1

Share Repurchase Announcement, Real Buyback, Funding Sources,

and Dividend Policy

Chao Chen* California State University, Northridge

and

Min-Ming Wen

Corresponding author: Department of Finance, College of Business and Economics, California State University, Northridge, CA 91330-8379, U.S.A. Phone: (818) 677-4622; Fax: (818) 677-6079. The authors would like to thank James Chong and seminar participants at 2004 Financial Management Association Annual Conference, Tsinghua University and California State University, Northridge for their helpful comments.

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Share Repurchase Announcement, Real Buyback, Funding Sources, and Dividend Policy

Chao Chen

Min-Ming Wen Abstract: Favorable stock price reactions to share repurchase announcements are documented by early empirical studies. However, several recent studies raise the concern about the credibility of repurchase signals. A major innovation of this paper is to classify stock repurchase into complete repurchase programs versus incomplete repurchase programs reported by the SDC database, then we further investigate the actual stock repurchases of these two groups based on a new measure of actual repurchased share of each sample firm. The stock price behavior before and after the buyback announcement and actual buyback activity are the focus of this study. Our empirical results show that regardless of the actual buyback shares, the two subgroups with incomplete buyback status outperform the market one-year after the stock repurchase announcement. In addition, both complete and incomplete buyback groups display sub-par performance with the market before the announcement but outperform the market after the announcement of buyback. When both buyback status and the actual buyback shares are taken into account, all four groups exhibit positive and significant post-stock returns. It suggests that the post-stock buyback announcement returns are all higher no matter the firms’ actual repurchases or buyback status. In addition, the post-stock price for the group with complete status and actual buyback shares does show equal to or larger than announced one underperforms, while the group outperforms if the group is with incomplete status and actual buyback shares equal to zero or less than 1% of announced shares. Since stock repurchase announcement, sources of financing, and dividend payout are all important managerial choices, this paper links these managerial choices by exploring the actual share acquisitions. The finding from this study suggests that dividend payout and average payout ratio do not affect the decision of the actual buyback. Moreover, the firm with a greater percentage of outstanding shares that the firm attempts to buyback and without disclosing the funding sources in the repurchase announcement is more likely to leave the stock repurchase program incomplete. JEL Classification: G30, G34, G35 Keywords: Stock buyback; Actual share repurchase; Funding sources; Dividend payout; Incomplete repurchase program

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Share Repurchase Announcement, Real Buyback, Funding Sources,

and Dividend Policy

1. Introduction

Under the information hypothesis, the stock repurchase announcement is seen as

a positive signal because it indicates top executives’ favorable outlook on future

performance.1 Several empirical studies find evidence consistent with this theory

(Vermaelen, 1981; Dann, 1981; Comment and Jarrel, 1991; Ikenberry et al, 1995),

whereas some other literature provides evidences contradictory to information

hypothesis, such as Bartov (1991) and Jagannathan and Stephens (2003). Bartov (1991)

discovers that prior to the announcement of an open-market repurchase, unexpected

earnings are generally higher and positive only to turn negative after repurchase

announcements. Bartov’s finding for the year after the repurchase announcement is

inconsistent with the information hypothesis.2 In addition, Jagannathan and Stephens

(2003) examine open-market share repurchase announcements over the period 1991 to

1 For an overview of this argument, see Rau and Vermaelen (2002). 2 Although Bartov’s (1991) findings indicate a significantly positive earnings in the second year

following the repurchase announcements, Huang, Liano, and Pan (2003) document a negative relation

between repurchases and profitability estimated by earnings change, earnings, or abnormal earnings in

subsequent years.

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1995 and find that earnings tend to fall in the years after these events. Kahle (2002)

investigates the relationship between open market repurchases and employee options

and suggests that while the traditional motives still exist, described by the signaling

hypothesis and free cash flow hypothesis, neither of these hypotheses can explain the

surge in buybacks during the 1990s. Kahle concludes that the recent innovations in

compensation policy, particularly the growing use of stock options by companies, have

caused changes in not only the payout policy, but also the incentives for stock

repurchase.

The mixed empirical results of stock repurchases motivate us to explore the

following question: Do actual share acquisitions matter? Recently, Kim, Schremper,

and Varaiya (2004) provide evidence that among the ten largest stock markets, the US

has the least stringent regulations for stock repurchase in terms of bringing the

repurchase intention into practice for executing the program. The finding from Kahle

(2002) suggests that when a buyback isn’t a buyback, employee options can be the

rationale behind stock shares repurchase.

Since an open-market repurchase announcement is not considered a commitment

or obligation of future actions, the initialization of a repurchase program could merely

be an attempt by management to raise stock prices at little or no cost. Both The Wall

Street Journal (March 7, 1995) and Fortune (September 4, 1995) have pointed out that

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actual repurchases are small relative to the amount of shares announced by the firms.

Differing from previous literature on the relation between future earnings and stock

price responses to repurchase announcements (either tender offer or open market), this

paper examines how firms behave prior to open-market repurchase announcements

based on whether or not the repurchase program is completed. In addition, along with

the buyback status the actual buyback shares are taken into account to investigate the

stock performance. In other word, to specifically distinguish the stock price behavior in

the complete buyback status, we further examine the two subgroups, group1 (CH) and

group3 (CM). Likewise, we examine two subgroups from the group with incomplete

buyback status, group 2 (IL) and group 4 (IM).3 By examining open market sharer

repurchases from 1995 to 2000, we find that both complete and incomplete repurchase

firms’ stock prices perform at a sub-par level relative to the market prior to repurchase

announcement, but outperform the market in the post-announcement period.

The stock price behavior before and after the buyback announcement and actual

buyback activity are the focus of this study. Results show that regardless of the actual

buyback shares, the two subgroups with incomplete buyback status outperform the

market one-year after the stock repurchase announcement. On the other hand, among

3 Group 1 (CH) includes the firms with complete buyback status and actually buyback shares equal to or

more than the announced shares, while group 2 (IL) includes firms with incomplete buyback status and

actually buyback shares equal to zero or less than 1% of the announced shares.

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the four groups, the post-stock price for group 1 (CH) underperforms, while group 3

(CM) outperforms.

We explore whether the probability of leaving a repurchase incomplete is

associated with the dividend payout, transparency of funding sources and the intention

of repurchase size. The findings from logistic models suggest that the firm with a higher

level of discretionary accruals has a higher probability of leaving the repurchase

program incomplete.

The rest of the paper is organized as follows: Section 2 reviews the literature

related to stock repurchases, while Section 3 describes the data and sample. This is

followed by Section 4, on the hypotheses and methodology. Empirical results are

presented in Section 5 with Section 6 concluding this paper.

2. Literature Review

The studies conducted by Dittmar (2000) and Barth and Kasznik (1999) focus

mainly on the motives of firms repurchasing stocks due to information asymmetry

suggesting that managers and investors evaluate the values of stocks differently. The

incidence of information asymmetry leads to share price under-valuation. Stock

repurchase can be viewed as a sign that the stock price is undervalued. Ikenberry,

Lakonishok, and Vermalen (1995) confirm this argument by showing that positive

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abnormal stock returns are earned after repurchase announcements, with gains

continuing to be captured in the subsequent one to three years. A firm can freely

distribute cash flows by stock repurchases or dividend payment, repurchasing the

stocks instead of paying out dividends. This can lead to greater benefits for the firm if

the stocks are purchased at a price below intrinsic value. Compared to dividend

payments, stock repurchase is not viewed as a commitment to shareholders.

Jagannathan, Stephens, and Weisbach (2000) and Guay and Harford (2000) contend

that a firm tends to use dividend payments rather than stock repurchases to distribute

earnings only if higher permanent operating cash flows are presented to the firm, while

the main purpose of stock repurchases is to distribute temporary free cash flows, it

could be motivated by the excess capital hypothesis, optimal leverage hypothesis, and

takeover deterrence hypothesis.4

Vermaelen (1981) discovers the trend for positive stock price responses to

tender-offer stock repurchase announcements. In addition, Vermaelen observes

positive unexpected earnings after the repurchase announcement. Dann, Masulis, and

Mayers (1991) document positive earnings surprises following repurchase tender offers.

They conclude that stock price reactions to repurchase announcement are positively

4 Detailed review of the motives for stock repurchases includes Easterbrook’s (1984) excess

capital hypothesis, Opler and Titman’s (1996) optimal leverage hypothesis, and Dittmar’s (2000)

takeover deterrence hypothesis.

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correlated with earnings surprises over the concurrent and subsequent two years.

Hertzel and Jain (1991) use tender-offer stock repurchases as their sample to test the

relation between future earnings and stock repurchases. Their evidence shows that

tender-offer repurchase announcements convey favorable information about the future

prospects of the firms; therefore the information hypothesis is supported and is

consistent with the signaling model.

However, research by Grullon and Michaely (2003) indicates that the

cash-flow-signaling hypothesis cannot explain why firms repurchase their shares. They

find no evidence that repurchasing firms experience an improvement in future

profitability. Their findings are corroborated by Jagannathan and Stephens (2003), who

examine open-market repurchase announcements and find earnings fall in the years

after the repurchase announcement. Bartov (1991) conducts a test for open-market

stock repurchase announcements and earnings information. In his study, he finds that

the unexpected earnings are higher and positive before the repurchases announcement,

while they become negative during the year of the announcement, which is inconsistent

with the information hypothesis.5

5 Bartov (1991) finds the unexpected earnings reverse to significantly positive in the second year

following the repurchase announcement.

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In addition, Kahle (2002) introduces that executives’ stock options provide

alternative incentive for a firm to buyback their shares. The financial media such as The

Wall Street Journal and Fortune raise the question that the announcement of

repurchases may merely be an attempt by managers to raise stock price at little or no

cost. In addition, Billett and Xue (2003) also raise a concern about the credibility of

repurchase announcements. They conjecture that repurchases may be attempts to

falsely signal undervaluation with the subsequent seasoned equity offerings (SEOs) as

the means to benefit from the false signal. Billett and Xue (2003) argue that the market

may need to verify whether the firm actually completes the repurchase program for the

signal to be credible. It suggests that asymmetric information will be reduced as the

firm actually completes the shares repurchase.

Stephens and Weisbach (1998) investigate the factors that motivate firms to

“actually” repurchase shares. They find that the time and magnitude of actual shares

repurchase are consistent with the asymmetric information (undervaluation) hypothesis

and cash flow considerations.

Given the findings inconsistent with the signaling theory and alternative views

about the credibility of stock repurchase announcement in existing literature, this study

provides new empirical evidence for the behavior of actual share acquisitions,

especially for those firms that leave the repurchase incomplete.

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3. Data and Sample

The data in this study are from the SDC’s Worldwide Merger and Acquisition

database, where we gather repurchase data in which firms made the repurchase initial

authorization between 1995 and 2000. The data provide names of firms that

repurchased their stocks, the announcement date, status of repurchase program (i.e.

completed, suspended, or terminated), type of repurchase (i.e. open-market or tender

offer), and number of shares the firm seeks to repurchase.

Jagannathan et al. (2000) point out that SDC reports duplicate entries of share

repurchase announcement when the same announcement is reported by different

sources on different days. As such, we eliminate these duplicate announcements from

our sample. Firms are also excluded if their accounting data are not available from the

COMPUSTAT database. Finally, due to the highly-regulated character of financial

firms, in this study we only include non-financial firms whose SIC codes are either less

than 6000 or larger than 6999.

When a stock repurchase program is announced, it can be implemented by one of

the following techniques: Dutch auction (DA), fixed price tender offer (FPOL), odd lot

(OL), negotiated (NG), or open market repurchase (OPR). A mixed technique such as

the open market blended with the negotiated method (OPNG) may also be used. The

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open market repurchase technique is the most commonly employed, ranging from

45.7% (year 2000) to 60.41% (year 1997). The analyses of this study focus on

open-market stock shares repurchase.

Panel A of Table 1 reports that about 21.4% (year 2000) to 54% (year 1996) of

the repurchase authorizations were completed. SDC database defines a “completed”

repurchase program if all of the shares that the board authorizes to repurchase have

been repurchased. On the other hand, an incomplete repurchase program may be due to

the fact that either the board has chosen to temporarily suspend repurchase activity or

that the board has decided to withdraw the repurchase authorization.

In addition, based on the information provided by the SDC, the status (complete

or incomplete) of all existing repurchase programs is updated at the time when there is a

repurchase news released by firms. The SDC database applied in this paper has updated

the status of completion up to January 2003. 6 Hence, “incomplete” status means that

until January 2003, firms that had announced repurchase programs between 1995 and

6 Stephens and Weisbach (1998) report that a typical repurchase program lasts for three years, which

suggests that firms that announced repurchase programs before year 2000 are unlikely to further

complete the shares repurchase if the status of repurchase is still incomplete as of January 2003. To

confirm the results that apply to incomplete repurchase programs, we further use a more conservative

method by choosing firms that initially authorized shares repurchase prior to the year 1998 and the

repurchase status stays incomplete in January of 2003. The results support our finding from Table IV.

Specifically, earnings management is more severe if the firms announced repurchase but left the

program incomplete. This empirical result is available upon request.

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2000 did not actually buyback any shares. In order to specifically distinguish the

behaviors in the complete buyback status based on the actual buyback shares, we

further examine the two subgroups with complete, one of which is with actual buyback

shares equal to or more than announced shares ( group1— CH) and group3 (CM)

otherwise. Likewise, we examine two subgroups from the group with incomplete

buyback status, one of which with actual buyback shares equal to zero or less than 1

(group 2— IL) and group 4, otherwise.

As shown in Panel A of Table 1, 36% and 64% of the open market repurchase

programs are completed and incomplete on average, respectively from 1995 to 2000,

with an increasing trend of incomplete repurchase from 46.2% in 1997 to 78.6% in

2000.

The accounting data of firms with repurchase programs are gathered from the

COMPUSTAT yearly database. Panel B of Table 1 presents the descriptive statistics of

firm characteristics including total assets (TA), market value to book value ratio

(MV/BV), debt ratio (LD/TA), operating income to total assets (OI), and non-operating

income to total assets (NOI).

(Insert Table 1 about here)

4. Hypotheses and Methodology

4.1 Hypotheses

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In this study, we focus on firms that have made announcements to participate in

an open-market stock buyback program, but the repurchase can be in completed or

incomplete status. Based on the information hypothesis, the incentive of repurchases

announcement is due to stock undervaluation. However, the inconsistent results with

information hypothesis in extant literature (Bartov, 1991; Jagannathan and Stephen,

2003; Grullon and Michaely, 2004) motivated us to investigate whether managers

complete share acquisitions as they promised. Do stock prices behave differently for

firms with complete and incomplete buyback? In addition, how stock price behaviors

may change when both buyback status and actual buyback shares are taken into account.

Stephens and Weisbach (1998) argue that the popularity of open-market repurchase

program is less likely due to the managers’ attempts to manipulate their firm’s stock

price than it is the inherent flexibility of these programs with respect to the timing and

quantity of actual stock repurchase. In actuality, the concerns about the credibility of

stock repurchase have been raised in recent literature.

Following their research, we use the status of the repurchase program as a

measure of credibility to investigate whether the percentage of shares of announced

buyback, the transparency of funding sources, dividend payout ratio, and other control

variables are associated with the probability of leaving repurchase incomplete. Hence,

we develop the following hypotheses competing with information hypothesis (posited

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in the alternative form). In addition, all the following hypotheses are investigated based

on both buyback status and the actual buyback shares.

Hypothesis 1: Underperformance hypothesis

Corporate managers are more likely to announce stock repurchases when their stocks

underperform the market.

Generally, the stock market responds positively surrounding the announcement

of stock repurchase. If a corporate executive attempts to signal, the firm may announce

a repurchase when its stock underperforms.

Hypothesis 2: Price runnup hypothesis

If the stock prices outperform the market after the announcement of buyback, managers

are more likely to leave the stock repurchase program incomplete.

Hypothesis 2 suggests one of the reasons for the manager to leave the repurchase

program incomplete is that the concern about the under performance of the firm’s stock

prior to repurchase is alleviated by the price runnup phenomenon.

Hypothesis 3: Dividends certification hypothesis

If a firm initiates its cash dividend after the announcement repurchase, the firm is more

likely to have permanent operating cash flow and complete its buyback program.

Jagannathan et al. (2000) argue that a firm with higher “permanent” operating cash

flows will prefer to distribute earnings to shareholders by dividend, while firms

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initiated a repurchase program are likely to have higher “temporary” non-operating

cash flows. The primary hypothesis under this argument is that “dividends represent an

ongoing commitment, while repurchases preserve financial flexibility relative to

dividends because they do not implicitly commit the firm to future payouts.”7 Based on

Jagannathan’s hypothesis that if dividends are attributed to operating income, those

firms that announce their intent to repurchase shares and initiate cash dividends are

more likely to have a higher operating income.

We separate the entire sample firms which announce to buyback shares into two

groups: one is with dividend payout in the year of repurchase announcement (stock

repurchase with dividend firms), and another group is with stock repurchase but

without dividend payout (stock repurchase without paying dividend firms). We

hypothesize that firms initiating cash dividends after repurchase announcements are

more likely to complete their repurchase programs.

Hypothesis 4: Funding transparency hypothesis

A firm did not disclose the funding sources but announced a greater percentage of

outstanding shares that the firm attempts to buyback, the firm has a higher probability

leaving the stock repurchase program incomplete.

7 See Jagannathan et al. (2000), p.356.

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We conjecture that if a firm did not disclose the funding sources, which may

affect the capital structure due to the initiation of a stock repurchase program, and

announced a greater percentage of share repurchase, the credibility of stock repurchase

signals is lower so that the probability of leaving the repurchase program incomplete is

higher.

Hypothesis 5: Buyback commitment hypothesis

Do actual share repurchases matter? If shareholders are concerned about the buyback

commitment of a firm, then the stock price of the firm that actually completes its

repurchase program is more likely to outperform the market.

4.2 Methodology

This paper attempts to investigate whether a firm did what it announced to do,

we trace its repurchases program and estimate its actual buyback. Specifically, the

actual repurchased shares are estimated from decreases in shares outstanding and

purchases in common stock minus changes in the value of preferred stock. Decreases in

shares outstanding can be collected from the CRSP monthly database. Annual

purchases of common stock and annual changes in the value of preferred stock can be

obtained from the Compustat database.

The market adjusted abnormal return method is used to estimate cumulative

abnormal returns around repurchase announcement date and in several

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post-announcement periods. Then, the CARs are used as the dependent variable to test

the determinants of the abnormal returns.

In order to link the probability of leaving a repurchase program incomplete and

the attributes of the firm, we conduct a logistic model analysis. The model is to test

whether those firms with certain characteristics have higher possibility leaving the

repurchase program incomplete.

The logistic regression model can be written as:

Logit (p) = log (p

p−1

) = α + ×′β x,

Where p is the probability of leaving a repurchase program incomplete and defined as

Pr (Y = 1 | x ), Y =1 if the repurchase program is incompleted, and Y = 0 if the

repurchase program is completed; x is a vector of explanatory variables, which are

pre-stock repurchase discretionary current accruals, the number of shares firms

intended to buyback at the time of announcement, firm size, and debt ratio. α is the

intercept, and β is the vector of slope parameters. Thus the probability of a repurchase

program left to be incomplete can be represented by p = xβ'

xβ

e1e+

′

.

5. Empirical Results

We decompose our sample into two groups: (1) firms that have announced and

completed the repurchases (hereafter completed group), and (2) firms that have

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announced but did not complete the repurchases (hereafter incomplete group). An

initiated repurchase program could become incomplete with the termination, pending,

suspension, and extension of the program, among which pending and termination

contribute most to the incompletion of stock repurchase8.

Table 2 presents the time series changes of variables including average annual

dividend payout ratio (Div), operating income (OI), and non-operating income (NOI)

scaled by total assets from year-2 to year+2 surrounding the repurchase announcement

year. All of them are significantly different from 0 at the 1% level. For the entire sample,

before the initialization of repurchase, dividends payout ratios from year-2 up to year0

exhibit a decreasing trend, whereas increases one year after repurchase. On the other

hand, both operating income and non-operating income increase one year prior to

repurchase announcement, and decrease after the repurchase announcement. On

average, the payout ratio at the year of repurchase initialization is, 10.96%, which is

lower than the average payout ratio (11.39%) from year-3 to year 0.

Table 3 shows that the average dividend payout ratio of those firms with a

buyback program and cash dividends declines from the years before repurchase

announcement (year-2, year-1) to the years after repurchase announcement (year+1,

8 The detailed information is obtained from the SDC database.

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year+2). For example, the payout ratio decreases to 28.99% in year+2 from 30.36% in

year-2, which both are less than the average payout ratio for three years prior to

repurchase announcement, 30.39%. The above result is consistent with the argument

that repurchase can be viewed as a substitute for dividend (Guay and Harford, 2000,

Grullon and Michaely, 2002, and Dittmar and Dittmar, 2002).

The average operating income of those firms with a buyback program and cash

dividends is consistently higher than that of those firms with a buyback program but do

not pay cash dividends. On the contrary, those firms with a stock repurchase program

but with cash dividends have a higher non-operating income than those

repurchase-dividends firms. The results are consistent with the argument of

Jagannathan et al. (2000) that permanent operating cash flows measured by operating

income are higher in the dividend paying firms to retain the on-going cash distribution

commitment to shareholders; temporary non-operating cash flows are higher if firms

only use share repurchases to distribute cash, which can preserve the financial

flexibility embedded in repurchases.

Panel A of Table 4 reports the result based on complete and incomplete buyback

status without considering the actual repurchased shares. The clarification of buyback

status defined by the SDC is either complete or incomplete regardless of the actual

shares repurchase; thereby, we found that both firms with actual repurchased shares

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less than the announced shares and with more than announced shares are classified as

complete status, same finding for the incomplete status firms.

As shown in Panel A of Table 4, we further divide the group of

repurchase-dividends firms into two sub-groups based on their status of repurchase

program; that is whether the repurchase program is completed (complete repurchase

with dividend group) or is left incompleted (incomplete repurchase with dividend

firms). The Div, OI, and NOI of the complete repurchase with cash dividend group are

larger than that of the incomplete group, except the year prior to repurchase

announcement in which OI of the incomplete group is larger than that of the complete

group.

In order to specifically investigate the dividend policy and price performance of

those firms actually completed or actually left the repurchase program incomplete, we

take the actual repurchased shares into account along with the buyback status defined in

the SDC database. In addition, the consideration of actual shares buyback along with

buyback status enables us to distinguish the behavior of those firms categorized as

“complete” in the SDC, but may have large difference in their actual shares. Therefore,

we further defined subgroups from “complete” and “incomplete” as group 1 “CH” and

group 2 “IL”. The firms in group 1 have actual repurchased shares equal to or larger

than announced, while the firms in the later subgroup have actual buyback shares equal

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to zero or less than 1%. The empirical results for these two subgroups are reported in

Panel B of Table 4.

As shown in Panel A of Table 5, the firms that do not pay dividend in the year of

repurchase announcement and do not complete the repurchase program, on average,

have higher dividend payout ratios in the years prior to the repurchase announcement

than those firms with complete repurchase but without paying dividends in the

repurchase announcement year. Especially, for the complete group, their dividend

payout ratios are consistently close to zero prior to the repurchase announcement.

However, in the year right after the repurchase announcement, the complete group has a

significantly larger payout ratio as well as operating income (OI) than the incomplete

group. The significantly decreasing dividend ratios and OI of the incomplete group in

the first year after the repurchase announcement seem to suggest that the decreasing in

OI causes the firms to decrease their dividend payments and withdraw their repurchase

programs.

Panel B of Table 5 considers both actual shares repurchase and cash dividend

payment. We compare the characteristics between firms in group 1 (CH) and group 2

(IL) that paid cash dividends. Group 1 (CH) includes the firms with complete buyback

status and actually buyback shares equal to or more than the announced shares, while

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group 2 (IL) includes firms with incomplete buyback status and actually buyback

shares equal to zero or less than 1% of the announced shares.

For both with dividend and without dividend firms, the differences between the

“CH” and “IL” groups are even larger and significant than the case where actual

repurchased shares were not taken into account in the complete and incomplete groups.

In group 2, their dividend payments increased significantly after their repurchase

announcements but leaving the repurchase program incomplete or with actual

repurchased shares equal to 0 or less than 1%. For the same group, its operating income

(OI) significantly decreases after the buyback announcement year. For groups 3 and 4,

both groups do not pay dividends in the year they announced to buyback shares. Group

3 didn’t pay any dividends three-year prior to their stock repurchase announcement,

while group 4 paid a little prior to the buyback announcement. It seems that group 3 is

more inclined to the employment of financial flexibility embedded in stock repurchase

instead of applying long-term dividend payment commitments.

Table 6 reports the descriptive statistics of firm size and repurchase contents

including buyback shares and the percentage of targeted shares for both completed and

incompleted groups. The number of observations differs for each variable due to the

fact that some firms announced the number of shares they attempted to buyback, but not

the percentage of targeted repurchase shares. For example, there were 1045 firms in the

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incomplete group that announced shares to be repurchased using the open market

technique, of which 999 of them also announced the percentage of targeted shares.

Firms in the incomplete group announced more shares (3.6 million) and a higher

percentage of outstanding shares (7.86%) that they attempted to buyback than those in

the completed group (3.4 million shares and 6.37%). In addition, compared to firms in

the completed group, the average firm size in the incomplete group is smaller in terms

of total assets. The mean value of assets for the incomplete group and completed group

are about $2.22 billion and $2.69 billion, respectively.

Comparing the stock returns for the complete and incomplete groups, Panel A of

Table 7 shows that both incomplete and complete groups underperformed prior to the

repurchase announcement, and both groups outperformed after stock repurchase in the

period of one, two, and three years after the announcement. In addition, the degrees of

underperformance prior to repurchase announcement and outperformance after the

repurchase announcement are larger and more significant in the incomplete group than

in the complete group. Panel A of Table 7 also shows the mean of abnormal returns and

their corresponding t-values for the entire sample, incomplete, and complete groups.

In order to specifically distinguish the stock price behavior in the complete

buyback status, we further examine the two subgroups, group1 (CH) and group3 (CM).

Likewise, we examine two subgroups from the group with incomplete buyback status,

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group 2 (IL) and (IM). The stock price behavior before and after the buyback

announcement and actual buyback activity are the focus of this study.

As shown in Panel B of Table 7, the post-stock price for group 1 (CH)

underperforms, while group 3 (CM) outperforms. On the other hand, regardless of the

actual buyback shares, the two subgroups with incomplete buyback status outperform

the market one-year after the stock repurchase announcement.

Panel A of Table 8 reports the results of regression analyses of post-stock

repurchase returns on the buyback status. In addition, the results from the consideration

of the actual repurchased shares along with the buyback status are shown in Panel B of

Table 8. Panel A of Table 8 indicates that a firm with complete buyback status has a

significant post-announcement stock return. However, when both buyback status and

the actual buyback shares are taken into account, all four groups, CH, IL, CM, and IM,

exhibit positive and significant post-stock returns, it suggests that the post-stock

buyback announcement returns are all higher no matter the firms’ actual repurchases or

buyback status. Nevertheless, as the variable of cross-product of the ratio of the actual

shares buyback to the shares the firms announced to buyback (AI) and the buyback

status along with actual buyback shares larger than the announced ones.

The statistical tests and the signs of the variables of repurchase status and the

percent of shares that firms announced to buyback as reported in Table 8 indicating that

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if the firm leaving the repurchase incomplete, its post-announcement CAR is positive.

If a firm announces to buyback more shares, its CAR is higher, though the repurchase is

incomplete. Moreover, the empirical result suggests that a larger firm is more likely to

have a smaller post-announcement CAR and the firm with a higher pre-CAR will also

has a higher post-announcement CAR. The result of Table 8 indicates that the actual

share repurchases along with the buyback status do not outperform the market.

We further investigate the financial performance in terms of return of assets

(ROA) of firms announced stock repurchases. Table 9 reveals that both mean and

median of complete and incomplete repurchase groups experienced increasing ROA

from two-year before to one-year before the buyback announcement, then both groups

experienced persistently declining ROA from the year to two-year after the

announcement of buyback. However, the mean ROA and median ROA of the complete

group are significantly higher than those of the incomplete group from two-year before

to two-year after the buyback announcement. This evidence is inconsistent with the

information hypothesis.

The logistic model examines the attributes of the probability for leaving

repurchase program incomplete. The empirical result of Table 10 shows that the

probability of an incomplete repurchase is significantly higher if the greater percentage

of outstanding shares that the manager attempts to buyback in the repurchase

26

announcement. The loose regulation of stock repurchases in the U.S. market in terms of

the disclosure of funding sources of the buyback program, we show that firms do not

report their funding sources tend to have a higher probability of leaving repurchase

programs incomplete. This evidence is consistent with the funding transparency

hypothesis. The debt to equity ratio (D/E), firm size, operating cash flow (OCF), cash

dividend payout and dividend increase, and changes ROA are all insignificant in

determining the probability of incomplete repurchase.9

6. Conclusions

A large body of academic literature has examined the extent to information

signaling hypothesis, (Bartov, 1991; Jagannathan and Stephens, 2003; Grullon and

Michaely, 2004), which suggests that stock repurchase conveys information of stock

undervaluation. Kahle (2003) argues that when a buyback isn’t a buy back, the

incentive of stock repurchase can be attributed to the existence of employee and

executive stock options. Moreover, the credibility of such signal has been raised by

several studies such as The Wall Street Journal and Fortune. Integrating the issues of

underperformance prior to repurchase, price runnups in the post-repurchase periods,

cash dividend certification, and the determinants of abnormal returns and incomplete

9 When we exclude ROA and the change of ROA or add non-operating income, the result remains

robust.

27

buyback program, this paper offers some new evidence related to the behavior of

repurchase commitments. Using open-market share repurchases data during the period

1995-2000 and separating the sample into firms with completed or incomplete

repurchase programs, we find that the firm with a greater percentage of outstanding

shares that the firm attempts to buyback, and without disclosing the funding sources in

the repurchase announcement tends to have a higher probability leaving the stock

repurchase program incomplete. The above findings have important implications for

investors and regulators. In sum, we conclude that prior to stock repurchase

announcements, these firms tend to underperform the market. Information signaling

from cash dividend initiation certifies the commitment of stock repurchase program.

28

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32

Table 1

Panel A: Frequency Distribution of the Completion of Open Market Stock Repurchase. A completed repurchase program is defined as all of the shares that the board wants to repurchase under the authorization have been repurchased, while the incomplete repurchase program include the possibility of extension, pending, suspended, and terminated programs.

Programs

Completed buyback Incomplete buyback Total

Frequency Percent Frequency Percent 1995 75 44.4% 94 55.6% 169

1996 128 53.8% 110 46.2% 238

1997 124 46.4% 143 53.6% 267

1998 136 31.0% 303 69.0% 439

1999 83 29.1% 202 70.9% 285

2000 53 21.4% 195 78.6% 248

33

Table 1

Panel B: Descriptive Statistics of Firm Characteristics

Total assets (TA) are measured in millions of dollars. market value (MV), and book value (BV) are obtained at the end of the fiscal year of the repurchase announcement, or fiscal year 0. Debt ratio (DR) is the ratio of long-term debt at fiscal year 0 to total assets at fiscal year -1. Operating income (OI) is the average ratio of operating income to total assets measured over the four-year period from fiscal year -3 through 0. Non-operating income (NOI) is the average ratio of non-operating income to total assets measured over the four-year period from fiscal year -3 through 0. Each year’s (non-) operating income is deflated by its corresponding prior year’s assets.

Total

Assets MV/BV DR OI NOI

Mean 2507.15 2.67 0.19 0.191 0.0134 Median 295.04 1.91 0.13 0.192 0.0074 Std. Dev. 11078.84 4.58 0.23 0.158 0.1697 N 1641 1635 1633 867 869

34

Table 2

The four-year average ratio (year-3 to year0) and average annual dividend payout ratio (Div), operating income (OI), and non-operating income (NOI) scaled by total assets

from year-2 to year+2 surrounding the repurchase announcement year (year 0). (Total 5262 time series and cross-sectional observations from year-3 to year0)

Year (-3,0) -2 -1 0 1 2

Div 11.39%a 11.33%a 11.12%a 10.96%a 11.02%a 10.82%a OI 19.08%a 18.99%a 19.94%a 17.69%a 16.69%a 15.14%a NOI 1.34%a 1.32%a 1.33%a 1.24%a 1.24%a 1.21%a

Note: a denotes statistical significance at the 1% level, using t-test for the mean. Firms are included in the sample only if the dividend payout ratio is between 0 and 1.

35

Table 3 For groups paying dividends and not paying dividends at the year of share repurchase

announcement, the average four-year ratios (year-3 to year0) and average annual dividend payout ratio (Div), operating income (OI), and non-operating income (NOI) scaled by total assets from year-2 to year+2 surrounding the repurchase announcement

year (year 0). (1944 and 3294 time series and cross-sectional observations for dividend paying firms

and non-dividend firms, respectively.)

Year (-3,0) -2 -1 0 1 2 Dividend paying firms Div 30.39%a 30.36%a 29.87%a 29.66%a 29.64%a 28.99%a

OI 21.59%a 21.59%a 22.03%a 21.28%a 20.57%a 19.67%a

NOI 0.89%a 0.88%a 0.91%a 0.92%a 0.89%a 0.86%a Non-dividend paying firms Div 0.25% 0.19% 0.14% 0 0.12% 0.17% OI 17.59%a 17.46%a 18.71%a 15.58%a 14.40%a 12.48%a

NOI 1.60%a 1.58%a 1.57%a 1.43%a 1.44%a 1.42%a

Note: a denotes statistical significance at the 1% level, using t-test for the mean.

The mean values of OI and NOI are significantly different from 0 at the 1% level in each time

period and for the two groups. Mean value of dividend payout ratio is significantly different

from 0 in each time period for the group of paying dividends, but insignificantly from 0 for the

group not paying dividends at the year of repurchase announcement.

36

Table 4

The sample of stock repurchase with dividend firms are divided into two subgroups: complete repurchase group and incomplete repurchase group (852 and 1092 time series and cross-sectional observations of dividend paying firms with complete buyback programs and dividend paying firms with incomplete buyback programs, respectively.) Panel A reports the results for the complete and incomplete groups without considering the actual repurchased shares. Panel B considers the actual repurchased shares and defines “CH” and “IL” subgroups as the firms with complete buyback status actually buyback shares equal to or more than the announced, and the firms with incomplete buyback status actually buyback shares equal to zero or less than 1% of the announced, respectively.

Panel A Year (-3,0) -2 -1 0 1 2 Dividends paying firms with complete buyback programs

Div 30.69%a 31.47%a 30.15%a 30.87%a 29.63%a 29.56%a

OI 21.91%a 22.30%a 21.91%a 21.59%a 20.91%a 20.28%a

NOI 0.97%a 0.97%a 1.02%a 0.95%a 0.95%a 0.86%a Dividends paying firms with incomplete buyback programs

Div 30.15%a 29.50%a 29.66%a 28.71%a 29.64%a 28.54%a

OI 21.34%a 21.04%a 22.13%a 21.03%a 20.31%a 19.19%a

NOI 0.83%a 0.80%a 0.83%a 0.89%a 0.84%a 0.86%a

Note: “a” denotes statistic significance at the 1% level

Panel B Year (-3,0) -2 -1 0 1 2

Dividends paying firms of group 1 (CH)

Div 29.13% 29.50% 27.27% 29.94% 28.89% 29.77% OI 20.83% 20.48% 20.92% 21.54% 21.11% 19.99% NOI 2.03% 2.00% 2.16% 1.97% 2.09% 1.91%

Dividends paying firms of group 3 (IL)

Div 34.74% 33.35% 34.47% 32.77% 37.83% 35.64% OI 21.51% 21.29% 21.58% 20.95% 17.32% 15.46% NOI 0.74% 0.72% 0.70% 0.82% 0.71% 0.96%

37

Table 5 The sample of stock repurchase with dividend firms are divided into two subgroups: complete repurchase group and incomplete repurchase group (1272 and 1998 firm-year time series and cross-sectional observations for non-dividend paying firms with complete buyback programs and non-dividend paying firms with incomplete buyback programs, respectively).

Panel A Year (-3,0) -2 -1 0 1 2 Non-dividend paying firms with complete repurchase programs

Div 0.18% 0.09% 0.08% 0.00% 0.26% 0.16% OI 18.09%a 18.64%a 18.22%a 16.25%a 16.38%a 14.82%a

NOI 1.60%a 1.53%a 1.51%a 1.46%a 1.45%a 1.29%a Non-dividend paying firms with incomplete repurchase programs

Div 0.30% 0.25% 0.17% 0.00% 0.03% 0.18% OI 17.27%a 16.71%a 19.03%a 15.15%a 13.16%a 11.00%a

NOI 1.60%a 1.60%a 1.60%a 1.40%a 1.44%a 1.50%a

38

Table 5 Panel B

Year (-3,0) -2 -1 0 1 2 Non-dividend paying firms with complete repurchase programs (NonDiv & Done)

Div 0.00% 0.00% 0.00% 0.00% 0.06% 0.05% OI 19.03% 21.73% 19.31% 17.02% 16.82% 15.50% NOI 1.21% 1.12% 1.31% 1.07% 0.84% 0.77% Non-dividend paying firms with incomplete repurchase programs (NonDiv & Yet)

Div 0.37% 0.19% 0.00% 0.00% 0.10% 0.30% OI 12.83% 11.32% 17.34% 14.88% 11.68% 11.48% NOI 1.29% 0.90% 1.52% 1.03% 1.09% 0.98%

39

Table 6

Samples of Completed and Incomplete Repurchase Programs

Descriptive Statistics of Repurchased Shares and the Percentage of Targeted Buyback Shares represent the announced shares to be repurchased; Percent is the announced buyback shares as a percent of the firm’s outstanding shares at the time of the repurchase announcement. The difference between the observations of firms announced repurchased shares and the intended percent of buyback shares is due to the fact that some firms only announced the number of buyback shares and not the percentage. Total assets are measured in million dollars, and are obtained at the end of the fiscal year of the repurchase announcement. (Number of observations: 599 complete repurchases and 1045 incomplete repurchases)

Group Shares Percent Total assets

Mean Complete 3400386 6.37 2694.86 Incomplete 3584094 7.86 2222.50

Standard Deviation Shares Percent Total assets Complete 6854995 5.32 10973.93

Incomplete 8093569 6.52 11093.14

40

Table 7

Cumulative Abnormal Returns (CARs) .

Panel A The CARs and their respective t-statistic of whole sample, complete group and

incomplete group, which do not take actual share repurchases in account. Whole Sample Complete Group Incomplete Group

Event Period MCAR t-statistic MCAR t-statistic MCAR t-statistic (-250,-3) -10.56%a -13.95 -7.66% a -6.12 -12.25% a -12.92 (-43,-3) -8.34% a -21.70 -5.95% a -7.53 -9.74% a -13.48 (-250,1) -11.25% a -14.24 -8.24% a -6.30 -13.00% a -13.16 (-30,-1) -7.33% a -14.31 -5.17% a -7.02 -8.58% a -12.54 (-1,1) 2.87% a 9.51 3.17% a 7.20 2.70% a 10.64 ( 0,1) 3.29% a 9.72 3.45% a 6.52 3.19% a 7.32 (-1,30) 4.87% a 12.71 4.97% a 6.00 4.81% a 7.38 (-1,250) 11.47% a 8.09 7.63% a 3.78 13.72% a 7.19 (1,250) 9.09% a 5.30 3.51% 1.39 12.47% a 5.46 (1,500) 12.35% a 5.18 9.45% b 2.54 14.19% a 4.58 (1,750) 14.55% a 5.21 7.95% c 1.78 18.72% a 5.25

Note: a, b, and c denote statistic significance at the 1%, 5%, and 10% level

41

Table 7 Panel B

The CARs for the whole, complete, and incomplete groups taking the actual repurchased shares into account

The group with complete buyback status is categorized into two subgroups: group 1 (CH) as the one with complete buyback status and actual repurchased shares equal to or more the announced repurchases; group 3 (CM) as the group with complete buyback status, but with actual repurchased shares larger than 1% and less than 100% of the announced repurchases. The group with incomplete buyback status is categorized into two subgroups: group 2 (IL) as the one with incomplete buyback status and the actual repurchased shares equal to zero or less than 1% of the announced shares, and group 4 (IM) as the group with incomplete buyback status with actual buyback shares larger than 1% but less than 100% of the announced repurchases.

Whole Sample Complete Group Incomplete Group CH (group1) CM (group3) IL (group2) IM (group4) Event

Period MCAR

MCAR MCAR MCAR MCAR

(-250,-3) -10.56%*** -8.95%*** -7.40%*** -10.36%*** -12.83%***

t-statistic -13.95 -3.58 -4.81 -3.99 -11.57

(-43,-3) -8.34%*** -6.13%*** -6.23%*** -9.13%*** -9.86%***t-statistic -21.7 -3.43 -7.07 -4.00 -12.30

(-250,1) -11.25%*** -9.61%*** -8.12%*** -11.79%*** -13.35%***t-statistic -14.24 -3.67 -5.10 -3.92 -11.74

(-30,-1) -7.33%*** -4.82%*** -5.58%*** -9.18%*** -8.40%***t-statistic -14.31 -3.13 -6.64 -4.29 -10.82

(-1,1) 2.87%*** 1.45%* 2.85%*** 3.43%** 2.49%***t-statistic 9.51 1.79 6.51 2.40 6.35

( 0,1) 3.29%*** 2.02%*** 3.22%*** 3.98%*** 2.89%***t-statistic 9.72 3.09 8.15 4.02 8.58

(-1,30) 4.87%*** 1.85% 5.35%*** 8.35%*** 4.36%***t-statistic 12.71 1.45 6.31 3.99 5.91

(-1,250) 11.47%*** -7.13%* 11.55%*** 11.10%* 14.48%***t-statistic 8.09 -1.73 5.06 1.88 6.63

(1,250) 9.09%*** -7.02%* 11.95%*** 13.09%** 14.42%***t-statistic 5.3 -1.69 5.30 2.29 6.71

Note: ***, **, and * denote statistical significance at the 1%, 5%, and 10% level

42

Table 8 Panel A

Regression Analysis of Post-Stock Repurchase CARs on Buyback Status PostCAR (-1,250) = a0 + b1PreCAR (-250,-1) +b2Status + b3 Size +b4PS + ε

PostCAR (-1,250) = the CAR in the period of (t-1, t+250) when the stock repurchase announcement was made at time t=0; PreCAR (-250,-1) = the CAR in the period of (t-250, t-1) when the stock repurchase announcement was made at time t; Status is a dummy variable indicating the buyback status, where Status = 1 if the repurchase is completed, otherwise Status = 0. Size = log (total assets) and PS = Percent of shares that a firm intends to repurchase when the announcement is made. (Observations = 1496)

Variable Coefficient Standard

Deviation t-statistic

Intercept 0.464*** 0.057 8.16 PreCAR 0.575*** 0.050 11.58 Status -0.080** 0.032 -2.47 Size -0.049*** 0.008 -6.06 PS 0.007*** 0.003 2.64

F = 43.49 (p < 0.001)

Adjusted R-Square = 0.102

Note: *** and ** denote statistical significance at the 1% and 5% level

43

Table 8 Panel B

Regression Analysis of Post-Stock Repurchase CARs on Buyback Status along with Actual Buyback Shares

Model 1: PostCAR (-1,250) = b1PreCAR (-250,-1) +b2 Size +b3PS + b4 AI + b5CH +b6 IL +b7 CM +b8 IM + ε Model 2: PostCAR (-1,250) = b1PreCAR (-250,-1) +b2 Size +b3PS + b4 AI + b5CH +b6 IL +b7 CM +b8 IM +b9AI*CH + b10AI*IL +b11AI*CM

+ ε PostCAR (-1,250) = the CAR in the period of (t-1, t+250) when stock repurchase announcement was made at day t=0; PreCAR (-250,-1) = the CAR in the period of (day-250, day-1) when stock repurchase announcement was made at day t=0; Size = log (total assets), PS = The percentage of shares that a firm announced to repurchase, AI = the ratio of the actual repurchased shares relative to the announced shares to buyback. CH = 1, if buyback status is complete and the actual repurchased shares are equal to or more than what they announced. IL = 1 if buyback status is incomplete and the actual repurchased shares are equal to zero or less than 1% of the number of shares they announced to buyback. CM = 1 if buyback status is complete and the actual repurchased shares are larger than 1% but less than 100% of the number of shares they announced to buyback. IM = 1 if buyback status is incomplete and the actual buyback shares are larger than 1% but less than 100% of the number of shares they announced to buyback. In Model 2, the cross-product terms, AI*CH, AI*IL, and AI*CM are used to examine the effects of “the ratio of the actual repurchased shares to the shares the firms announced to buyback” and the “buyback status along with the actual repurchased shares compared to announced repurchases”. Specifically, AI*CH = the product of AI and CH ; AI*IL = the product of AI and IL; AI*CM = the product of AI and CM.

44

Model 1 Model 2

Variable Coefficient t Statistic Variable Coefficient t Statistic

PreCAR 0.489*** 9.49 PreCAR 0.486*** 9.42

Size -0.043*** -5.06 Size -0.045*** -5.2

PS 0.006** 2.11 PS 0.006** 2.11

AI -0.012 -1.03 AI -0.006 -0.47

CH 0.232** 2.95 CH 0.356*** 3.42

IL 0.380*** 5.29 IL 0.386*** 5.34

CM 0.399*** 6.16 CM 0.366*** 4.84

IM 0.441*** 7.04 IM 0.444*** 7.08

AI*CH -0.064* -1.75

AI*IL 2.302 0.04

AI*CM 0.091 0.95

R-Square 0.1318 R-Square 0.1346

Adj R-Sq 0.1263 Adj R-Sq 0.1271

N 1279 N 1279

F-Value 24.11*** 17.93***

***, **, and * denote statistical significance at the 1%, 5%, and 10% level, respectively.

45

Table 9

Comparison of ROA between the Complete and Incomplete Repurchase Group

Firms are categorized in the completed group if they announced the stock repurchase and completed the intended buyback shares. Firms are in incomplete group, if they announced stock repurchase, but left the program incomplete.

(i) ∆ ROAGroup = ROA (Complete) – ROA (Incomplete) (ii) % ∆ in ROA = [ROA(t+i) – ROA(t+i-1)]/ROA(t+i-1), i = -1, 0, 1, 2. *** denotes statistical significance at the 1% level, using one sided t-test for the mean

and Wilcoxon signed rank tests for the median.

Median Mean

Group (t-2) (t-1) t0 t+1 t+2 (t-2) (t-1) t0 t+1 t+2

Complete ROA 0.0871 0.0949 0.0880 0.0727 0.0660 0.1025 0.1130 0.0923 0.0826 0.0694

% ∆ in ROA(ii) 8.96% -7.27% -17.39% -9.22% 10.24% -18.32% -10.51% -15.98%InComplete ROA 0.0806 0.0827 0.0680 0.0501 0.0396 0.0968 0.0606 0.0664 0.0416 0.0351

%∆ in ROA 2.61% -17.78% -26.32% -20.96% -37.40% 9.57% -37.35% -15.63%∆ ROAGroup

(i) 0.65%*** 1.22%*** 2.00%*** 2.26%*** 2.64%*** 0.57% 5.24%*** 2.59%*** 4.10%*** 3.43%***

46

Table 10 Analysis of logistic model

Logistic regression model: Logit (p) = log (p

p−1

) = α + ×′β x, where p is the

probability of leaving a repurchase program incomplete and defined as Pr (Y = 1 | x ), Y =1 if the repurchase program is incomplete, and Y = 0 if the repurchase program is completed; x is a vector of explanatory variables, x = [the percentage of shares a firm announced to buyback (PS), the disclosure of funding source (Funding=1 if the firm does not disclosure the funding source, otherwise Funding=0)，firm size (lnTA), Div=1, if the firm paid cash dividends in the year of announcing repurchase, otherwise Div=0, the average dividend payout ratio of the firm over the past three years before the repurchase announcement (DivAvgt3t0), operating cash flows (OCF) of the firm one year prior to the repurchase announcement, the average operating income of the firm over the past three years before the repurchase announcement (OIAvg3t0), the ratio of total liabilities to shareholders’ equities (DE), the change of return on assets between time t0 and t1 (∆ROA(t-1)), the change of return on assets between time t0 and t2 (∆ROA(t-2)), α is the intercept parameter, and β is the vector of slope parameters, i.e. β = [ β1, β2, β3, …, β9, β10]. The probability of a repurchase program left to be incomplete can be

represented by p = xβ'

xβ

e1e+

′

.

Variables Parameters Estimate Chi-Square α 0.137 0.14 PS 0.060*** 11.34 Funding 0.328 ** 3.80 lnTA(t-1) -0.072 1.91

Div -0.222 0.65 DivAvgt3t0 0.819 1.17

OCF(t-1) 0.190 0.05 OIAvgt3to 0.013 0.99 DE(t-1) 0.006 0.91 ∆ROA(t-1) -1.087 2.39 ∆ROA(t-2) -0.292 0.42

Note: ***, **, and * denote statistical significance at the 1%, 5%, and 1% level, respectively.