Is price support a motive for increasing share repurchases?

• Published in: Journal of corporate finance (Amsterdam, Netherlands) Vol. 38; pp. 77 - 91
• Main Authors: Liu, Harrison, Swanson, Edward P.
• Format: Journal Article
• Language: English
• Published: Amsterdam Elsevier B.V 01-06-2016; Elsevier Science Ltd
• Subjects: Abnormal returns; Arbitrage; Earnings per share; Effectiveness studies; Overvalued equity; Return on assets; Securities buybacks; Share repurchase; Short sales; Short selling; Stock buyback; Stock prices; Arbitrage; Stock buyback; G 12; Short selling; G 35; G 14; Overvalued equity; Share repurchase
• ISSN: 0929-1199; 1872-6313
• DOI: 10.1016/j.jcorpfin.2016.03.011

Prior research shows that companies repurchase stock during quarters with low returns, presumably because the stock is undervalued. We focus on repurchase increases and investigate another motive: Are repurchases increased to provide price support for a stock that, despite recent low returns, remains overvalued? Using an increase in short selling to indicate overvaluation, we regress quarterly changes in share repurchases on quarterly changes in short interest. Consistent with price support, the association is positive and statistically significant each year from 2003 to 2014. We find that the price support quarter is followed by a sharp multi-quarter decline in ROA (return on assets), but the corresponding decline in EPS (earnings per share) is modest due to the reduction in outstanding shares. Abnormal returns after the price support quarter are positive, indicating that price support is effective. We also examine trading by insiders. While insiders generally sell when shorts sell, they hold onto shares during the price support quarter. This indicates that insiders are confident that they can maintain the current stock price.
•We provide evidence that price support is an important motive for increasing share repurchases.•Following a quarter with price support, operating profitability (ROA) deteriorates substantially.•EPS declines very little, however, due to the reduction in shares outstanding.•Both raw and abnormal stock returns are positive following price support, so prices paid to repurchase stock are below future prices.•Corporate insiders do not sell from personal stock holdings during the price support quarter.