Precautionary vs Signaling Motive of Share Repurchases: Evidence from Policy Uncertainty and the COVID-19 Crisis

Abstract

Using policy-related uncertainty as a shock to firms’ internal and external financing frictions, we find significantly lower repurchase likelihood, short-term market reactions, and post-announcement completion rate of open market share repurchases during periods of high policy uncertainty. Firms are more likely to switch from a high- to low-commitment repurchase technique when policy uncertainty is high. In contrast, for firms that are significantly undervalued ex-ante, higher policy uncertainty leads to more repurchase activities. In addition, we show that the COVID-19 crisis is associated with lower repurchase likelihood for financially constrained firms or those with high cash flow volatility, while undervalued firms repurchased more shares during the pandemic period. Our results are robust after controlling for potential sources of endogeneity and conducting a battery of robustness tests. Collectively, our evidence suggests that the relationship between uncertainty and share repurchases are conditional on institutional contexts. Firms’ level of financial flexibility, their demand for signaling, the creditability and magnitude of repurchase signals, all significantly affect their precautionary and signaling motives.

Keywords: Policy uncertainty; share repurchases; precautionary motive; signaling motive; COVID-19

JEL Classification: G32, G35, G38