Share repurchases: analyzing short-term and long-term wealth effects

Abstract

PurposeThe purpose of this paper is to examine the short-term and long-term wealth effects of two share repurchase motivations.Design/methodology/approachThe authors use a multi-period numerical model and a Monte Carlo simulation. The Monte Carlo simulation introduces uncertainty into firms’ market values and eliminates some restrictions used in the numerical model.FindingsIn the long term, firms that refrain from repurchasing overvalued shares outperform otherwise identical firms that do not exhibit such restraint. In the short term, firms that repurchase overvalued shares can outperform firms that refrain from such repurchases. Total returns are a function of misvaluation, the firm’s repurchase decision, the rate of return on invested cash and how long the shares remain misvalued. Share price volatility can influence share repurchase decisions.Research limitations/implicationsThe models are incapable of fully modeling the complexities of a dynamic economic environment.Practical implicationsManagers and investors need to be aware of the short-term and long-term effects of share repurchases. Additionally, investors can gain insight into a firm’s share repurchase motivation by observing its cash balances over time.Social implicationsShare repurchases are a zero-sum game with potentially different short-term and long-term wealth effects.Originality/valueWhen studying the wealth effects of share repurchases, it is important to consider the motivations for repurchasing shares as well as the short-term and long-term effects.