Stock Repurchases Research Articles

Equalizing the Tax Treatment of Stock Buybacks and Dividends

This policy brief highlights flaws in the current federal tax treatment of stock buybacks and proposes to address those flaws by equalizing the tax treatment of buybacks and dividends. (We explore the proposal in greater detail in Hemel & Polsky, Taxing Buybacks, 38 Yale J. on Reg. 246 (2021), https://ssrn.com/abstract=3764112.) Stock buybacks allow foreign shareholders to avoid U.S. withholding tax on corporate cash distributions. Stock buybacks also allow U.S. taxable investors to reduce or eliminate shareholder-level tax on corporate cash distributions through a combination of deferral, loss harvesting, and stepped-up basis at death. Our proposal—based on an idea first suggested by Marvin Chirelstein a half century ago—would plug these gaps in the tax base by treating stock buybacks as imputed dividends. We explain the mechanics of the proposal and the principal design choices facing policymakers. We also estimate—conservatively—that the proposal would raise more than $500 billion over the 10-year budget window.

Does leveraged stock buyback improve firms’ profitability?

ABSTRACT We provide a structural explanation about how and when leveraged stock buyback improves firms’ profitability. We find operating profit on equity and operating profit sensitivity on debt are crucial factors to consider when determining the source of stock repurchase. Our theoretical reasoning and empirical tests show that companies with high operating profit on equity and low operating profit sensitivity on debt have a higher chance of improving profit through leveraged buyback. We also suggest a structural form to estimate leveraged buyback and cash buyback based on financial variables instead of companies’ disclosure.

Agency Conflicts and Dividend Persistence

Bank dividends are unusually persistent. In a crisis, they exacerbate systemic risk and raise concerns for regulators. Bank managers, however, may keep dividends elevated to mitigate agency conflicts with shareholders. One theory holds that persistent dividends may substitute for monitoring by dispersed shareholders. A second theory proposes that they attract institutional shareholders who monitor banks, mitigate agency conflicts, and seek to protect their investments’ value. After controlling for regulatory enforcement actions, we test both theories using 7722 bank-quarter observations spanning the 2007–2009 financial crisis. Our results suggest that dividend persistence increases with managerial agency conflicts but decreases in the presence of concentrated institutional shareholders, consistent with the second theory. In addition, contrary to the first theory, dispersed shareholders have no influence on bank dividend policies. Instead, these dispersed shareholders are associated with more frequent stock repurchase programs.

Do managers provide misleading earnings forecasts before stock repurchases?

AbstractWe question previous evidence that managers mislead investors into selling their stock for artificially lowered prices by releasing overly negative earnings forecasts before stock repurchases. We rely on forecast errors (forecast minus actual earnings) and show that these are insignificantly different between repurchase and matching firms. Our tests are powerful at detecting small differences and yet, across multiple subsamples, we find no statistical difference in forecast errors of repurchase and matching firms. Prior evidence of managerial misleading relied on the negative stock market reaction to management forecasts. We show that this negative reaction is observed only in the subsample where board authorization of repurchase follows management forecast. When board authorization precedes forecast, market reaction to management forecasts for repurchase firms is somewhat higher than that for matching firms. Our evidence suggests that managers are not misleading but exploiting low market prices to the advantage of their long‐term shareholders.

The Effect of Unsuccessful Past Repurchases on Future Repurchasing Decisions

We find that managers are less likely to repurchase stocks when they lose money on past stock repurchases but find no robust evidence that past gains on repurchases influence future repurchasing activity. This asymmetric sensitivity is strongest for young CEOs and those with the shortest tenure. Also, future repurchases are more sensitive to past repurchase losses for CEOs whose previous lifetime experience with the stock market is unfavorable. The sensitivity of future repurchases to past losses costs firms, on average, about 3.7% per year. When this cost is decomposed into systematic and idiosyncratic components, we find that nearly half (1.8%) comes from mistiming idiosyncratic shocks. Past losses on repurchases have a significant and negative impact on the CEO’s future bonus and increase the likelihood that future CEO termination is involuntary. We also find that negative outcomes from past repurchases encourage the subsequent use of dividends. Our findings suggest that outcomes of past repurchases have economically significant consequences through both nonbehavioral (career concerns) and behavioral (snakebite effect) factors. This paper was accepted by Tyler Shumway, finance.

Payouts and stock ownership

Using a unique Swedish database that records the ultimate stockholdings in public firms, we decompose stock ownership by domiciles using votes rather than cashflows. We then study the impact of variables related to the lifecycle theory of dividends and the catering theory of dividends. We also examine the propensity of firms to pay dividends and/or activate a stock buyback program. Univariate analysis reveals a positive association between a firm’s maturity and its likelihood to pay dividends. Logistic regression finds a positive relation between payouts and retained earnings to total assets. Foreign institutional investors are less likely to hold dividend-paying stocks than domestic institutional investors. The analysis finds no support for the catering theory of dividends. After controlling for stock ownership, our evidence is consistent with the lifecycle theory of dividends, which states that more mature firms are associated with dividends. It also supports the transaction cost hypothesis claiming that foreign investors face additional administrative costs when holding dividend-paying stocks.

제도적 환경 변화에 대한 전략적 대응으로서의 자사주 매입: 한국의 기업집단(재벌)을 중심으로

제도적 환경 변화에 대한 전략적 대응으로서의 자사주 매입: 한국의 기업집단(재벌)을 중심으로

Firm–bank credit network, business cycle and macroprudential policy

We present an agent-based model to study firm–bank credit market interactions in different phases of the business cycle. The business cycle is exogenously set, and it can give rise to various scenarios. Compared to other models in this literature strand, we improve the mechanism according to which the dividends are distributed, including the possibility of stock repurchase by firms. In addition, we locate firms and banks over a space and firms may ask credit to many banks, resulting in a complex spatial network. The model reproduces a long list of stylized facts and their dynamic evolution as described by the cross-correlations among model variables. The model allows us to test the effectiveness of rules designed by the current financial regulation, such as the Basel III countercyclical capital buffer. We find that the effectiveness of this rule changes in different business cycle environments and this should be considered by policy makers.

Dividends versus Stock Repurchases and Long-Run Stock Returns under Heterogeneous Beliefs

Abstract We analyze a firm’s choice between dividends and stock repurchases under heterogeneous beliefs. Firm insiders, owning a certain fraction of equity, choose between paying out cash available through a dividend payment or a stock repurchase, and simultaneously choose the scale of the firm’s project. Outsiders have heterogeneous beliefs about project success and may disagree with insiders. In equilibrium, the firm distributes value through dividends alone, through a repurchase alone, or through a combination of both. In some situations, the firm may raise external financing to fund its payout. We also develop results for long-run stock returns following dividends and repurchases. (JEL G32, G35) Received June 2, 2020; editorial decision November 3, 2020 by Editor Andrew Ellul. Authors have furnished an Internet Appendix, which is available on the Oxford University Press Web site next to the link to the final published paper online.

Do Managers Use Reference Points? Evidence from Stock Repurchases

The extent to which managers use reference points in their corporate decisions remains an open question in the literature. This paper studies the effect of managerial reference points on actual share repurchases. We argue share repurchases are an ideal setting to study managerial reference points because repurchase prices are salient to managers and actual share repurchases typically occur as a sequence of events. We find that the percent change from the prior repurchase price to the current stock price is negatively related to the current level of repurchases. To facilitate a causal interpretation, we find that this relationship disappears when the prior repurchase price is associated with a previous manager. These results are consistent with the idea that managers use past repurchase prices as reference points for current repurchase decisions.

Are Stock Buybacks Crowding Out Real Investment? Empirical Evidence from U.S. Firms

We investigate the role of financialization in the decline of investment for U.S. non-financial firms from 1992 - 2017. We show that the tendency to maximize shareholder value, fuelled by stock-based manager compensation, has led U.S. firms to divert resources from real investment to share repurchases to increase stock prices. Using micro-data from U.S. firms balance sheets and manager compensation, we estimate two dynamic panel data models: (i) to analyze the effects of share repurchases on capital investment; (ii) to examine the interaction between stock-based CEO pay and the likelihood of share repurchases. We find that stock buybacks have a negative effect on capital investment with this effect being stronger among large firms, operating in non-competitive markets. Moreover, an increase in stock options make firms more likely to repurchase shares. Our findings suggest that stock-based compensation creates incentives for managers to focus on increasing shareholder value by repurchasing shares at the cost of declining real investment and long-run growth.

Stock Buyback: Toxic Cure for the Company to Get out the Dilemma

Stock Buyback: Toxic Cure for the Company to Get out the Dilemma

Negative Tangible Equity

About 40% of the S&P 500 firms reported negative tangible equity (NTE) in 2019, a significant increase from the 10% level two decades ago. We find that debt-fueled NTE firms are associated with larger market caps with more stock buybacks and acquisitions of intangibles. NTE firms’ higher credit ratings and lower bond yields in the latest decade suggest that they are viewed as less risky by debtholders than previously. We also find that their stock prices increase (decrease) immediately after the Federal Reserve’s monetary policy action decreased (increased) interest rates. In addition, NTE firms’ stock returns outperform by 3.77% and 3.65% in the first and the second year after portfolio formation in 2011–2019, but such outperformance is not accompanied by higher earnings expectations. Our results contradict Graham and Dodd’s (1940) advice to avoid NTE firms but raise questions about their valuations, should interest rates rise in the future.

More Value, Less Profit: The Value and Organization of an Internally Financed Firm

Problem definition: Profit maximization is the default criterion in operations management and much of economics, but its pursuit achieves a firm's financial value only under stringent conditions. Otherwise: (A) Profit optimization is sub-optimal, but the proper operational criterion to maximize value can be determined clearly for a firm that is financed internally. (B) Identification of the organizational structure to coordinate decisions regarding working capital and operations properly is a by-product of the answer to (A). Methodology/results: The results emerge from the analysis of a Markov decision process model of a firm that makes periodic decisions regarding operations and working capital. The value of the firm is the maximal expected present value of the time stream of net payouts (cash dividends, stock dividends, and stock buybacks). That is one end of an axis on which the other end is profit. (a) Simple formulas connect the two criteria on the axis. The value corresponds to a perturbed profit criterion in which revenue is deflated. (b) Thus, the use of a straightforward profit criterion compromises value. (c) The analysis depends on whether a bankruptcy risk is present or not and, if present, how it is modeled. The paper analyzes two cases: no risk of bankruptcy, and risk of bankruptcy under Chapter 11 of the U.S. Bankruptcy Code. (d) If there is no risk of bankruptcy, profit-optimal and value-optimal decision rules have the same qualitative features, and the management of working capital should be subordinated to operations management. (e) These results are applied to models of inventory, a vertically integrated supply chain, a fishery and capacity management. Managerial implications: CFOs should mandate lower inventories than operations managers deem profit-optimal. CEOs should not subordinate operations management to working capital management.

The Relationship between Stock Repurchase Completion Rates, Firm Reputation and Financial Reporting Quality: A Commitment-Trust Theory Perspective

The Relationship between Stock Repurchase Completion Rates, Firm Reputation and Financial Reporting Quality: A Commitment-Trust Theory Perspective

Identifying economic shocks with stock repurchase programs

This paper aims to identify economic shocks in four developed countries that authorize different buyback programs. Previous research has revealed that there are few public debates about buyback act...

Efektifitas Kebijakan OJK Terkait Buyback Saham Terhadap Perubahan IHSG Di Masa Pandemi Covid-19

The covid-19 pandemic affected of Indonesia Composite Index (IHSG) decline, to minimize the impact of covid-19 the financial services authority (OJK) made a shares buyback policy. Share buyback is repurchase of stock by an issuer that issues share on a stock exchange with the aim of reduce outstanding shares to be able to reduce a significant share price decline. This working paper will focus on the effectiveness of financial services authority policies related to share buyback on changes of composite index during the covid-19 pandemic, using qualitative research methods and analiytical descriptive. Indonesia Composite Index (IHSG) has decreased greatly since early this years until March, but now it’s slightly better despite the changes less significant but can suppress further decline in stock price.

Complementarity or Substitution: Time-Variant Implications of Dividends and Stock Repurchases – An Explorative Study

Prior studies associate dividends with permanent earnings signals and stock repurchases with transitory earnings signals. In contrast, we provide empirical evidence that in recent decades, dividends and stock repurchases have converged to each other in terms of their signaling for future earnings. According to our explorative empirical analysis using a modified version of the Dechow et al. (2008) earnings persistence model, the relation between dividend and stock repurchase signals has changed from complementary to substitutive. However, cumulative abnormal returns following payout announcements indicate that the stock market is not fully aware of this convergence as cumulative abnormal returns in response to stock repurchases do not increase in conjunction with their changing signals. We also explore potential reasons for the documented convergence, and find that the declining signaling of dividends for future earnings may be driven by increased institutional ownership, reducing agency-problems between management and shareholders. Furthermore, the signaling of stock repurchases converges to that of dividends because the former are paid more persistently and are less related to transitory non-operating income. Our findings help investors and managers in allocating their assets more efficiently by improving their understanding of payout policy implications.

Dividend Policy and the COVID-19 Crisis

This paper examines dividend payment behavior of the S&P1500 firms during the COVID-19 crisis characterized by the stock market crash and a V-shaped stock price recovery propelled by technology stocks. We find that the great majority of firms either maintain or increase the level of dividend payment during the crisis period. Yet, the relationship between the dividend payout and bottom-line earnings available to common shareholders is significantly negative. This relationship holds even for dividend-increasing firms whose earnings streams should be relatively higher (or increasing) compared to other firms in the sample. We also find that forecast earnings of up to one year in the future are negatively associated with the current dividend level implying that the existing payout policies are unsustainable. Interestingly, we document similar patterns for stock repurchases.

Litigation Risk and Debt Contracting: Evidence from a Natural Experiment

In June 2001, Nevada changed its state corporate law by substantially reducing the legal liability of directors and officers for breaching fiduciary duties owed to the corporation. We examine the impact of the reduced litigation risk caused by this legislative change on Nevada-incorporated firms’ loan contract terms and related borrower-lender agency conflicts. Using a difference-in-differences analysis, we find that the legislative change led to less favorable loan contract terms for Nevada-incorporated firms: higher spread and more restrictive covenants. In addition, after the legislative change, Nevada-incorporated firms with severe borrower-lender agency conflicts took more risk, increased payout through stock repurchase, and reduced capital investment and equity issuance. Collectively, these results suggest that the reduced litigation risk exacerbates the borrower-lender agency conflicts.