Signaling, stock actual repurchase, and stock price behavior
Authors: Chia-Chung Chan, Chin-Shun Wu, Tsung-Hao Ho
Journal: Chiao Da Management Review. Jun. 2006, 26(1): 143-171.
Keywords: Stock repurchase; Actual repurchase
Abstract:
Managers conduct open market repurchases for many different reasons, including signaling hypothesis, dividend substitution hypothesis,
managerial opportunism hypothesis and so on. However, the most mentioned explanation for open market repurchases is the “signaling theory”. The
first purpose of this paper is to show that actual repurchase is more reliable signal than its announcement. We use a game theory model to
demonstrate that information asymmetries existing in the stock market can result in stock actual repurchase at the equilibrium. Under some
specific circumstances, a partially separating equilibrium is derived. That is, the high-quality companies with low financial distress cost
will choose stock actual repurchase, while the high-quality companies with high financial distress cost and the low-quality ones will refuse
to repurchase stock. The second purpose of this paper is to examine the hypotheses implied in the proposition from our theoretical side. We
investigate share price performance following actual share repurchase. On average, repurchasing firms with low financial distress cost do
exhibit superior abnormal performance. The empirical results are in accordance with the suggestions in our model.