Two of the most prominent trends in corporate finance in the U.S. during the past 15 years are the growing popularity of share repurchases and the decreasing popularity of dividends. Repurchasing stocks is another way for managers to distribute money to shareholders, thus it plays an equivalent role as dividend payments.
Consistent with Grullon and Michaely (2002) U.S. corporations distribute cash by rather repurchasing stock than by paying dividends to shareholders. Fama and French (2001) argue in the same direction. Their study provides evidence that the proportion of corporations paying cash dividends fell from 66.5% in 1978 to 20.8% in 1999. According to Grullon’s (2000) findings the total of share repurchases exceeded the total of dividend payment for industrial firms in 1998.
In Germany share repurchases were highly restricted until 1998. As a consequence the volume of repurchases was small. The popularity of repurchases in the U.S. and in other countries was a strong argument for lifting the restrictions. These days, German companies announce buybacks regularly.
Although capital markets in the USA and Germany are efficient the impact of stock repurchase programs differ, resulting in higher stock performance after buyback announcements in Germany than in the USA.
Table of Contents
1. Introduction
2. Value Creation and Reduction of the Number of Shares
3. Economic Motivation for Stock Repurchase
3.1. Excess Capital Hypothesis
3.2. Undervaluation Hypothesis
3.3. Optimal Leverage Ratio Hypothesis
3.4. Management Incentive Hypothesis
3.5. Takeover Deterrence Hypothesis
4. Abnormal Returns around Stock Repurchase
4.1. Germany’s institutional setting
4.2. Abnormal Returns in the U.S. and Germany
5. Summary and Conclusion
Research Objectives and Themes
This paper examines the growing trend of share repurchases in the United States and Germany, analyzing the economic motivations behind these corporate decisions and comparing the resulting abnormal stock returns within the context of their respective institutional settings.
- Mechanisms of value creation through share count reduction
- Economic hypotheses driving corporate buyback decisions
- Comparison of institutional legal frameworks between the U.S. and Germany
- Empirical analysis of abnormal returns following repurchase announcements
- Impact of information asymmetry on market efficiency
Excerpt from the Book
3.1. Excess Capital Hypothesis
Agency conflicts can occur in cases of excess of free cash flow. Managers have to decide how to use excess cash. They can either invest it in negative net present value investments and thereby harm the owners of the firm or distribute the excess cash among the shareholders (Jensen 1986). According to Jensen (1986) stock repurchase is like dividend payment another way of distributing excess cash among shareholders. Although share repurchase announcements might indicate a poor set of investment opportunities, they offer the management an alternative instrument to return excess cash to shareholders and thereby to reduce principal-agent conflicts.
Results by Stephens and Weisbach (1998) support the hypothesis that companies will use free cash flow to repurchase stock instead of investing in low-return projects. Their study shows a positive correlation between stock repurchases and the level of cash flows.
From the excess cash point of view, corporations prefer stock repurchases to dividend payment mainly for two reasons: In open market repurchases (prevalent in the USA) companies are not bound to repurchase stock. Shareholders don’t expect, other than with dividend payments, repurchases to occur on a regular basis. Therefore stock repurchase represents a flexible mean to distribute excess cash among the shareholders (Dittmar, 2000).
In addition to that stock repurchases are also favorable to dividend payment from a taxation point of view. Excess cash financed share buybacks are in line with shareholders’ interest in countries where dividend payment incur a higher tax burden on dominant shareholder groups than stock repurchase transactions which represent capital gains (Dittmar, 2000).
Summary of Chapters
1. Introduction: This chapter introduces the shift from dividends to share repurchases in the U.S. and the regulatory changes that allowed for similar trends in Germany.
2. Value Creation and Reduction of the Number of Shares: This section explores how buybacks mechanically increase earnings per share (EPS) and discusses the limitations of value creation under the Irrelevance Theorem.
3. Economic Motivation for Stock Repurchase: This chapter outlines five core hypotheses—excess capital, undervaluation, optimal leverage, management incentives, and takeover deterrence—that explain why firms engage in buybacks.
4. Abnormal Returns around Stock Repurchase: This chapter compares empirical evidence on stock performance in the U.S. and Germany, highlighting the impact of different legal frameworks on market reactions.
5. Summary and Conclusion: This chapter synthesizes the findings, confirming that while buybacks serve various motives, institutional differences significantly influence their impact on stock price.
Keywords
Share Repurchase, Stock Buyback, Abnormal Returns, EPS Calibration, Excess Capital Hypothesis, Undervaluation Hypothesis, Corporate Finance, Information Asymmetry, Market Efficiency, Germany, United States, Institutional Setting, Capital Structure, Dividend Payments, Principal-Agent Conflict
Frequently Asked Questions
What is the core focus of this paper?
The paper investigates the economic motivations behind corporate share repurchases and analyzes the resulting abnormal stock returns, with a specific comparative focus on the United States and Germany.
What are the central themes discussed in this study?
The study centers on value creation through share reduction, various economic hypotheses for buybacks (such as undervaluation and agency cost reduction), and the role of institutional frameworks in shaping market reactions.
What is the primary objective of this research?
The primary goal is to understand why firms engage in share repurchases and to demonstrate how legal and institutional differences between the U.S. and Germany affect the market's response to buyback announcements.
Which scientific methods are employed?
The paper uses an analytical review of empirical literature and existing studies on market performance to compare stock price reactions across different global jurisdictions.
What topics are covered in the main section of the paper?
The main sections cover the technical mechanics of EPS enhancement, detailed economic hypotheses for repurchases, and a comparative analysis of institutional settings, including legal requirements in Germany.
Which keywords best characterize this work?
Key terms include Share Repurchase, Abnormal Returns, Information Asymmetry, EPS Calibration, and Institutional Setting.
How does the German legal framework differ from the U.S. regarding buybacks?
Unlike the U.S., where buyback announcements are not binding contracts, Germany mandates a structured procedure, requiring shareholder assembly authorization and public disclosure of the repurchase timeframe.
Why are abnormal returns for German firms often higher than for U.S. firms?
Research suggests that differences in the legal system and the fact that German firms frequently provide a specific motivation for the repurchase lead to stronger positive signals and higher abnormal returns compared to the U.S.
- Arbeit zitieren
- Jan Heise (Autor:in), 2006, Stock repurchase and abnormal returns in den USA and Germany, München, GRIN Verlag, https://www.grin.com/document/84635
