Revisit to Stock Buyback in the Perspective of the Theory of the Firm

Abstract

In this research, we examine why firms buy back their own stocks by revisiting the extant studies. We hypothesize that: 1) Firms that make repurchase announcement will witness an increase in market value during the short announcement window; 2) Firms that make repurchases are relatively undervalued compared to non-repurchasing firms in the same industry; 3) Proportion of ownership by institutional investors for stock repurchase firms is greater than that for non-repurchasing firms in the same industry. Our findings support the first and the third hypothesis. We do not find that firms that repurchase their own stocks are undervalued compared to the non-repurchasing firms. However, further tests show that compared to the less undervalued subsample of the repurchasing firms, relatively more undervalued subsample of the repurchasing firms exhibit a more stable and consistent increase in market value, suggesting a difference in the growth pattern of the market value between these two subsample firms following the stock repurchases.