Stock Market Liquidity and the Decision to Repurchase

41 Pages Posted: 2 Mar 2006 Last revised: 14 Jul 2013

See all articles by Paul Brockman

Paul Brockman

Lehigh University - College of Business

John S. Howe

University of Missouri at Columbia - Department of Finance

Sandra Mortal

University of Alabama - Culverhouse College of Commerce & Business Administration

Date Written: January 1, 2008

Abstract

We examine the impact of stock market liquidity on managerial payout decisions. We argue that stock market liquidity influences payout policy through a first-order effect on the share repurchase decision, and a second-order or residual effect on the dividend decision. Managers compare the tax and flexibility advantages of a repurchase against its liquidity cost disadvantage. All else equal, higher market liquidity encourages the use of repurchases over dividends. Our empirical results confirm that stock market liquidity plays a significant role in repurchase and dividend initiations, as well as in recurring payout decisions. Unlike previous studies that measure liquidity changes following the repurchase decision, we examine liquidity levels prior to the payout decision. We show that managers condition their repurchase decision on a sufficient level of market liquidity, consistent with Barclay and Smith's (1988) theoretical analysis and Brav et al.'s (2005) CFO survey results. Repurchases have recently become the payout decision of choice in part because of rising stock market liquidity.

Keywords: payout policy, repurchases, dividends, liquidity

Suggested Citation

Brockman, Paul and Howe, John S. and Mortal, Sandra, Stock Market Liquidity and the Decision to Repurchase (January 1, 2008). Journal of Corporate Finance, Forthcoming. Available at SSRN: https://ssrn.com/abstract=887426 or http://dx.doi.org/10.2139/ssrn.887426

Paul Brockman (Contact Author)

Lehigh University - College of Business ( email )

Bethlehem, PA 18015
United States

John S. Howe

University of Missouri at Columbia - Department of Finance ( email )

224 Middlebush Hall
Columbia, MO 65211
United States
573-882-5357 (Phone)
573-884-6296 (Fax)

Sandra Mortal

University of Alabama - Culverhouse College of Commerce & Business Administration ( email )

Culverhouse College of Business
Tuscaloosa, AL 35487-0223
United States

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