SSRN-Share Repurchase, Executive Options and Wealth Changes to Stockholders and Bondholders by Sang-Gyung Jun, Mookwon Jung, Ralph Walkling
Short version: This paper attempts to disentangle the signaling story ("we are buying back stock because we are undervalued") and the wealth transfer ("we are buying back stock because we can screw over bondholders") stories.
The findings are
"generally consistent with the positive signaling effect of stock repurchases, but also provide some support for wealth transfer. In the subset...where signaling effects are less likely, the positive correlation of wealth changes between stockholders and bondholders is completely eliminated. Finally, bond ratings are much more likely to be upgraded in samples without executive options which is precisely where the signaling effects are expected to be concentrated."Besides updating previous literature (and looking at data in the post 1997 Lehman Brother Bond Database world), the authors find that the reason for the buyback is important. Not surprisingly (and confirming Kahle's 2002 findings), if the repurchase is being done to fund option plans, then there is less of a stock price reaction.
Again in the authors' own words:
"In general, our results on equity alone or bonds alone indicate positive wealth changes to equity holders and negative wealth changes to bondholders surrounding repurchase announcements. For bondholders, however, the wealth losses are only significant in the subset of firms associated with options. These are precisely the cases where any off-setting effects of positive signaling are less likely to occur....."additionally:
"...results show that bond ratings for [repurchasing] firms with options are less likely to be upgraded after stock repurchases." [Thus, the] ...results are generally consistent with positive signaling but also provide some support for wealth transfer."
VERY COOL! An I^3 paper! (Interesting, Important, and Informative!)
Jun, Sang-Gyung, Jung, Mookwon and Walkling, Ralph A., "Share Repurchase, Executive Options and Wealth Changes to Stockholders and Bondholders" (March 14, 2006). Available at SSRN: http://ssrn.com/abstract=891664