Actual Share Repurchases, Price Efficiency, and the Information Content of Stock Prices

Stefan Obernberger is Assistant Professor of Economics at Erasmus University Rotterdam. This post is based on an article by Professor Obernberger and Pascal Busch.

Share repurchases have become the dominant form of payout in the United States. Nowadays, open market share repurchases can even match the trading volumes of short sellers and institutional investors. The economic significance of share buybacks has raised credible concerns that managers use repurchases to manipulate the stock price in their favor (e.g., Bloomberg, 2009; Gersten, 2013; Economist, 2015). The concerns expressed in the business press have also alarmed U.S. politics. Senators Warren and Baldwin have recently called on the Securities and Exchange Commission (SEC) to investigate buybacks as a potential form of market manipulation. Hillary Clinton even made regulating share repurchases part of her core economic agenda (Brettel et al., 2015).

In our article, Actual Share Repurchases, Price Efficiency, and the Information Content of Stock Prices (Review of Financial Studies, 2016), we contribute to this discussion by investigating whether open market share repurchases distort market prices. We approach this question by examining the impact of share repurchases on price efficiency, that is, the degree to which publicly available information is incorporated into the stock price. Contrary to public opinion, our main result is that share repurchases make prices more efficient.

Our baseline hypothesis postulates that share repurchases increase the stock price beyond its fundamental value and, thereby, reduce the information content in stock prices. Consequently, prices become less efficient. Managers have a strong incentive to use share repurchases to intentionally increase the stock price beyond its fundamental value, that is, to manipulate the stock price, because their compensation is at least partly based on equity. Recent empirical evidence is consistent with the notion that managers deliberately attempt to influence the stock price to increase their compensation. For example, studies show that CEOs strategically time corporate news releases (Edmans et al., 2014) and firm advertising (Lou, 2014) to temporarily increase stock prices in months in which their equity vests.

Our alternative hypothesis postulates that share repurchases make prices more efficient. Share repurchases may have this effect via two different channels. First, firms engaging as investors in their own stock can react to other investors’ inattention and actively trade on positive information not yet reflected in the stock price. By doing so, share repurchases will improve the speed with which positive information is incorporated into the stock price. Second, share repurchases may improve price efficiency by providing price support at fundamental values. Given the substantial size of repurchases, firms have the ability to define a lower bound for the stock price and intervene whenever the price drops below this value. If firms provide price support at fundamental values, the price adjustment to new information will be less noisy because the stock price response to new, negative systematic information is bounded from below at the stock’s fundamental value. Thus, the repurchasing firm’s stock will again be more efficiently priced.

The idea of price support is in line with both how CFOs claim to execute their repurchase programs and empirical evidence. According to personal accounts from CFOs, at least some firms provide brokers with specific instructions that include exact price ranges and repurchase volumes. In a survey by Brav et al. (2005), CFOs name buying back at low stock prices the most popular reason to conduct share repurchases. Several empirical studies confirm the notion that valuation plays an important role in the repurchase decision (e.g., Stephens and Weisbach, 1998; Dittmar, 2000).

For the empirical analysis, we collect data on monthly repurchase activity from SEC filings. Our unique data set covers roughly 6,500 repurchase programs of almost 3,000 U.S. firms for the period 2004–2010. In total, we record almost 40,000 repurchase months.

Our main variable of interest is a parsimonious measure of price efficiency coined price delay. Price delay captures the speed (or delay) with which prices respond to new information. Technically, the measure compares the explanatory power of a simple market model regression with an extended market model regression, which includes lags of the market return as explanatory variables. The lower the explanatory power of the lagged market returns, the lower the price delay and the higher price efficiency.

We find that share repurchases unequivocally decrease the delay with which prices respond to new market-wide information. Further analysis reveals that share repurchases decrease the idiosyncratic risk in stock prices. Therefore, the evidence is not consistent with the notion that share repurchases increase the noise in stock returns as indicated by many commentators. We also explore the channels via which repurchases increase price efficiency. We find that repurchases increase price efficiency and decrease idiosyncratic risk, in particular in months in which the market goes down, that is, when there is new negative information. We conclude that share repurchases primarily increase the efficiency of stock prices by providing price support at fundamental values.

The complete article is available for download here.

References

Bloomberg Business, August 2009, “The Buyback Boondoggle” (http://www.bloomberg.com/bw/magazine/content/09_34/b4144096907029.htm)

Brettel, K., Gaffen, D., and D. Rohe, November 2015, The Cannibalized Company, Reuters Investigates, Retrieved from reuters.com.

Brav, A., J. R. Graham, C. R. Harvey, and R. Michaely. 2005. Payout policy in the 21st century. Journal of Financial Economics 77:483-527.

Dittmar, A. 2000. Why do firms repurchase stock? Journal of Business 73:331-55.

Economist, The, December 2015, Hyperactive, yet passive, December 5th Issue.

Edmans, A., L. Goncalves-Pinto, Y. Wang, and M. Xu. 2014. Strategic news releases in equity vesting months. Working Paper.

Gersten, B., January 2013, Why Stock Buybacks are more harmful than you think, in MoneyMorning (http://moneymorning.com/2013/01/23/why-stock-buybacks-are-more-harmful-than-you-think/)

Lou, D. 2014. Attracting investor attention through advertising. Review of Financial Studies 27:1797-829.

Stephens, C. P., and M. S. Weisbach. 1998. Actual share reacquisitions in open-market repurchase programs. Journal of Finance 53:313-33.

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