Free Cash Flow or Market Timing: What Really Drives Share Repurchases?
University of Southern California - Marshall School of Business - Finance and Business Economics Department
March 15, 2014
Although market timing is empirically important, free-cash-flow (FCF) considerations have much stronger effects on managers’ share repurchase decisions. Managers either do not systematically time the market or have poor timing ability as many firms fail to exploit good timing opportunities through repurchases. Firms’ decisions to buy back shares often tend to be poor in a market-timing sense as they are more likely to experience negative than positive abnormal stock returns after repurchases. Although the average post-repurchase abnormal returns are positive, this finding is driven by the extreme abnormal stock returns following a modest number of repurchases that are small in dollar magnitude and that account for a small percentage of the aggregate dollar value repurchased. On the other hand, I find that variation in FCF induces a large change in the repurchase probability regardless of whether market-timing opportunities are favorable or unfavorable. This FCF effect strongly dominates market-timing considerations. Firms with poor market-timing opportunities and high FCF are more than twelve times as likely to buy back shares as firms with good market-timing opportunities and low FCF. Although employee-stock-option (ESO) and leverage-rebalancing motives are at least as important as market timing in explaining managers’ share repurchase decisions, neither is as strong as FCF.
Number of Pages in PDF File: 59
Keywords: Share repurchases, Stock buybacks, Market timing, Free cash flow, FCF, Payout policy
JEL Classification: G35working papers series
Date posted: October 13, 2013 ; Last revised: May 16, 2014
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