Bank Stock Repurchases: A Multivariate Analysis
Boudreaux, Denis O., Payne, Bruce C., Rumore, Nancy C., The Journal of Bank Cost & Management Accounting
Following the 1990-91 Recession, the demand for bank loans declined, security yields were unattractive, and the base of bank equity capital was increasing. The situation provided a challenge to bank managers whose responsibility it was to maximize the value of the institution's shares. During the period 1991-994 there were few, if any, investment opportunities for banks that would improve return on equity and thus share value more than simply repurchasing outstanding shares.
It has been reported that in recent years approximately one half of the 150 largest banks In the United States have implemented stock repurchase programs (Huggins, 1994). This wave of repurchases has been the subject of a great deal of interest in academic and professional literature.
For example, Davis (1993) found that in addition to improving return on equity, three objectives may be accomplished by repurchasing shares: 1) proving liquidity to shareholders, 2) maintaining a market value for outstanding shares that best reflects the firm's intrinsic value, and 3) limiting the number of shareholders.
Dann, Masulis, and Mayers (1991) examined repurchase tender offers as a source of information about firms' future earnings prospects and market risk levels. They documented positive earnings surprises and reduction in equity systematic risk levels. Their findings are remarkably consistent with a study published at the same time by Hertzel and Jain (1991).
The Hertzel and Jain study provided evidence that repurchase tender offer announcements conveyed favorable information about the level and riskiness of future earnings. They showed that analysts revise their forecasts of earnings per share upward following repurchases announcements. They also provided evidence that equity betas declined after repurchases as a result of decreases in underlying riskiness of the firm's assets.
Following these two studies in a seemingly logical progression of information, Lee, Mikkelson, and Partch (1992) found that with the exception of dutch auction offers, managers trade their firm's shares prior to repurchase announcements as though repurchases convey favorable information to outsiders. Prior to fixed price repurchase offers, managers increase their buying and reduce their selling of their firm's shares.
Scholes and Wolfson (1989) found that stock repurchase plans allowed shareholders to capture part of the underwriting fees incurred in new stock offerings and saved sponsoring firms some of the usual underwriting costs. They tested the degree to which individual investors could profitably implement simple investment strategies based on share repurchases. The tests produced extraordinary profits, prompting the authors to ask why more shareholders do not participate.
Finally, Medury, Bowyer, and Srinivasan (1992) established, as did others, that repurchases significantly affected the wealth of participating and non-participating shareholders. They then ask the logical questions: Are repurchasing firms different from non-repurchasing firms in terms of their operating and financial characteristics? Is repurchasing activity predictable? Their findings were that there were indeed differences in the two groups of firms, and that repurchasing activity is predictable. Their study, however, was limited to manufacturing firms.
Despite a high degree of academic and professional interest in the stock repurchase activity of commercial banks, there have been no studies that sought to identify differences in the risk-return characteristics of banks engaged in repurchasing activity and banks that do not repurchase stock.
The major purpose of this study is to identify the financial characteristics of banks engaged in aggressive repurchase activity. More specifically, the study is concerned with those variables that are indicators of the bank's risk and return trade-off character. Market value is established by the action of investors at the margin in buying and selling. …