Monday, March 27, 2006

Mimicking Repurchases by Massimo Massa, Zahid Rehman, Theo Vermaelen

SSRN-Mimicking Repurchases by Massimo Massa, Zahid Rehman, Theo Vermaelen


Most examinations of stock buybacks find that the management is conveying information to the market about the relative valuation of the firm. Thus, buybacks are seen as good signals and the price tends to increase atthe time of the announcement and (at least according to some authors) continue to outperform in the months following the buyback announcement.

Massa, Rehman, and Vermaelen extend this research by looking at the other firms in the industry. In the authors' words:
"The central idea of this paper is that an open-market share repurchase announcement may provide information not only about the repurchasing firm but also about its competitors. The competitors, aware of the information externality of their rival’s repurchase decision, react accordingly....We argue that a stock repurchase affects positively the stock price of the repurchasing firm but affects negatively the price of the other competing firms in the same industry. Indeed, as a firm repurchases, it generates expectations that the other firms within the same industry will also repurchase. If they do not, the market will interpret this negatively, attributing it to worse economic prospects or higher agency costs. This induces the other firms in the industry to repurchase, not because they want to take advantage of a significantly undervalued stock price (as predicted by the market timing hypothesis), but simply to correct the negative market perception by mimicking the behavior of their competitors. "
The authors hypothesize that the negative impact on competitors of a stock buyback will be most pronounced in a concentrated industry. And sure enough, they find this to be the case:
" the unconcentrated industries, a repurchase of a firm does not significantly affect the other firms, in the concentrated ones, the impact is significant and negative."

The implication of this is that "The more concentrated the industry, the more likely it is that a firmrepurchases shares if other firms are repurchasing shares. " When coupled with the finding that in concentrated industries, there is less of a positive response to these subsequent announcements, this is taken as evidence that the firms in concentrated industries are expected to do buybacks after the initial firm does a buyback.

If this is true, then it implies that firms in concentrated industries are doing buybacks not because of market timing but because of peer pressure, should not have as strong of signal nor should they experience a positive long term drift. Again in the authors' words:
"Stocks of high concentration firms initiating a repurchase do not experience any significant long run abnormal returns (over the 36 months following the announcements). This contrasts with repurchases in competitive industries that deliver an average long run abnormal return equivalent to 25% over the 36 months following the announcement.
See, I told you it was interesting. So maybe there is more to a simple stock buyback than meets the eye!

Massa, Massimo, Rehman, Zahid and Vermaelen, Theo, "Mimicking Repurchases" (February 26, 2005). EFA 2005 Moscow Meetings Paper. Available at SSRN:

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