A Study of Motives and Effects of Stock Repurchasement Programs
This survey concerns motives of making a stock repurchasement and the possible consequences of such a financial strategy. The survey is focusing on the Swedish market because of the proposed deregulation of stock repurchasement programs. We have examined what motives may drive Swedish companies’ in pursuing a stock repurchase and what consequences this program may cause as viewed from a company and a market perspective.
The sample of the survey consists of ten Swedish multinational companies within various industries and five Swedish investment banks. These were asked to answer a questionnaire dealing with both the listing of motives as well as a prediction of the positive and negative consequences of a stock repurchasement.
The survey consists of an investigation and a survey of earlier research within the problem area. Most of the research concerning stock repurchases has been accomplished in the American market, therefore the survey will be based on these results.
The five primary motives listed by the Swedish companies participating in the survey are the following: to transfer wealth from bondholders to stockholders; to change the firm’s capital structure; to inform the market about the firm’s future prospects; to defer taxes for shareholders; and to reduce the level of future required dividends. Respondents were aware of both the advantages and the risks associated with stock repurchases, but to sum up the analysis; Swedish industry is in favour of a deregulation and believe this strategy to be primarily of advantage for stockholders, corporations, and the market.
The repurchase of outstanding shares by corporations is a common occurrence in the United States. It had its break-through in the end of the 1970's and has since become a popular financial strategy due to its diversity of opportunities. The reported frequency and amounts of shares repurchased have increased successively but had its peak after the October 1987 stock market crash which resulted in an abnormal increase of stock repurchase announcements. During the six weeks following the crash, more than 900 companies announced repurchase plans accounting for nearly 1.3 billion shares and exceeded the announcements for any previous year according to the Institutional Investor (1988).
We became interested in this problem area after observing the same phenomenon occurring in the financial market during the last stock market crash in October 1997.
Another reason for finding stock repurchasement programs an interesting issue is the proceeding of the deregulation of these phenomena in the Swedish market.
At present Swedish companies are only allowed to repurchase their own stocks during
special circumstances: when a company acquires a firm with the acquiring company's stocks included in the business; when power is abused by a shareholder; when the shares have been distrained for the company's debts
However, according to the second EU directive stock repurchasements are allowed in those cases when the corporation uses the equity and when the total amounts of shares do not exceed 10 %, this is stated in Balans (1996). Although, as clarified in the Swedish Public Official Report (1997), the rule of stock repurchasement in Europe differs for each country. However no legislation in Europe can be compared to the American one. In the United States companies can choose to pursue stock repurchasement programs freely. We believe that the United States serves as a model for the European Union in many ways, including how the financial market works. This fact and the increasing need of global harmonisation of accounting rules are arguments for a deregulation of stock repurchasements in Europe.
Therefore we have chosen to make a survey concerning the Swedish companies' view of a deregulation of stock repurchasement programs and what motives would direct them in following such a strategy.
Frame of reference
The following studies of stock repurchasement have served as a base for our problem formulation and implementation of research.
A study conjectured by Tsetsekos, Kaufman, and Gitman (1993) examines the primary motives of American companies for conducting a stock repurchasement program. The results show that the primary circumstance when a company decides to repurchase its own stock is when the stock price is low. The primary motives behind a stock repurchase are; changing the firm's capital structure, increasing the stock price, and signalling to the market.
In order to evaluate motives for stock repurchase programs we have found it necessary to examine the effects of such a program. Most studies concerning effects of stock repurchases have been limited to the American market. Bartow (1991) investigated the coherence of stock repurchasements and the actual earnings and risk changes of the companies in question. In his article he presented findings indicating that: there are positive unexpected annual earnings in the repurchase announcement year; and analysts tend to revise the earnings forecasts positively around announcement dates; and finally that repurchase announcements are followed by declines in the repurchasing firms' common-stock risk, .
In a survey made by Vermaelen (1981) it is examined if an argument could be made for increased regulation of stock repurchases on the wealth of the different classes of stockholders. Vermaelen investigates the different reasons for making a repurchasement and the effects of these. The primary motives being examined are; information and signalling hypothesis, dividend and personal taxation hypothesis, and leverage hypothesis.
Scope and purpose
Our purpose with the survey is to investigate the general motives behind a stock
repurchasement and the effects of such a program.
We will also make an empirical investigation concerning the primary motives
given by the Swedish companies in pursuing this financial strategy. The empirical
effects of stock repurchasement programs will be analysed and compared to
consequences predicted by Swedish companies. Thereby we will analyse how this
financial strategy may affect the Swedish market in the long-run.
Our survey consists of a descriptive part and an empirical part. In the descriptive part we list the motives for stock repurchasement programs and the consequences of this financial strategy. The information in the survey is mainly based on results from the American market.
In the empirical part we present an investigation concerning the primary motives of the Swedish companies in pursuing stock repurchasement programs and the effects predicted by them. The empirical information is based on questionnaires answered by ten Swedish companies listed on the Stockholm Stock Exchange and by four of the major investment banks situated in Stockholm.
In the analysis, our purpose is to link the five primary motives selected by Swedish companies to the effects found in earlier research concerning these motives. Additionally, we compare the effects from previous surveys with the effects predicted by the industry in order to forecast the effects of stock repurchasement.
Stock repurchasement program is an occuring phenomena therefore we have chosen to approach the subject by reviewing documented reports within the problem area. However the earlier research is not sufficient enough to examine our view of the problem. Due to the fact that our survey needs complementary information
Results of Survey
The general conclusions from our empirical survey is listed below. We are presenting the motives found in the investigation concerning Swedish companies’ view of stock repurchasement strategies. They are listed according to their grade of importance.
* Motives not stated in the questionnaire but given in order of preference by the respondents.
Outline of Paper
The outline of the paper is the following. In the descriptive part we will list the motives and consequences of stock repurchasement programs .We will thereafter present an investigation based on interviews with the Swedish companies pursuing stock repurchasement programs. In the analysis we will link our Swedish investigaton to our theoretical survey and thereby forecast possible effects of a stock repurchasement program in Sweden.
. The information in the survey is mainly based on results from the American market. We have also added information found in the Swedish Public Official Report (1997) which deals with the proposed deregulation of stock repurchasement.
The empirical information will be based on questionnaires answered by ten Swedish companies listed on the Stockholm Stock Exchange and by four of the major investment banks situated in Stockholm.
In the analysis, our purpose is to link the five primary motives selected by Swedish companies to the effects found in earlier research concerning these motives. Additionally, we will compare the effects from previous surveys with the effects predicted by the industry in order to forecast the effects of stock repurchasement.
The companies participating in our survey were chosen with regard to their: listing on the Stockholm Stock Exchange, size, business area, and international exposure. To be listed on the Stockholm Stock Exchange makes it possible for the companies to announce an open market stock repurchase. The majority of research being completed is focusing on stock repurchases made in the open market. Companies listed on the Stockholm Stock Exchange obtain the requirement of a large turnover ratio and thereby the risk of having too large sums of excess cash increase. We have chosen companies with an international exposure since it is highly relevant for these to be able to attract capital under the same conditions as other international companies. The Swedish companies chosen are: Astra, Ericsson, Volvo, Skanska, Sandvik, Skandia, SCA, Handelsbanken, Atlas Copco, and ABB. The investment banks chosen are: Hagströmer & Qviberg, Investor, Carnegie, and Swedbank.
Our investigation is related to information gathered by a questionnaire sent out to the companies and investment banks listed above. The questions in the questionnaire are based on our survey on stock repurchasement programs.
According to the Swedish national law for securities, paragraph seven, it is generally forbidden for a company to buy back its own shares. Swedish companies are only allowed to repurchase their own stock in special cases, when a company acquires a firm with the acquiring company’s stocks included in the business, when power is abused by a shareholder, and when the shares have been distrained for the company's debts. If the company buys back its own stock it has to resell them within three years. These stocks cannot be stated as an asset in the balance sheet.
The EU directives do not forbid stock repurchasements as the Swedish legislation does. Instead the fourth directive gives the member states the possibility to decide whether it is legal or not to repurchase stock and also on how the repurchased shares should be treated in the balance sheet.
A proposition has been made by the Swedish Official Committee for limited
corporations (1997) to deregulate stock repurchasement. The proposition is in
accordance with the second EU directive for limited corporations. According to the
second directive, stock repurchasement can be made when the total amount of shares
do not exceed 10 percent. The decision to make a stock repurchasement should be
taken by the shareholders at the general meeting or by the the board of directors after
an approval from the owners of the corporation. The committee adds some
propositions to the second directive. For instance the proposition for making a stock
repurchasement has to be handed to the shareholders in advance. The decision must be
based on qualified voting and the shareholders should have preferential claim on the
repurchased shares. Another suggestion is to reformulate the directives for stock
exchange in order to reduce risk for stock price manipulation. The law of stock
repurchasement should be in accordance with legislation against insider trading.
To minimize the risk of a hostile takeover the committee proposes a possibility for
corporations facing such a threat to make tender offers to all or some of their
shareholders, or to make an open-market stock repurchasement.
The Swedish Committee of Shareholders have a great influence on the proposed
deregulation of stock repurchasement. According to Balans (1996) they are in favor
of the proposition but put a great emphasise on rules against inappropriate stock price
manipulation. Additionally they want to forbid the company to sell its own shares.
However, these are just recommendations of how to regulate stock repurchasement
programs, no actual propositions have been made by the Swedish Official Committee
for limited corporations. The proposition of a deregulation has been handed for
consideration to referral institutions and a decision will be taken during 1998..
Research on a Stock Repurchasement Program
Implementation of a Stock Repurchasement Program
Another form of distributing excess cash to stockholders is when the corporation
implements a stock repurchasement program. There are three principle ways of
making a repurchase according to Vermaelen (1981):
- Shares are repurchased in the open market. This form involves a gradual process of buying back small quantities of stock from day to day in the open market through a broker. The firm pays normal commission rates and the seller of the stock is not aware that he is selling to the corporation. It is not uncommon that repurchase plans take place over several years and the amounts repurchased are generally smaller than via tender offers.
- Shares are repurchased by a general tender offer either to all shareholders or only to small shareholders. The corporation usually engages an investment banker to manage the tender and pays a special commission to brokers who persuades shareholders to accept the offer. In a tender offer, the company usually specifies the number of shares it is offering to purchase, the tender offer price i.e. the premium at which it will repurchase shares, and the period of time during which the offer is in effect.
- Shares are repurchased after direct negotiations with a major shareholder. The most common circumstance is when the target of a takeover attempt buys off the hostile bidder by repurchasing any shares that it has acquired i.e. greenmailing. This means that the shares are repurchased by the target at a price which makes the bidder happy to agree to leave the target alone. The agreed upon price does not always make the target's shareholders happy.
According to Dann (1981) the major differences between an open market stock
repurchasement and a tender offer are the following: with tender offer repurchases,
the announcement date, the actual day of repurchase, and the repurchase prices are
known, whereas with open market repurchases the repurchase dates and repurchase
prices are infrequently reported. Tender offer repurchases are substantially larger than
open market repurchases, the effects are likely to be more pronounced and therefore
more readily observable in a tender offer. The extent of public disclosure of the terms
of repurchase is significantly greater for tender offers than for open market buy-backs,
which provides greater assurance that the full impact of the repurchase will be
observed at the announcement date.
Concerning the treatment of the shares repurchased these are seldom deregistered and
cancelled, instead they are kept in the company's treasury and then resold when the
company needs money. In these cases shareholders are not obliged to authorize the
resales of stocks. The shareholders do not have pre-emptive rights on such stocks.
Implementation of Redemption of Shares
The following part describes redemption of shares which is closely linked to stock repurchasement programs and where the option lies in whether the shares will be canceled or not. According to Ratos (1997) Swedish companies’ are allowed to issue share redemption rights after an approval from the district court and the shareholders.
To clarify share redemption we will use an example based on the following
assumptions. The example involves a shareholding of 100 shares during a redemption procedure in which the holder elects either to sell the redemption rights or redeem 10 shares with 100 share redemption rights. Net worth is SEK 100/share and the share price is SEK 80/share throughout the period. Accordingly, the net-worth discount amounts to SEK 20/share.
As dividend payment is an alternative strategy to stock repurchasement, we will present theories concerning market reactions to different dividend policies.
The dividend policy of a corporation is of importance since it determines what funds flow to investors and what funds are retained by the firm for reinvestment.
Except from being an important strategic decision the dividend policy also involves market signalling. Dividend policy provides information to the stockholder about the corporation's performance. A higher dividend one year may indicate a better future of the corporation according to Ross, Westerfield and Jaffe (1990).
Increasing dividends increases equity value for three reasons: there is some wealth
expropriation from bondholders by stockholders; increasing dividends operate as a
positive signal about future cash-flows to financial markets; and there are investors
who like receiving dividends. The counter argument is that dividends reduce value for
two reasons: they create a tax disadvantage for investors; and to receive them they can
cause cash shortfalls for investment projects that are expensive to overcome, as stated
by Damodaran (1994).
Ross et al. (1990) concludes that any sensible treatment of dividend policy will be twofold. On the one hand there are many good reasons for corporations to pay high dividends, but on the other hand there are many good reasons to pay low dividends.
An argument stated by Miller and Modigliani (1965) concerning dividend policy, is