Can managers time the market? Evidence using repurchase price data Amy Dittmar University of Michigan Laura Field Pennsylvania State University Little is known about the prices firms pay for repurchases. We compile a U.S. dataset of actual repurchase prices paid, and we compare that price to the average market price. We find that firms repurchase at significant lower prices than the market average. Firms' ability to time the market varies cross-sectionally: less frequent repurchasers obtain significantly lower prices, as do firms repurchasing when insiders buy on their own account. Also, market timing ability is greater in the face of higher information asymmetry. Controlling for market risk factors, we find that managers' ability to time is limited to short investment horizons. * We appreciate helpful comments from Malcolm Baker, Robert Dittmar and Michelle Lowry. We thank Anahit Mkrtchyan and Jason Kotter for research assistant. Contact the authors at: Amy Dittmar, The Ross School of Business, University of Michigan, Ann Arbor, MI 48109, adittmar@umich.edu; and Laura Field, Smeal College of Business, Penn State University, University Park, PA, 16802, laurafield@psu.edu.
Abstract Little is known about the prices firms pay for repurchases. We compile a U.S. dataset of actual repurchase prices paid, and we compare that price to the average market price. We find that firms repurchase at significant lower prices than the market average. Firms' ability to time the market varies cross-sectionally: less frequent repurchasers obtain significantly lower prices, as do firms repurchasing when insiders buy on their own account. Also, market timing ability is greater in the face of higher information asymmetry. Controlling for market risk factors, we find that managers' ability to time is limited to short investment horizons.
1. Introduction Can managers time the market in making security issuance and repurchasing decisions? This question has spurred many studies in both the security issuance and repurchases literatures. Despite numerous investigations, it remains unclear if the evidence supports or disputes the market timing hypothesis. 1 One of the reasons that it is difficult to determine whether managers can time the market is that much of this literature relies on long-run returns after the event to determine whether a manager is timing the market [Laknoishok and Vermaelen (1990, Ikenberry, Laknoishok and Vermaelen (1995 and 2000) and Peyer and Vermaelen (2008)]. 2 In the case of stock repurchases, this is particularly problematic because the returns are measured after announcement of a repurchase program, yet many firms announce but never actually repurchase stock [Stephens and Weisbach (1998)]. Other studies based on large scale U.S. data on actual repurchases show that firms repurchase after a stock price run-down [Jagannathan, Stephens, and Wesibach (2000)], but this analysis is based on annual or perhaps quarterly data on amount of (but not the price paid for) stock repurchased. Further, several studies provide evidence that firms repurchase for reasons other than undervaluation [Dittmar (2000), Grullon and Michaely (2002), Jagannathan, Stephens, and Wesibach (2000), Kahle (2002), Bens, Nagar, Skinner (2003), Massa, Rehman, Vermaelen (2007)]. Understanding managers ability to repurchase undervalued stock is vital to being able to reconcile the academic studies of repurchases with the 1 Baker and Wurgler (2000 and 2002), Ikenberry Laknoshok and Vermaelen (1995 2000), and Peyer and Vermaelen (2009) present evidence consistent with market timing and Eckbo, Masulis, and Norli (2000), Schultz(2003), Butler, Grullon, and Weston (2005), and Dittmar and Dittmar (2007) dispute the interpretation of these findings as evidence of market timing. 2 The evidence based on operating performance is similar to the long run returns but more inconclusive. Lie (2005) shows that firms report significant improvement in operating profitability following a repurchase announcement and Gong, Louis, and Sun (2008) show that this is at least in part due to pre-repurchase announcement downward earnings management rather than growth in profits. 1
fact that CFOs list undervaluation as the primary factor driving the motive to repurchase [Brav, Graham, Harvey and Michaely (2005)]. In this paper, we employ new, monthly data that indicates actual firm repurchases and the average price paid for the stock to examine whether firms are able to time the market with repurchases. By utilizing these data, we are able to speak to both the ability of firms to time the market and the cross-sectional dispersion in a firm s ability to repurchase at a low and possibly undervalued price. Our sample consists of 1,243 firms that repurchase stock as part of a stock repurchase program in a total of 15,866 firm-months between 2004 and 2006 and is an exhaustive list of stock repurchased within a program over this period. By knowing the actual average repurchase price, we are able to measure market timing. We create a variable comparing the average monthly repurchase price (available from the notes in financial statements) to the average of closing prices from CRSP for the same stock over the month of the repurchase, as well as at one-, three-, and six-month windows before and after the repurchase month. Throughout the paper, we refer to this variable as the Relative Repurchase Price t, where t notes the number of comparison months before and after the repurchase. We predict that if firms can time the market, this measure should be significantly less than zero. Indeed, we find that the relative repurchase price is, on average, significantly less than zero: the average firm repurchases stock at a price significantly lower than the average closing price over the month of the repurchase, as well as over the periods of one, three, and six months before and after the repurchase. In addition to examining the repurchase price, we observe detailed information on the amount and timing of repurchase activity over a monthly window, which is much narrower than is used in other U.S. studies. We find that the frequency of repurchase activity varies considerably, with 20% of firms repurchasing stock in at least nine months of a calendar year. 2
Further, frequent and infrequent repurchasers differ significantly in several ways: frequent repurchasers are significant larger and more profitable and have significantly more cash and higher dividend payouts. Moreover, though the fraction of stock repurchased in one month is smaller for frequent repurchasers, frequent repurchasers account for over 65% of aggregate repurchases over this sample period. These differences suggest that the motives for repurchasing (and the potential role of market timing) may differ for frequent and infrequent repurchasers. We next examine how the frequency of repurchases impacts managers ability to time the market. In addition to providing insights into the cross-sectional ability to time the market, this analysis also provides insights into the duration a firm may remain undervalued. One fundamental concern often levied at the long-run performance analysis of market timing is that it presumes the misvaluations remain after both the announcement as well as several months after initial repurchases, thus allowing firms a long window to repeatedly repurchase at low or possibly undervalued prices. We find that firms ability to time the market is decreasing in the frequency of repurchase activity. That is, the relative repurchase price increases monotonically as the repurchasing frequency increases. Further, the relative repurchase price is not significantly different from zero for the most frequent repurchasers. This evidence suggests that frequent repurchasers are likely repurchasing stock for reasons other than misvaluation. This result is particularly interesting given that these firms repurchase the largest percentage of their market value and are the largest firms in the sample, thus indicating that though some firms time the market, a large portion of stock repurchases are done for other reasons. However, for all but the most frequent repurchasers, we find that firms Relative Repruchase Prices are significantly negative, suggesting that many firms do time the market with repurchases. 3
The evidence indicates that, on average, some managers are able to time the market and repurchase at a relatively low price and that the degree of potential mispricing captured by the firm varies based on the frequency of the repurchase. To further examine the cross-sectional variation in firms abilities to time the market, we compare repurchase activity to insider trading behavior over the same period. Seyhun (1986) provides evidence of managers ability to time the market with their personal trades. Thus, similar to Jenter (2005), we use insider buying and selling as an indicator that a firm is potentially misvalued. In doing so, we are able to confirm whether the relative repurchase price is lower when a firm is more likely undervalued, as well as to provide insight into which firms are able to time the market. We find that repurchasing firms with relatively high insider buying during the repurchase month have a negative relative repurchase price. This suggests that, for firms with substantial insider buying during the repurchase month, repurchasing firms do so at significantly lower prices than the average. This result is consistent with the findings of Bonaimé and Ryngaert (2011). However, whereas Bonaimé and Ryngaert examine long run returns following the quarter of a repurchase, we focus on the actual price paid in the repurchase. We confirm these results in a multivariate analysis, controlling for firm characteristics. Specifically, we regress the relative repurchase price on the variables discussed above, several firm characteristics, and year and firm fixed effects. The results confirm the previously discussed findings: firms are able to repurchase at a significantly lower price when they repurchase infrequently and concurrently with insider buying. Further, this analysis reveals characteristics of those firms that are able to time the market, thus providing insight into the cross-sectional variation of the motives to repurchase. We show that firms that repurchase at a lower relative price tend to be smaller firms with less cash and a lower market-to-book ratio. These results are 4
consistent with firms timing the market with stock repurchases when they are potentially undervalued with less excess cash to distribute. To better understand if firms are undervalued and what managers know about the price of the firm when implementing a repurchase program, we next examine measures of information asymmetry. Using the number of analysts and the dispersion of analyst forecasts as measures of information asymmetry, we find evidence that more opaque firms are able to obtain a lower repurchase price. To investigate this result further, we examine abnormal returns around repurchase announcements. However, we find no evidence that, at announcement, investors can predict which firms are undervalued. One concern with our relative repurchase price measure may be that the comparison period spans before, as well as after, the repurchase. We know from the previous literature that firms repurchase after a stock price run-down [Jagannathan, Stephens and Weisbach (2000)]. Clearly, to truly time the market firms would repurchase at a low price relative to future prices as well. We repeat our analysis using a forward-looking relative repurchase price, which compares the repurchase price to the months during and following the repurchase. We find that, generally, our results are robust to using post-repurchase windows: infrequent repurchasers, those with net insider buying, and those with more information asymmetry are best able to time the market with repurchases. Finally, we examine post-repurchase returns by calculating the alpha from a Fama-French regression to control for market risk, and examine this return over the several investment horizons. The results are insightful. In both the full sample and in sub-samples where earlier tests found evidence of market timing, we confirm that managers earn superior returns after controlling for risk factors. However, these superior returns hold only on short investment horizons of three to six months. Thus, this paper provides evidence that over short horizons, 5
managers time stock repurchases when they repurchase infrequently and when their repurchases coincide with insider buying. However, managers forward insight into prices is limited to a relatively short window. This paper contributes to a vast literature on stock repurchases and the ability of firms to time the market when they repurchase stock. The papers most similar to this paper are Brockman and Chung (2001) and Cook, Krigman, and Leach (2004). Brockman and Chung examine the timing ability of approximately 190 repurchasing firms in Hong Kong. Cook, Krigman, and Leach pursue a similar research agenda using 64 U.S. firms repurchase trading data. Both papers find that, on average, managers are able to time the market. However, Brockman and Chung find that approximately half the managers are able to beat a naïve investment strategy and that their repurchases impact trading behavior, while Cook, Krigman and Leach find little cross-sectional variation in the ability to time the market or an impact on trading. As explained in Cook et al., the conflicting evidence in these two studies illustrates the important differences in the U.S. and Hong Kong regulatory environments for repurchases. Further, Ikenberry, Lakonishok, and Vermaelen (2000) examine monthly repurchases for firms in Canada using monthly repurchase volume but not price data. Our paper extends prior research by examining a full sample of all U.S. repurchasing firms, thus allowing a more complete analysis and a greater ability to examine cross-sectional variation in timing. In section 2, we describe the sample and data collection. Section 3 discusses and presents evidence on the relative repurchase price. In section 4, we examine our results in a multivariate setting and the cross-sectional variation in timing. In section 5, we examine forward-looking measures of the relative repurchase price. Section 6 reports Fama-French regressions, controlling for market risk factors, to further examine timing ability. Section 7 concludes the paper. 6
2. Data and methodology In 2003, the SEC amended Exchange Act Rule 10b-18, requiring companies to disclose all repurchases in their annual and quarterly reports as of March 15, 2004. As a result, at the end of each fiscal quarter, firms are now required to disclose the number of shares repurchased each month, whether these shares were repurchased as part of a public plan, and the average price paid for repurchases over the month. We utilize these data to speak both to the ability of firms to time the market and the cross-sectional dispersion in firms ability to repurchase at a low and possibly undervalued price. 3 To construct our sample, we utilize PERL to search 10-K and 10-Q filings on EDGAR to identify firms conducting repurchases between 2004-2006. To ensure we have captured all repurchases, we also use the purchases of stock variable from the Statement of Cash Flows to identify repurchasing firms over the period. For any firms not identified in the PERL search but identified by Compustat as having purchased stock, we manually search all 10-K and 10-Q filings on EDGAR to collect data on the amount and price of repurchases. Using both methods, we identify 1,243 firms that have repurchased at least once during 2004-2006 as part of a publicly-announced program. Our final sample includes these 1,243 firms, encompassing 43,051 firm-months, of which 15,866 are firm-months with repurchases. Table 1 provides summary statistics for the sample. As shown in the table, the frequency of repurchase activity varies considerably in any given year. About half of firms repurchase infrequently, fewer than five times during the year. Perhaps more surprisingly, about 20% of repurchasing firms repurchase quite frequently at least nine times a year. Over the sample 3 Though Banyi, Dyl, and Kahle (2008) provide summary statistics of the amount repurchased by a random sample of 520 firms in 2004 using these data (to determine the accuracy of previously used measures of the quantity of stock repurchased), no other paper utilizes data on both the amount and price of a full sample repurchasing firms over multiple years. 7
period, frequent repurchasers account for 65.6% of the aggregate dollar value of repurchases, compared to 23.6% for the moderate and 10.8% for the infrequent repurchasers. Table 2 presents summary statistics of accounting characteristics for the full sample and for subsamples, based upon repurchase frequency. Frequent and infrequent repurchasers differ significantly on many dimensions. Frequent repurchasers are significantly larger and more profitable and have significantly more cash and higher dividend payouts than infrequent repurchasers. Also, although the percent of stock repurchased monthly is smaller for frequent repurchasers, frequent repurchasers tend to repurchase more over the entire year (although the difference in annual repurchases is only significant for the median). Specifically, although the median frequent repurchaser s monthly repurchase is only 0.29% of market value (compared to 0.40% for infrequent repurchasers), the median frequent repurchaser repurchases 4.21% of the firm s market value on an annual basis (compared to 1.08% for infrequent repurchasers). These differences suggest that the motives for repurchasing (and the potential role of market timing) may differ for frequent and infrequent repurchasers. Before we investigate these differences, we first examine the extent to which managers, on average, are able to time the market. 3. Relative repurchase price Unlike prior research on repurchases by U.S. firms, which relies on long-run returns after the announcement of the repurchase to determine if managers are timing the market, in this paper we are able to observe and examine the average price paid for actual repurchases each month. Thus, we are able to more directly measure whether managers are using repurchases to time the market. To measure firms ability to time the market, we construct a measure that compares the average price paid for repurchases during the month (as reported in the 10-Q and 10-K), R EP0, to the average daily closing stock prices (from CRSP) over several comparison periods of t 8
months before and after the repurchase month, C Pt. If managers are not timing the market, we would expect the average price paid by the firm to be insignificantly different from the average CRSP price from the same month. Conversely, if a manager is able to time the market, conditional on deciding to repurchase in a given month, we would expect the firm to pay a price significantly lower than the average price a random investor may pay for the stock in that month (that is, R EP0 < C Pt ). We measure market timing as the percentage difference between the average price paid for repurchases, R EP0, and the average CRSP closing price, C Pt, measured t months surrounding the repurchase. We refer to this variable throughout the paper as the Relative Repurchase Price: Relative Repurchase Price t = REP CP t 0 1 (1) where REP0 is the repurchase price paid in the repurchase during the repurchase month and CPt is the comparison price measured during t months before and after the repurchase. If firms can time the market, we posit that the relative repurchase price should be significantly less than zero. Not only do managers choose when to repurchase in a given month, but they also choose the period in which to implement the repurchase. Thus, we expect the relative repurchase price to be negative for longer comparison periods as well as shorter ones. We therefore estimate the relative repurchase price comparing the average repurchase price to the average daily closing CRSP price during the repurchase month, as well over ±1, ±3 and ±6 month windows surrounding the repurchase month. If the manager is timing the market, we expect he will not only buy at a low price relative to historical prices but also at a price lower than his forecast of future prices. Thus, we compare the repurchase price to the price in the months before and after the repurchase to gain insight into a manager s ability to forecast the 9
future stock price and time the market. In later analysis, we also estimate this relative price using forward-looking data only (that is, excluding pre-repurchase months). Table 3 provides summary statistics on the mean (median) relative repurchase price for the month of repurchase, as well as windows of one, three, and six months surrounding the repurchase, for the full sample and for each sample year. We find that the average and median relative repurchase prices are significantly negative in all sample years, thus indicating that the average (median) firm is able to time the market. On average, firms repurchase at a price that is 0.67% lower than the average daily closing price for that firm during the same month. Moreover, we find that the relative repurchase price is significantly negative for all three comparison periods we examine, suggesting that managers not only time the days within a short window in which they repurchase, but they also choose to repurchase when the price is low relative to the price over longer horizons (of up to six months). Indeed, the relative repurchase price is lower the longer the window we examine: the average firm is able to repurchase at a price that is 1.01%, 1.57%, and 2.01% lower in the one-, three-, and six-month periods surrounding the repurchase month. Given that the average firm repurchases 4.23% of its market value over a calendar year, the 2.01% repurchase discount using a six-month window represents a substantial gain to the firm. Indeed, the average repurchase discount amounts to $810,291 per firm-year, or an average discount of $1,745,772 per repurchasing firm over our three-year sample period. Clearly, the ability to time repurchases potentially provides substantial savings to firms. We conjecture that repurchase frequency may affect a manager s ability to time the market. Specifically, firms that repurchase once a year have more flexibility in terms of timing than do firms that repurchase monthly. As shown earlier in Table 1, 20% of sample firms repurchase frequently (at least nine months in the year). Thus, we next examine how the frequency of repurchases impacts a manager s ability to time to the market. Table 4 presents the 10
mean and median relative repurchase price by repurchasing frequency to examine whether there is a relation between firms ability to time the market and how often firms conduct repurchases. We find that, for all windows, both the average and median repurchase price is monotonically decreasing in repurchase frequency. For example, using the repurchasing month as the window of comparison, firms that repurchase only once during the year have an average (median) relative repurchase price of -1.62% (-1.03%), compared to only -0.15% (-0.05%) for firms repurchasing monthly. For the six month window surrounding the repurchase month, we find that firms repurchasing just once during the year have an average (median) repurchase price of -5.03% (-4.81%) compared to an insignificant -0.05% (-0.11%) for monthly repurchasers. In fact, we find that monthly repurchasers mean and median relative repurchase prices are not significantly different from zero for either the three or six month window. Further, as shown in the bottom panel, the difference between the Repurchase Repurchase Price for frequent and infrequent repurchasers increases monotonically as the measurement window increases. This evidence demonstrates that many firms time the market when repurchasing stock, particularly those that repurchase infrequently. In the next section, we model the relative repurchase price in a multivariate setting, in which we control for firm characteristics. 4. Cross-sectional variation in the relative repurchase price We next utilize a multivariate setting to control for firm characteristics. Specifically, in Table 5, we regress the relative repurchase price on repurchase frequency and several firm characteristics, as well as including year and firm fixed effects. In the regressions shown in Table 5, the dependent variable is the relative repurchase price, measured over ±1, ±3 and ±6 months of the repurchase, respectively. We include two variables to capture repurchase frequency: infrequent repurchase is an indicator variable equal to one for firms that repurchase 11
1-4 times a year, and frequent repurchase is an indicator variable equal to one for firms that repurchase at least nine times a year. Focusing on repurchase frequency, regardless of the event window we estimate over, we find that infrequent repurchasers obtain a significantly lower relative repurchase price, consistent with the univariate results in Table 4. For the ±3 and ±6 month windows, we also find that larger firms with higher market to book ratios pay a higher relative repurchase price, indicating these firms are less likely to be timing the market. The results for ±6 months also show that firms with more cash and lower return on assets pay higher relative prices. For the shorter ±1 month window, the coefficient on market to book is negative and significant, indicating that low market to book firms pay higher relative repurchase prices. Given the opposing results on M/B for the one month versus three and six month windows, we are cautious in our interpretation of the relation between market-to-book and relative repurchase price. Overall, the results in Table 5 suggest that infrequent repurchasers time the market, while frequent repurchasers have alternative motives to repurchase other than misvaluation. Given that both the univariate and multivariate evidence suggests that many firms are able to time the market, a natural question is, If managers can time the market, do they do so on their own account? Thus, we next turn our attention to the relation between the relative repurchase price and the prices at which insiders purchase shares on their own account. 4.1. Insider trading activity To further examine the cross-sectional variation in firms ability to time the market, we examine insider trading behavior for firms repurchasing during the same time period. Seyhun (1986) provides evidence of managers ability to time the market with their personal trades. Thus, similar to Jenter (2005), we use insider buying (selling) as an indicator that a firm is 12
potentially misvalued. In doing so, we are able to confirm whether our relative repurchase price measure is lower when insiders view the firm as undervalued, providing further insight into whether firms are able to time the market. Information on insider trading is obtained from The Insider Filing Data Feed, available through Thomson Reuters. This database captures all U.S. insider trading activity as reported on Forms 3, 4, 5 and 144. For our full sample of 1,243 firms with 15,866 repurchases during the 2004-2006 period, we search for insider trades occurring in the same month. We find 7,129 repurchase months where insiders are also trading. In Table 6, we divide our sample firms into quartiles based on the net insider buying over the same period that the relative repurchase price is measured. That is, we measure net insider buying as insider buys minus insider sells for each month, scaled by shares outstanding at the end of the prior period. We then sort firms into quartiles based upon this net insider buying measure. 4 For each quartile of insider buying, we summarize the relative repurchase price paid by the firm. As shown in Table 6, for all insider trading quartiles, firms repurchase at significantly less than the average CRSP closing price during the repurchase month and for the one month window surrounding the repurchase. However, for longer windows, a different picture emerges. Firms that are in the lowest quartiles of insider net buying (which are those that have high insider selling) have a positive mean and median relative repurchase price over the three- and six-month windows surrounding the repurchase month. That is, when insiders tend to be selling and the firm is repurchasing, the firm repurchases at a relatively high price. This contrasts with our earlier findings of apparent market timing of repurchases by managers, and shows that not all managers time the market. These results suggest that firms repurchasing stock during periods 4 Quartile 1 has net insider buying of -0.007 (thus more selling than buying) and Quartile 4 has net insider buying of 0.001. 13
when insiders are net sellers do so at significantly higher values than average, or they appear to mis-time the market. In contrast, firms with substantial insider buying repurchase at significantly lower mean and median relative prices for all three windows: ±1, ±3 and ±6 months. In Table 7, we examine the effects of net insider buying on the relative repurchase price in a multivariate setting. The coefficient on net insider buying is significantly negative, confirming our univariate results that firms repurchase at significantly lower relative prices when insiders are also net buyers. This result is consistent with the findings of Bonaimé and Ryngaert (2011), which finds that firms repurchasing with concurrent net insider buying have higher longrun returns. 5 However, whereas Bonaimé and Ryngaert examine long-run returns following the quarter of a repurchase, we focus on the actual price paid in the repurchase. Table 7 shows that, after controlling for net insider buying, we continue to find that infrequent repurchasers obtain a lower repurchase price over each time window we examine. Taken together, these results provide evidence that repurchasing firms obtain lower relative repurchase prices when insiders are net purchasers of stock and when the firm repurchases less often. These results provide evidence that some firms time the market using open market repurchases and offer insights into which firms time the market. 4.2. Announcement returns Our results thus far demonstrate that firms which repurchase infrequently time their repurchases to obtain a lower repurchase price, coinciding with more insider buying. In this 5 Several papers examine the correlation between insider trades and firms repurchase as well as how the announcement and long run returns vary based on insider trading behavior [Lee, Mikkelson, and Partch (1992), Chan, Ikenberry and Lee (2003), Louis, Sun, and White (2010), Babenko, Tserlukevich, and Vedrashko (2011), and Bonaimé and Ryngaert (2009)]. These papers provide mixed evidence of the related timing of insider buying and firm repurchases as well as the impact of long run returns. However, consistent insider buying being an indication of market timing, Bonaimé and Ryngaert (2011) find higher long run returns after repurchasing by firms with concurrent net insider buying. 14
section, we examine returns surrounding announcements of repurchase programs to investigate whether investors anticipate firms timing through repurchases. Thus, for the 1,243 firms that repurchase stock over our 2004-2006 sample period, we search SDC for repurchase announcements back to January 1, 2000. We then match repurchases to the most recent announcement. Since repurchase programs are often approved for up to four years, we search for repurchase program announcements up to 4.5 years prior to repurchase. Using this procedure, we are able to find and match announcement dates for 716 firms where the announcement date is within 4.5 years of the actual repurchase. These announcements occur on average (at the median) 18 months (one year) prior to the repurchase. We summarize the announcement returns in Panel A of Table 8. The average three-day cumulative announcement return is 1.2%, which is consistent with prior evidence, given the majority of the announcement are open market stock repurchases [Vermaelen (1984), Comment and Jarrell (1991), Ikenberry et al. (1995), and Grullon and Michaely (2002)]. To examine the variation in announcement CARs, we categorize firms into quartiles based upon their announcement returns. We find substantial variation in CARs, with the lowest quartile having an average three-day abnormal returns of 4.9% (median 3.4%), and highest quartile having an average abnormal returns of 8.0% (median 6.2%). Thus, we may expect that, if announcement returns measure undervaluation and if this undervaluation is not fully corrected by the announcement, the announcement return will be correlated with the relative repurchase price. We next investigate the relation between the announcement CAR, which signals potential undervaluation, and our relative repurchase price measure, which captures the manager s ability to actually capture any remaining undervaluation with subsequent repurchases. Panel B of Table 8 presents mean and median relative repurchase prices for firms divided by quartiles based on the announcement return, using various CRSP comparison windows. 15
If investors anticipate firms timing through repurchases, we would expect firms that repurchase to signal undervaluation would have a positive and higher CAR at the repurchase announcement. However, if the announcement corrects for mispricing, we would not expect any variation in the relative repurchase price across the CAR quartiles. Alternatively, if firms remain substantially undervalued after the announcement and the degree of post-announcement mispricing is correlated with the degree of pre-announcement mispricing (as assumed in the long-run performance literature), then we would expect that firms with the lowest announcement returns will be those that also repurchase at the lowest relative price. Thus, the correlation between the CAR and the relative repurchase price may be positive or negative. Assuming that firms with high CARs are more undervalued and remain more undervalued, then we would expect a positive correlation. But, if a lower CAR results from less reaction for a given level of misevaluation (perhaps a more serve under reaction), then we may expect a negative correlation. For shorter windows surrounding the repurchase, we find no significant differences in the mean relative repurchase price between high and low CAR quartiles. However, we find significant differences in mean and median relative repurchase price for high and low CAR quartiles for the six month window surrounding actual repurchases and a significant difference in medians for the repurchase month. The relative repurchase price is 0.51% lower over a sixmonth window for firms with the lowest CARs, indicating that these firms, with a less positive or negative reaction at the announcement, are able to repurchase at a lower price. However, once we control for other firm characteristics in a multivariate setting, the differences disappear. That is, in untabulated tests, we include the repurchase announcement CAR in a multivariate regression similar to that shown in Table 5, we find no evidence that announcement returns are significantly related to the relative repurchase price. Taken together, the results suggest that, at 16
the time of the repurchase program announcement, investors do not anticipate any future ability of management to time the market through repurchases. 4.3. Information asymmetry In the prior section, we demonstrate that investors do not anticipate managers ability to time the market through repurchases. To further examine how the motives to repurchase impact the price paid in a repurchase and to better understand the information managers use in timing stock repurchases, we next investigate the influence of information asymmetry. If managers have superior information and use this to time the market and get a lower relative repurchase price, then we may expect the effects to be stronger when the firm are opaque, and thus more difficult to value. We use two measures from IBES to capture information asymmetry: the number of analysts following the stock and the dispersion of the EPS forecast divided by the absolute value of the mean forecast in the most recent period reported prior to the repurchase month. Brennan, Jegadeesh and Swaminathan (1993) find that stocks that are followed by many analysts react faster to common information than stocks followed by a few analysts. Krishnaswami and Subramaniam (1999) argue that disagreement among analysts is an indication of the lack of information about the firm. Thus, we expect information asymmetry to be decreasing in the number of analysts following the stock and increasing in the dispersion of analysts forecasts. We examine the relation between information asymmetry and the relative repurchase price in Table 9. Similar to Table 7, we regress the relative repurchase price on repurchase frequency, insider buying, firm characteristics. and year and firm fixed effects, but here, in Table 9, we include the two measures of information asymmetry. As in Tables 5 and 7, the dependent 17
variable is the relative repurchase price measured over ±1, ±3 and ±6 months of the repurchase, respectively. Although we find no relation between the relative repurchase price and the number of analysts following a firm, we find a significant negative relation between EPS forecast dispersion and the relative repurchase price for all comparison windows. This evidence provides support for the contention that opaque, harder-to-value firms are better able to time the market. Notably, after including the information asymmetry variables, we continue to find that infrequent repurchasers and repurchases that coincide with insider buying receive a significantly lower relative repurchase price. The evidence thus far indicates that, on average, managers are able to time the market by repurchasing stock and that the degree of potential mispricing captured by the firm varies based on the frequency of the repurchase, insider buying, and information asymmetry. 5. Forward-looking relative repurchase price Thus far, we have used comparison periods that span before and after the repurchase to determine the relative price. The rationale for this balanced measure is that firms are looking at windows for when to repurchase and, if they are timing the market, firms choose low prices within that window. However, much of the long-run performance literature examines the prices after the announcement. Thus, providing a similar measure using comparison windows after the actual repurchase may add additional insight, as we would expect managers insight to be forward-looking if they can time the market. Further, it is difficult to interpret the results from the multivariate regressions that use windows before and after the repurchase, as the dependent variable includes prices from before the repurchase and firm characteristics are from the fiscal year end prior to the repurchase, which may encompass the evaluation window. 18
We, therefore, next examine a forward-looking relative repurchase price. Specifically, we recalculate equation (1), replacing the comparison price (CP) with the average of CRSP closing prices measured the month of and t months after the repurchase, were t is one, three, or six months after the repurchase month. In other words, we exclude the pre-repurchase month(s) portion of the comparison period. We then repeat all analysis presented in this paper. For brevity, we do not present the univariate statistics. However, the average relative repurchase price variables using these forward-looking alternative comparison periods are negative and follow a similar pattern within subcategories based on frequency of repurchase. In Table 10, we present results similar to those presented in Table 9 using the three forward-looking windows. In general, the results are similar to those using windows surrounding the repurchase: smaller firms, firms with lower M/B ratios, firms whose insiders are net purchasers of stock, and firms which repurchase infrequently tend to repurchase at a lower price, although the coefficients for infrequent repurchasers are significant for the one- and three-month windows and those for net insider buying are significant at the three- and six-month windows. The results for the information asymmetry proxies suggest that firms with more information asymmetry are better able to forecast when prices are undervalued. While EPS forecast dispersion is no longer significant for the forward-looking windows, the # analysts variable is significantly positive, suggesting that firms with lower analyst following (more information asymmetry) tend to repurchase at lower prices. Further, the evidence on size is consistent with this interpretation, if we assume smaller firms are harder to value. Regardless of whether we use measurement windows surrounding the repurchase month or windows that follow the repurchase month, we generally find that firms which repurchase infrequently and those in which insiders are net buyers are able to time the market, that is, repurchase at a relatively low price. 19
6. Controlling for market risk factors We provide evidence that firms which repurchase infrequently and those for whom managers trade on their own account repurchase at relatively low prices. We find that these firms repurchase both at historically low prices and that firms seem to be able to repurchase ahead of a price increase. However, our analysis thus far has not controlled for market risk. In this section we examine post-repurchase returns utilizing Fama French regressions, controlling for the market, small minus big, and high minus low book to market factors. We implement these regressions using the month of the repurchase plus three and six months following the repurchase. For the month of the repurchase, we estimate the return by comparing the repurchase price to the month-end closing price. All other monthly returns are calculated using monthly returns. If managers have inside information and use this information to time the market, we predict a positive and significant alpha. We estimate these regressions on the full sample as well as on portfolios based on infrequent versus frequent repurchasers and for firms with low versus high insider net purchasing, as we have found evidence of timing among firms which repurchase infrequently and those in which insiders purchase on their own account. As shown in Panel A of Table 11, for the whole sample, we find a positive intercept (alpha) for the short-run returns, of three months and six months. This evidence confirms that managers are able to time the market over these horizons. Next, in Panel B, we compare the alphas of subgroups by repurchase frequency and by the amount of net insider purchases, based on the evidence presented about which firms are able to time the market. To examine the market-adjusted returns by repurchase frequency, we form a portfolio of infrequent repurchasers (1-4 times/year) and a portfolio for frequent repurchasers 9 ( times a year). We find that both portfolios exhibit significantly positive alphas at the three month 20
horizon and, consistent with our prior evidence, firms which repurchase infrequently significantly outperform frequent repurchasers. Similarly, we form a portfolio of repurchasers with low insider net buys and another portfolio of repurchasers with high insider net buys. We find a significantly positive alpha for firms with high insider net buys for the three-month horizon, but the alpha for portfolio with low insider net buys is not significant and is not significantly different from the alpha for the portfolio with high insider net buys at the threemonth horizon. Panel C of Table 11 presents the results over the six-month horizon. We find a significantly positive alpha for infrequent repurchasers, but no significant alphas for any of the other portfolios. Overall, the evidence demonstrates that firms that are able to time the market with repurchases are those which repurchase infrequently and those in which insiders are net purchasers on their own account. These results suggest that some managers are able to time the market with repurchases. 7. Conclusion By utilizing a new dataset of monthly prices and shares repurchased for a complete sample of firms that repurchased stock between 2004 and 2006 in the U.S., this paper examines the ability of firms to time the market using repurchases. By utilizing the actual price paid in the repurchase and comparing this repurchase price to average market prices available over several windows, we show that many firms are able to time the market. We further show that this ability varies with the frequency of the repurchase, the correlation with insider trades, and several firm characteristics. We further provide evidence that firms with greater information asymmetry have greater ability to time the market. We confirm our findings using Fama and French regressions and provide evidence that managers are able to time the market in the short-term. 21
This paper contributes to a vast literature on stock repurchases and firms ability to time the market when they repurchase stock. Our paper is the first to utilize the actual average monthly price paid for a full sample of all U.S. repurchasing firms. In doing so, this paper goes beyond documenting potential timing but is able to explore the cross-sectional variation in timing in order to give show not only into if managers can time the market but to provide insight into what they know. 22
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