Academic journal article Financial Management

Share Repurchase Offers and Liquidity: An Examination of Temporary and Permanent Effects

Academic journal article Financial Management

Share Repurchase Offers and Liquidity: An Examination of Temporary and Permanent Effects

Article excerpt

Open-market repurchase programs do not allow for precise estimates of share buy-back intensity to measure liquidity effects. To circumvent the uncertainty surrounding the quantity and timing of shares truly acquired in repurchase programs and to measure their long-term impact, we examine Dutch auctions and fixed-price tender offers. We investigate both the temporary and permanent liquidity effects of share repurchase programs and find that the improvement in liquidity is transitory and limited to the tender period when the firm's offer to repurchase shares is outstanding. Improvements in liquidity over longer intervals appear to be the result of an overall price improvement and a reduction in volatility rather than the result of structural change in market dynamics.

Share repurchase programs have taken on an increased importance in recent years. Firms can repurchase shares through an open-market repurchase, targeted share repurchase, fixed-price tender offer, or Dutch auction tender offer. In this paper, we examine the short- and long-term effects of firms' self-tender (stock buy-back) programs on the liquidity of the underlying shares.

We believe that the long-term liquidity effects cannot be fully explored in an "open-market share repurchase programs" setting because there is no finite date for the conclusion of such programs. If there is no program expiration date, then the researcher cannot determine the precise periods over which to construct the liquidity variables necessary for the empirical analyses. Additionally, firms that conduct open-market repurchase programs are under no obligation to disclose when, or even if, they repurchase shares. Furthermore, open-market share repurchase programs are often renewed and can span several years. The indefinite time horizon impedes the researcher's ability to measure the long-term impact of share repurchase programs on firm liquidity.

To overcome these difficulties, we examine repurchases using the Dutch auction (DA) and fixed-price tender offer (FPTO) formats. These share repurchase formats have two advantages. First, the timing, quantity, and price of shares acquired for DA/FPTO repurchases are known because they are announced in company press releases. Second, these repurchases occur over a relatively short period, typically 30 days. We prefer this shorter time period, since it minimizes the probability of a large-scale structural change (other than the repurchase per se) or some other informational event affecting liquidity. Using a 30-day period makes it possible for us to measure, examine, and compare liquidity over three distinct time periods: I) the pre-announcement or pre-event period, 2) the tender period, and 3) the post-event period. By examining these three periods, we can measure both the temporary impact of the share repurchase program over the duration of the tender period (typically one month) and its long-term impact by comparing the post-event period with the pre-event period. Being able to distinguish between temporary (i.e., short-term) and permanent (i.e., long-term) liquidity changes is a major advantage of using DA/FPTO repurchases to address this issue, as opposed to open-market repurchases. (1) However, neither the short- nor the long-term effects of repurchase programs on liquidity are very obvious.

Because the evidence on share repurchase programs is mixed and because we believe it is important for managers to understand the liquidity effects of the self-tender transactions, we examine the impact of DA/FPTO repurchases on various measures of liquidity such as the bid-ask spread and depth for the repurchasing firm's shares. We find that the true improvement in liquidity is transitory and that it is limited to the one-month tender period. During the tender period, the implicit demand (with price limits in the case of DAs, and a single price for FPTOs announced by the repurchasing firm) provides extra depth to the market. …

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