Early share repurchases made substantial use of fixed price tender offers and Dutch auctions with event returns of 10% to 15%, signaling undervaluation. During the 1980s, buybacks were mostly open market repurchases (OMRs) with high positive event returns whose persistence may be related to subsequent repeated announcements occurring every 1 to 3 years. Studies of share repurchases during the 1990s are consistent with the hypothesis that a major motive was to offset the dilution effects of the exercise of stock options. These findings were also supported by the public statements of major companies that share repurchases were used to support their stock prices and by reductions in equity shares outstanding over the years by many firms. The growth of share repurchases took place after 1980 when the number and percentage of firms paying dividends decreased.
Dividend payers were predominantly large, mature firms. Also earnings and dividend payments were concentrated in 25 firms which accounted for over 50% of the totals for all industrials by 2000. A relatively small number of firms also accounted for a high concentration of share repurchases by the late 1990s. Early repurchases moved stock valuations toward their intrinsic values; later repurchase programs may have contributed to overvaluation and over investment.
During the four years ending in 1998 share repurchase announcements increased by $150.4 billion; during the four years beginning in 1998, share repurchases decreased by $105.0 billion, about 50% (Mergers & Acquisitions, February 2003, p. 58). This paper is not an obituary for share repurchases, but it is a story filled with paradoxes.
Studies of share repurchases using data for 1960-1979 assigned undervaluation as the dominant motive. Share repurchases made in response to undervaluation served the economic role of moving share prices toward their intrinsic market values, providing improved information for resource allocation. Stock prices rose almost without interruption between 1982 and 2000. By 1998 valuations in relation to earnings and cash flows had reached multiples significantly higher than historical patterns. Yet the growth of share repurchases continued to accelerate. That undervaluation was the dominative force behind the growth was no longer plausible.
Econometric studies of share repurchases in the 1990s found an association between the growth of employee stock options and the use of share repurchases to offset the earnings per share dilution when the options are exercised. If this form of accounting manipulation was the dominant reason for share repurchases, the resulting distortions in earnings measures would create misleading metrics for guiding resource flows.
Further uncertainties are raised by the Jobs and Growth Tax Relief Reconciliation Act of 2003 which substantially removed the tax advantages of share repurchases. In mid 2003 Microsoft announced that it would replace stock options with restricted stock grants. On 7/18/03 Dell’s CFO J. M. Schneider stated that the dividend tax changes were not as favorable as Dell had hoped for and that after meeting with institutional investors it had decided to continue with share buybacks instead of cash dividends.
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The demise of share repurchases
