Stock Repurchases And False Signals

Abstract

Each year many firms repurchase shares of their common stock. Research evidence shows that when firms announce the repurchase of common stock, their share prices typically rise.  Numerous studies attribute these increases to a signaling effect.  But some firms that announce their intention of repurchasing shares of common stock either repurchase no shares at all or repurchase fewer shares than initially announced. Although the practice of firms intentionally announcing the repurchase of more shares than they expect to repurchase is illegal, the expected increase in share prices may give firms an incentive to make such false announcements.

This study surveys top financial executives to learn the extent that firms repurchase fewer shares than announced, identify the reasons for this activity, and learn how managers view this activity.  We surveyed 642 firms that conducted common stock repurchases from January 1998 to September 1999.  Based on 218 responses, we find that while managers are uncertain about the legality of this activity, they believe that the intentional repurchase of fewer shares than announced is unethical, sends a false signal to the market, and damages the firm’s credibility with its stockholders.  Managers also believe that firms repurchasing fewer shares than announced should publicly reveal both the reason for not repurchasing all shares and the amount by which the repurchase fell short of the firm’s announced intentions.  Despite these beliefs, managers report that repurchasing fewer shares than announced is a common practice.