Share Repurchases and the Need for External Finance

Abstract

We investigate the relationship between the need for external finance and the information content of share repurchases. We find that share repurchase announcement returns increase in the likelihood the firm will need to raise equity in the future. We then examine whether announcement returns to seasoned equity offerings (SEOs) differ when an open market share repurchase precedes the SEO. We hypothesize that repurchases may reduce asymmetric information regarding firm value. In this case, the repurchase mitigates the adverse selection problem associated with issuing equity, and the abnormal return to the SEO announcement should be less negative. We find significantly less negative abnormal returns when the SEO is preceded by a repurchase announcement. We document less negative SEO announcement abnormal returns when the SEO and repurchase announcements are closer in time. We find that compared to other repurchase firms, repurchase firms that are more likely to issue equity have better investment opportunities, have less internally generated cash flow, and face more severe financial constraints. We conclude that payout policy, in the form of stock repurchases, plays a significant role in conveying information about firm value.