Why Do Financially Unconstrained Firms Borrow to Repurchase Shares?
53 Pages Posted: 24 Aug 2016 Last revised: 6 Dec 2019
Date Written: December 2, 2019
Abstract
We study the impact of financial constraints on cross-market arbitrage. We find that financially constrained firms are more likely to conduct debt-financed share repurchases. Such repurchases tend to reduce investments and increase financial distress risks, especially when financially constrained firms are over-leveraged. Less financially constrained firms instead tend to conduct debt-financed repurchases only when debt market conditions are favourable. Moreover, less financially constrained firms tend to issue overvalued debt to fund the repurchase of undervalued equity. These results are in line with the cross-market arbitrage hypothesis according to which firms fund repurchases during good debt market conditions even though internal funding is available.
Keywords: Levered share repurchases, financially unconstrained firms, debt market timing, equity undervaluation, investment expenditures
JEL Classification: G03, G30, G31, G32
Suggested Citation: Suggested Citation