Common stock repurchase and market signalling
Journal
of Financial
COMMON
Economics
9 (1981) 139-183.
STOCK REPURCHASES
North-Holland
Publishing
Company
AND MARKET SIGNALLING
An Empirical Study*
Theo VERMAELEN lJ/niversity of British Columbia, Vancouver, BC, Canada V6T 2 W5
Received January
1980, final version
received January
1981
This paper examines the pricing behavior of securities of firms which repurchase their own shares. The results are consistent with a market in which investors price securities such that expected arbitrage profits are precluded. The results are also consistent with the hypothesis that firms offer premia for their own shares mainly in order to signal positive information, and that the market uses the premium, the target fraction and the fraction of insider holdings as signals in order to price securities around the announcement date. The observation that repurchases via tender offer are followed by abnormal increases in earnings per share and that mainly small firms engage in repurchase tender offers, provides further support for the signalling hypothesis.
1. Introduction
The purpose of this study is to examine the price behavior of securities of firms which buy back their own shares in the open market or via a tender offer and announce the repurchase decision in the Wall Street Journal.
The U.S. is one of the few countries in the world which allows firms to make tender offers for their own shares at a price above the market price.
The rather negative attitude of legislators of other countries is generally motivated by a stated desire to protect non-insider investors. The argument is that insiders could manipulate prices by giving false ‘signals’ to the market or they could expropriate bondholders by reducing the size of their claims on the assets of the firm. In spite of some outcries for legislation,’ repurchases in the U.S. have been left largely untouched by the S.E.C.
*This paper is adapted
of Financial
COMMON
Economics
9 (1981) 139-183.
STOCK REPURCHASES
North-Holland
Publishing
Company
AND MARKET SIGNALLING
An Empirical Study*
Theo VERMAELEN lJ/niversity of British Columbia, Vancouver, BC, Canada V6T 2 W5
Received January
1980, final version
received January
1981
This paper examines the pricing behavior of securities of firms which repurchase their own shares. The results are consistent with a market in which investors price securities such that expected arbitrage profits are precluded. The results are also consistent with the hypothesis that firms offer premia for their own shares mainly in order to signal positive information, and that the market uses the premium, the target fraction and the fraction of insider holdings as signals in order to price securities around the announcement date. The observation that repurchases via tender offer are followed by abnormal increases in earnings per share and that mainly small firms engage in repurchase tender offers, provides further support for the signalling hypothesis.
1. Introduction
The purpose of this study is to examine the price behavior of securities of firms which buy back their own shares in the open market or via a tender offer and announce the repurchase decision in the Wall Street Journal.
The U.S. is one of the few countries in the world which allows firms to make tender offers for their own shares at a price above the market price.
The rather negative attitude of legislators of other countries is generally motivated by a stated desire to protect non-insider investors. The argument is that insiders could manipulate prices by giving false ‘signals’ to the market or they could expropriate bondholders by reducing the size of their claims on the assets of the firm. In spite of some outcries for legislation,’ repurchases in the U.S. have been left largely untouched by the S.E.C.
*This paper is adapted