Does Share Repurchase Increase the Financial Fragility? Evidence from a Regression-Discontinuity Approach

Abstract

This paper studies the agency costs associated with the open-market repurchase program and documents its real financial consequences. Specifically, we look at the role of a manager’s behavioral bias in making repurchase decisions. We find that the likelihood of open-market repurchase jumps discontinuously when the stock price equals the previous repurchase price. The anchoring effect holds after considering other fundamental determinants. After identifying this discontinuity, we then use a fuzzy regression discontinuity design based on this cutoff, which exploits the local randomness in stock price, to study the consequences of anchoring in share repurchases. We find that anchoring-driven repurchase leads to aggressive investment (investment, R&D) but poor financial performance (ROA, earning growth) and deteriorated financial health (more debt, lower credit rating upgrade probability). Overall, we provide some of the cleanest estimates, to date, of the agency cost and financial consequence of the open-market repurchase program. Our results highlight the non-contractable agency cost associated with the share repurchase program.

Keywords: Financial Fragility, Share Repurchase

JEL Classification: G35