Share Repurchases and the Flexibility Hypothesis

Abstract

Extant research finds that firms are increasingly substituting dividends with share repurchases. This substitution effect is largely attributable to the flexibility offered by share repurchases but not by dividends. Without fear of an adverse market reaction, firms can choose not to repurchase shares, which is not possible with dividends. Using the financial crisis as a natural experiment, we test whether repurchases are more flexible than dividends. We document that the proportion of repurchasing firms that reduced repurchase payouts is greater than the proportion of dividend payers that reduced their dividends during the financial crisis period. This extends to total payout reductions (dividends plus repurchases) as well between the two groups of firms. We also find that the propensity to reduce payouts between repurchasers and dividend payers exists even after controlling for several control variables. We also find that the market performance of repurchase-reducing firms is better than that of dividend-reducing firms over the financial crisis period, indicating that the markets do not penalize repurchasing firms more than dividend-reducing firms. Finally, we find that the operating performance of share repurchasers is better than dividend payers during the financial crisis and post-crisis periods. Overall, we conclude that share repurchases are more flexible than dividends.