The Flexibility of Share Repurchase and Managerial Timing in Japan

This paper assesses whether managers are able to time the market using share repurchase execution data. In Japan, managers decide when to start the share repurchase program and the length of the program. Using unique repurchase execution data, we find the following : (1) firms announce repurchase programs in response to their own stock price declines ; (2) the market recognizes repurchase announcements as a signal of stock undervaluation; (3) firms that announce repurchase programs and that actually buy back shares experience stock price discounts, but the stock prices of firms that are not purchased are not discounted ; and (4) the larger the magnitude of the discount, the more shares firms repurchase. These results show that managers in Japan have timing ability and use it to purchase undervalued shares. Lintner (1956), dividends are stickier than repurchases because dividends imply a commitment that the firm will continue to pay out at the level of the dividend. As suggested by Ikenberry and Vermaelen (1996) and Stephens and Weisbach (1998), it is thought that repurchases have flexibility in terms of timing of execution. Dividends are paid regularly and managers have no choice as to when to pay out cash; by distributing cash through repurchases, managers are able to choose the timing of execution. This flexibility of execution timing leads researchers to the view that the reason managers repurchase shares is that firms use share repurchases to buy back shares at undervalued prices. (2) There are two methods to determine whether managers possess timing ability. One is to test long-run stock price performance after the share repurchase announcement or after execution of stock purchases (Ikenberry, Lakonishok, and Vermaelen (1995), Stephens and Weisbach (1998), Ikenberry, Lakonishok, and Vermaelen (2000), Zhang (2005), and Akyol and Foo (2013)). The other is to compare the cost or stock price that the firm actually paid with the pseudocost or stock price that the firm would have had to pay if it had chosen another day to repurchase shares (Brockman and Chung (2001), Cook, Krigman, and Leach (2004), Ginglinger and Hamon (2007), and Dittmar and Field (2015)). The purpose of this paper is to investigate whether managers are able to time the market and take advantage of flexible share repurchases. It is thought that such an analysis would shed light on why firms distribute cash through repurchases instead of dividends. Furthermore, unlike previous studies, we use execution data not only for program-announced-and-actually-repurchased firms The Flexibility of Share Repurchase and Managerial Timing. (Satoru Yamaguchi) 96 (2) Stephens and Weisbach (1998) show that firms buyback shares in response to underpricing and conclude that firms use repurchase to exploit the flexibility inherent in repurchase programs. but also for program-announced but not-repurchased firms, to test the managerial timing hypothesis. Whether managers succeed in repurchasing shares at lower prices depends on stock prices during the authorized period, that is, the period in which firms can freely buy back shares. If managers use their timing ability to purchase their undervalued shares, even if their stock price is undervalued at the time of program announcement, they would not buy their shares when the level of stock price during authorization periods is not undervalued. Using the execution data for program-announced but not-repurchased firms and showing results consistent with the managerial timing hypothesis, this paper contributes to the vast literature on share repurchase and managerial timing. In Japan, firms can repurchase share in one of two ways. One method enables firms to set the timing and length of the authorized period. (3) It seems that firms like flexibility. From 26 March 2004 to 15 November 2013, of the 3,897 share repurchase announcements that Tokyo Stock Exchange (TSE) first-section listed firms made, the number in which managers could not decide the authorized period is only 90. (4) In addition, if managers are able to time the market, they purchase the permissible amount of shares if the stock price remains undervalued after program announcement. Therefore, by using a sample consisting of firms that announce repurchase programs that have flexibility with respect to the authorized period, we are able to investigate managerial timing ability in settings different from prior research. 甲南経営研究 第58巻第1号 (2017.6) 97 (3) As noted in the next section, when firms adopt the other way to repurchase shares, the authorized period is set to one year. (4) This is different from the number of our samples, because we impose restrictions for observations to be included our analysis, as explained in Section 3. Using our unique data, we first examine whether actually repurchased firms tend to be undervalued and whether not repurchased firms do not tend to be seriously undervalued. To this end, we estimate a logit model and perform an event study. The results of the logit regression show that the probability of firms actually repurchasing shares is significantly higher when they experience serious stock price drops. This finding is consistent with the managerial timing hypothesis. We then perform an event study to analyze stock price behavior around the event day. If managers have timing ability and the market recognizes this, then announcement of the share repurchase program should serve as a signal of stock price undervaluation. We find that abnormal returns around the event day are negatively correlated with prior abnormal return, and positively correlated with the target amount of shares intended to be repurchased. As suggested by Vermaelen (1981) and Comment and Jarrell (1991), such results support the signaling hypothesis. It seems that the market understands program announcement as a signal of undervaluation. Finally, we compare average stock price during the authorized period with average stock price before and after that period to test manager timing ability, because it is well known that the methodology using long-run stock-price performance after repurchase program announcement suffers from a misspecification problem of test statistics. (5) The average stock prices we adopt as a benchmark are calculated by averaging 180 daily closing prices before the first day of and after the last day of the authorization period and 360 daily closing prices consisting of these two The Flexibility of Share Repurchase and Managerial Timing. (Satoru Yamaguchi) 98 (5) See Kothari and Warner (1997), Berber and Lyon (1997), and Lyon, Barber, and Tsai (1999). periods. (6) As a result of these tests, we find that in the group of programannounced and actually repurchased firms, the average stock price during the authorized period is significantly discounted relative to the average stock price before the authorized period; otherwise, in the group of not-repurchased firms, average stock price is not significantly discounted. Furthermore, by using these average prices as a measure of undervaluation, we find that the number of shares actually repurchased is significantly negatively correlated with this measure. These results imply that firms purchase a lot of shares when their shares are undervalued. Our results indicate that in Japan, managers are able to time the market like managers in other countries.