Changing Motives for Share Repurchases

Net share repurchases have increased both in absolute terms and relative to cash dividends. Share repurchases during 1975-87 were predominantly fixed price tender offers and Dutch auctions, mainly signaling undervaluation. By 1994 open market repurchases (OMRs) represented over 95% of repurchase activity. Event returns were 10% to 15% for the early period. OMRs during the 1980s had initial event returns of about 3.5%, but had four-year buy-and- hold returns of 12% and higher. By the mid 1980s share repurchases took the form of multi- year programs with annual levels as high as $2-$3 billion. Econometric studies of the 1990s are consistent with the hypothesis that a major motive was to offset the dilution effects of the exercise of stock options. Dividend patterns were related to permanent components of cash flow patterns while share repurchases were associated with more transitory cash flow changes. Dividend paying firms were almost two-third of publicly traded, non- financial, nonutility firms in 1978, but declined to 20.8% in 1999. Non-dividend paying firms were characterized by higher investment rates, higher R&D rates, higher market-to-book ratios, and relatively small size. Firms which began share repurchases in the 1990s have similar characteristics. The use of stock options enabled these firms to make cash payouts based on the discounted values of optimistic expectations of future net cash flows and stimulated the use of share repurchases as documented. In contrast, dividend paying firms with earning increases accounted for a high concentration of payouts, were large and more mature, and were responsible for the secular rise in aggregate dividend payouts. Thus share repurchases did not substitute for dividends but performed different functions.