THREE ESSAYS IN CORPORATE SHARE REPURCHASES
Analytics
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Abstract
In a series of three related essays, my dissertation examines several unresolved issues in the corporate finance literature relating to the firm’s use of share repurchases. These include the mitigating effects of creditor-manager alignment on increases in the firm’s cost of debt surrounding entrenched managers use of defensive open market share repurchases (OMR), the question of short-term bondholder wealth expropriation around the announcement date of an OMR, and management’s motivation for the use of a relatively new form of share repurchase, a privately-negotiated Accelerated Share Repurchase (ASR) contract. As recent literature suggests that creditors’ interests may be more aligned with those of entrenched managers, in my first essay, I use TRACE daily bond data over the period from 2002 thru 2015 to empirically examine how creditor-manager incentive alignment affects changes in the firm’s cost of debt over a 3-quarter period surrounding 1,251 open market repurchase (OMR) announcements. Using the "E-index" from Bebchuk, Cohen, and Ferrell (2009) as the primary measure of managerial entrenchment, I find that increases in average quarterly yield spreads on the firm’s seasoned public bonds surrounding the announcement of an OMR are significantly reduced by 42.86% in the presence of entrenched management. Further, conditional on the presence of a blockholder, I find significant increases in the cost of debt are directly proportional to the concentration of total blockholder ownership as well as the total number of blockholders present. However, when the firm’s management is protected from takeovers (i.e., entrenched), the effect is more than offset. The mitigating effects of creditor-manager incentive alignment, however, appear limited only to firms that repurchase at least 1% of their outstanding equity during the announcement quarter. Lastly, I find that changes in the firm’s cost of debt are not the result of OMR announcements, but are instead driven by actual share repurchases. Overall, the results suggest that creditors may regard OMRs conducted by entrenched managers as defensive mechanisms that protect their interests as well in the presence of an effective external market for corporate control. In my second essay, using TRACE daily transactional bond data from 2002 thru 2015, I follow the prescribed methodology of Bessembinder et al. (2009) to calculate both 3-day and 5-day bond CARs around 553 open market repurchase (OMR) announcements to examine the unresolved issue of whether shareholders expropriate bondholder wealth around an OMR announcement. By calculating 3-day (and 5-day) bond CARs around the actual announcement date of an OMR, I can examine the direct interaction of short-term wealth effects between the firm’s shareholders and bondholders without the potential noise impounded in abnormal bond returns found in earlier studies. While I find mean bond (equity) CARs are slightly negative (positive), I find no statistical evidence of negative correlations between equity and bond CARs using traditional bond classification schemes, casting doubt on the wealth transfer hypothesis. However, I do uncover univariate evidence of negative correlations among bond and equity CARs when I focus on the joint stakeholder responses (e.g., negative bondholder/positive equity response) to an OMR announcement providing some support for the wealth transfer hypothesis. Additionally, in contrast to Jun et al. (2009), I find that bond and equity abnormal responses are highly positively correlated when management is protected from the external market for control, i.e., entrenched. However, this positive relationship is diminished in the presence of good governance, i.e., strong external shareholder control. Overall, my results suggest that agency conflicts as well as creditor-manager incentive alignment may play a more important role than previously thought in understanding the abnormal responses of different classes of stakeholders to the announcement of OMR.Finally, in my third essay, I examine management’s motivations for the increased use of a relatively new form of share repurchase, a privately-negotiated Accelerated Share Repurchase (ASR) contract. As no centralized database of ASR contracts exist, I hand-collect the largest sample of ASR contracts in the literature to date, 716 ASRs over the period from 2004 to 2015, to use in my study. I find that ASRs have now become the second largest method of share repurchase in the U.S. representing approximately 10% of all (common) shares repurchased over the last several years. As an ASR provides for the immediacy of share repurchase as well as sending a more credible signal of the intent to follow through with actual repurchases (i.e. an ASR is a legal contract to repurchase), the focus of my study is on possible motivations tied to these two potential ASR features, e.g., quarterly earnings management and/or signaling, either in the traditional sense of undervaluation (asymmetric information) or, as in Grullon and Michaely (2004), to signal management’s commitment to avoid the agency costs of overinvestment by returning excess free cash. While I find some univariate support for quarterly EPS management, multivariate logit results indicate that firms are more likely to initiate an ASR if they would have met EPS forecasts without the accretive effects of a share repurchase. Instead, my results primarily support the agency theory of free cash flow as I find the likelihood of conducting an ASR increasing in firms that are larger, have higher levels of cash and free cash flow, higher operating performance, but are facing declining investment sets as reflected by slowing sales growth and lower M/B ratios. Contrary to the nascent ASR literature, I find CARs surrounding ASR announcements are significantly higher than those of OMR firms. However, post-announcement operating performance is declining for both groups.