programs, which was recently made publicly available on SSRN, we empirically analyze whether institutions have the ability to produce information about firms announcing open-market repurchase (OMR) programs, and how their information interacts with the private information held by firm insiders (which they may attempt to convey to the equity market through a repurchase program).

Click here to read the complete post...

" /> Editor's Note: The following post comes to us from Thomas Chemmanur, Professor of Finance at Boston College, and Yingzhen Li of The Brattle Group.

In recent years, the number of firms undertaking stock repurchases has increased dramatically, while the proportion of firms distributing value through cash dividends has declined. The popularity of share repurchases has not been mitigated even after the passage of the Jobs and Growth Tax Relief Act of 2003. In our paper, The Role of Institutional Investors in Open-Market Share Repurchase Programs, which was recently made publicly available on SSRN, we empirically analyze whether institutions have the ability to produce information about firms announcing open-market repurchase (OMR) programs, and how their information interacts with the private information held by firm insiders (which they may attempt to convey to the equity market through a repurchase program).

Click here to read the complete post...

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The Role of Institutional Investors in Open-Market Share Repurchase Programs

The following post comes to us from Thomas Chemmanur, Professor of Finance at Boston College, and Yingzhen Li of The Brattle Group.

In recent years, the number of firms undertaking stock repurchases has increased dramatically, while the proportion of firms distributing value through cash dividends has declined. The popularity of share repurchases has not been mitigated even after the passage of the Jobs and Growth Tax Relief Act of 2003. In our paper, The Role of Institutional Investors in Open-Market Share Repurchase Programs, which was recently made publicly available on SSRN, we empirically analyze whether institutions have the ability to produce information about firms announcing open-market repurchase (OMR) programs, and how their information interacts with the private information held by firm insiders (which they may attempt to convey to the equity market through a repurchase program).

We make use of a detailed transaction-level institutional trading database provided by Abel Noser Solutions, and provide a number of new results on the role of institutional investors around open-market repurchases. First, we study, for the first time in the literature, the informativeness of institutional trading before the announcement of an open-market repurchase program. We find that institutional trading before an open-market repurchase announcement has considerable predictive power for announcement effect of programs. Greater selling by institutional investors is significantly associated with a more favorable announcement effect. This result is robust to controlling for various variables that have been found in the prior literature to be able to predict announcement effects of open-market repurchase programs, including prior firm performance and insider trading. This suggests that institutional investors possess private information about the intrinsic value of the firms announcing open-market repurchase programs.

Second, we study the predictive power of institutional trading immediately after open-market repurchase announcements (two quarters) for the firm’s subsequent long-run (one year) performance, again for the first time in the literature. We find that institutional trading immediately after an open-market repurchase announcement has considerable predictive power for the firm’s subsequent long-run stock performance: a 1% increase in institutional net buying is associated with about 0.4% increase in the firm’s abnormal stock return over the subsequent one-year period. This result is robust to controlling for various variables capturing publicly available information, as well as the extent of trading in the firm’s equity by insiders. The above result indicates that institutions have a residual information advantage over retail investors, even after the announcement of an open-market repurchase program.

Third, we study the realized profitability of institutional trading around open-market repurchase programs, using actual transaction prices and net of brokerage commissions, for the first time in the literature. We find that institutions make positive abnormal profits after the announcement of an open-market program, even after taking commissions and other trading costs into account. This is especially the case when the information conveyed by the announcement of an open-market program is noisier (i.e., when the size of the repurchase program is smaller or when the firm actually repurchases less subsequent to the announcement). For example, over the one-year horizon after an open-market repurchase program announcement, our sample institutions on average realize a risk-adjusted return of 1% when the size of the repurchase program is smaller (i.e., below the sample median), and they realize a risk-adjusted return of 0.8% when the firm actually repurchases less subsequent to the announcement (i.e., below the sample median). These results suggest that the information advantage possessed by institutional investors after an open-market repurchase announcement that we documented earlier translates into real trading profits, especially when the information conveyed by the open-market repurchase announcement made by the firm is noisier (i.e., when the size of the repurchase program is smaller or when the firm actually repurchases less subsequent to the announcement). In summary, we are able to show not only that institutions possess an information advantage after open-market repurchase announcements, but are also able to translate this advantage into real trading profits even after accounting for both explicit (brokerage commissions) and implicit (market impact) trading costs.

Fourth, we study the predictive power of institutional trading immediately after open-market repurchase announcements for the actual repurchases made by the firm in the subsequent period, again for the first time in the literature. We find that institutional trading immediately after an open-market repurchase announcement has considerable predictive power for the subsequent actual repurchases made by the firm: a 1% increase in institutional net buying is associated with about 3% increase in the firm’s actual repurchase over the subsequent two-quarter period. This result is robust to controlling for various variables capturing publicly available information, as well as the extent of trading in the firm’s equity by insiders. The above result again indicates that institutions have a residual information advantage over retail investors, even after the announcement of an open-market repurchase program.

Finally, we examine how institutional trading around open-market repurchase programs affects the information asymmetry faced by the firm in the equity market. We find that institutional trading over the two-quarter period immediately after an open-market repurchase program announcement has considerable predictive power for the reduction in information asymmetry faced by the firm around the repurchase program announcement (i.e., from before the announcement to after). Greater net buying by institutional investors is associated with more analyst coverage (i.e., more analysts covering the firm) and lower analyst forecasts dispersion (i.e., more precise analyst forecasts), two of the proxies for information asymmetry widely used in the literature. These results indicate that the information conveyed by institutional trading subsequent to open-market repurchase program announcements plays an additional role in reducing the information asymmetry faced by the firm, over and above that of the repurchase announcement itself in reducing this information asymmetry.

What do we learn from the above empirical results about the role of institutional investors as information producers around open-market repurchase programs? First, the fact that institutional trading has predictive power for the announcement effects of open-market repurchase programs, for the long-run stock return performance of the firm subsequent to the announcement of such programs, and for the actual repurchases made by the firm indicates that they have information advantage over retail investors both before and after the announcement of an open-market repurchase program. It should be noted that institutional investors continue to possess this information advantage over retail investors even after an open-market repurchase program announcement, which may convey firm insiders’ private information as well. Second, our results indicate that institutions are able to use their information advantage to realize abnormal profits by trading in the equity of firms undergoing open-market repurchase programs, especially when the size of the open-market repurchase program is smaller or when the firm makes less actual repurchase subsequent to the announcement of the repurchase program. It is worth noting that we are able to generate the above results mainly because we utilize transaction-level institutional trading data, which also enable us to account for both explicit (brokerage commissions) and implicit (market impact) trading costs of institutional investors. Finally, our results of the effect of institutional trading on the reduction in the information asymmetry facing the firm in the equity market around open-market repurchase programs indicate that not only do institutional investors have information advantage relative to retail investors around such programs, they are also able to reduce this information asymmetry facing the firms by trading in the equity of firms undergoing such repurchase programs.

The full paper is available for download here.

 

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