Abstract
Repurchase of shares by Indian firms are on the rise in recent years. What motivates Indian firms to repurchase their own shares? Signalling and free cash flow hypotheses are two competitive and popular explanations identified in empirical research in US and other countries. Do Indian firms buy back their shares to correct market misevaluations or to return excess funds? In the present paper an effort is made to decipher the motives behind repurchase decisions of Indian firms. Since there are positive returns only on announcement day and not in post-announcement days the signalling hypothesis cannot be an explanation for positive overall CAR in Indian announcements. The study hypothesizes that Indian firms use repurchases as a part of overall corporate restructuring mechanism of distributing excess funds and build promoters' stake holding. The evidence shows that low-q firms with higher free cash flow ratio earn higher abnormal returns than other firms. The cross-sectional analysis generates positive coefficient for low-q firms with higher cash flow and promoters' control.
Highlights
Signalling or undervaluation hypothesis has been the popular explanation for share repurchase decisions of companies (Dann, 1981; Vermaelen, 1981; Comment and Jarrell, 1991; Ikenberry et al, 1995)
Which hypothesis better explains for positive announcement returns of Indian buybacks-signalling or free cash flow? Do Indian firms improve market valuations after announcement of buyback decisions? What are the characteristics of firms in India announcing repurchase decision? The present paper aims to find answers to some of these questions
Abnormal returns: The announcement returns of 78 sample announcements for 41-day window-period along with t-test values are shown in Table 2: The announcement day AAR for 78 Indian buybacks is 2.75%, significant at 1% level
Summary
Signalling or undervaluation hypothesis has been the popular explanation for share repurchase decisions of companies (Dann, 1981; Vermaelen, 1981; Comment and Jarrell, 1991; Ikenberry et al, 1995). According to this hypothesis, a firm announces repurchases to signal market undervaluation and/or manager’s confidence of robust financial health of the firm. Since OMRs predominate over other methods of buyback and constitute almost 90% of total announcements in US (Grullon and Ikenberry, 2000) signalling explanation has lost some of its credibility. A firm may withdraw OMRs at any time and, on average, take three years to complete (Jagannathan and Stephens, 2003). Grullon and Michaely (2004) did not find any evidence of post-buyback improvement in firm’s operating performance
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