Essays on share repurchases

Abstract

This dissertation comprises three essays, which empirically examine the influence of investor and managerial irrationality on open market repurchases (OMRs) in the US market. In the first essay, we examine the systematic differences in the initial market response, long-run abnormal returns, long-run operating performance, and completion rate across repurchase announcements made in markets characterized by high and low investor sentiment. We find that while the low-sentiment announcers have lower short-run market reaction, they have higher long-run abnormal returns and operating performance than their high-sentiment peers. These results suggest an underreaction to the announcements made in the low-sentiment phase. The high-sentiment announcers also have relatively lower completion rate. Further, we find that while the price-support motive dominates among the high-sentiment announcers, the signaling motive drives the low-sentiment announcers. Overall, our results show that investor irrationality partly explains the repurchase anomaly (Peyer and Vermaelen 2009). The second essay investigates the influence of market irrationality on share repurchases for firms, which differ in their level of arbitrage constraints. We find that firms with higher limits-to-arbitrage earn a higher initial reaction, lower long-run abnormal returns, and have lower completion rate. The higher initial market reaction to repurchase announcements for firms with higher limits-to-arbitrage corroborates with the documented evidence (Baker and Wurgler 2006) that sentiment has a greater impact on the difficult-to-value and difficult-to-arbitrage firms. The results suggest that the variation in arbitrage cost incrementally influences the repurchase outcomes besides the influence of the investor sentiment. In the third essay, we study how the repurchase by overconfident CEOs differ across markets characterized by high- and low-sentiment. Overconfident CEOs believe their equity as undervalued and, therefore, show reluctance to raise external finance (Malmendier et al. 2011). Hence, they may be more inclined to repurchase shares. We find that overconfident CEOs announce larger repurchase programs in high-sentiment markets. We also find a higher initial market response to such announcements in the high-sentiment phase. These results suggest that the low-sentiment market has greater ability to identify the repurchases driven by CEO overconfidence. The dissertation contributes to the emerging literature on behavioral corporate finance. The result on the underreaction to OMR announcements in the low-sentiment markets emerges as an explanation for the widely observed repurchase anomaly.