Buybacks Around the World

Alberto Manconi

Tilburg University

Urs Peyer

INSEAD – Finance

Theo Vermaelen

INSEAD – Finance

European Corporate Governance Institute (ECGI) – Finance Working Paper No. 436/2014
INSEAD Working Paper No. 2013/101/FIN

Abstract:

This paper documents that outside the U.S. short-term returns around share repurchase announcements are positive, although only about half the size as in the U.S. Long-run abnormal returns after buyback announcements follow the same pattern in non-U.S. firms as document by prior literature for U.S. firms extending the buyback puzzle to the global level. Cross-country differences in corporate governance quality and regulatory differences can explain variation in the short- and long-run abnormal returns. Globally, long-run abnormal returns are related to an undervaluation index (Peyer and Vermaelen, 2009, RFS) consistent with the interpretation that managers are able to time the market.

Buybacks Around the World – Introduction

During the last decade share repurchases have become increasingly common around the world.

Regulation introduced in the 1990s has drastically changed a firm’s ability to repurchase its own shares in many countries outside the United States. As a result, it is possible to ask whether the findings based on U.S. data hold up in an international setting, and whether examining non-U.S. data can change the way we think about buybacks. Past research shows that in the U.S. open market share repurchase announcements are accompanied by positive announcement returns of about 3% and long-run abnormal returns in the order of 30% over three to four years (e.g. Ikenberry, Lakonishok and Vermaelen (1995), Peyer and Vermaelen (2009)). These results are consistent with a variety of non-mutually exclusive explanations, which can be grouped under two broad hypotheses: undervaluation and agency cost (e.g. Vermaelen (1981), Ikenberry et al. (1995), Grullon and Michaely (2004)). The undervaluation hypothesis posits that firms buy back their stocks when they are temporarily undervalued. Stock prices increase after buybacks when the market corrects the undervaluation, at least in the long run. The agency cost hypothesis argues that buybacks, by returning cash to the shareholders, mitigate the agency costs of free cash flow. In this case stock prices increase because the market is relieved that bad managers don’t waste excess cash. Note that this hypothesis assumes that board members and other large investors put enough pressure on these managers to pay out excess cash.

The interesting question is whether these findings and interpretations can be generalized in an international setting. In particular, the long term excess returns documented after buybacks are anomalous. As Fama (1998) points out, one way to test whether an anomaly is real or the sample-specific result of chance is to examine an entirely different data set. To take this question to the data, we investigate buyback announcements using a global sample of 17,487 announcements from 32 countries between 1998 and 2008. Our global approach also provides a unique laboratory to test for the relevance of the agency cost vis-à-vis the undervaluation hypothesis, by looking at corporate governance. Corporate governance practices and quality vary much more across an international sample than within the U.S. (e.g., La Porta et al. (2000)). The effect of governance quality on returns after buyback announcements is controversial.

If firms buy back shares to increase shareholder value by reducing agency costs of free cash flow, we expect a negative relation between corporate governance quality and excess returns. Indeed, firms with low corporate governance quality should benefit more from the reduction in agency costs of free cash flow. The undervaluation hypothesis would argue the opposite: firms buy back stock when the shares are undervalued, but they are more likely to do so if they care about shareholder value, i.e. when their corporate governance quality is high. Thus under the undervaluation hypothesis, the better corporate governance, the higher excess returns. Note that not all repurchases are driven by shareholder value. Examples include fighting a takeover bid by repurchasing shares from “pessimistic” shareholders, stabilizing the stock price by buying shares above “fair” value, manipulating earnings per share (Chan, Ikenberry, and Lee (2007), Cheng, Harford and Zhang (2014)), or acting in the interest of a majority stockholder at the expense of minority shareholders. The latter argument is particularly important in many European firms, where only a minority of the publicly traded firms are widely held (Faccio and Lang (2002).

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H/T Harvard Law Forum