When Do Share Repurchases Increase Shareholder Wealth?

Abstract

A popular misconception among practitioners and academics is that repurchasing shares can increase the share price, since total earnings and market capitalization are spread over a smaller number of shares outstanding. I present a numerical example that demonstrates the fallacy of this view. I demonstrate the irrelevance of share repurchasing when markets are perfect. I argue that the misconception may result in value-reduction if it means that firms become obsessed with using cash flow to repurchase shares rather than investing in positive NPV projects. I discuss the possible reasons identified by researchers for share repurchasing to enhance firm value.

JEL Classification: G32, G35