Share Repurchase under Diverging Beliefs about Carbon Risk
41 Pages Posted: 15 Jul 2020
Date Written: June 22, 2020
Abstract
Diverging beliefs about the impact of climate policy on the value of fossil fuel assets can lead investors to different valuations of fossil fuel companies. This paper models the share price formation in a market where one group of investors systematically overestimate future prices, and explores how firms can maximise firm value through share repurchases by responding to changing investor beliefs. We find that the optimal buyback strategy reduces the impact of price volatility on share prices, i.e. the optimal response of the firm is to counteract price variations. When expectations to future prices drop, the optimal response is to buy back shares. Furthermore, we show that the optimal buyback strategy can lead to a persistent and higher share of investors who overestimate future share value compared to the case where the supply of shares are fixed. The result implies that buybacks can dampen price signals originating from fossil fuel divestment. In the light of substantial engagement in buyback programs observed in the US oil sector, divestment is unlikely to have had any significant effect on share prices or firm valuations in this sector.
Keywords: buyback; stranded assets; portfolio optimization; false expectations
JEL Classification: G11;Q50
Suggested Citation: Suggested Citation