Wednesday, January 18, 2012

Silent Combat: Do Managers Use Share Repurchases to Trade Against Short Sellers? by Harrison Liu, Edward Swanson :: SSRN

Silent Combat: Do Managers Use Share Repurchases to Trade Against Short Sellers? by Harrison Liu, Edward Swanson :: SSRN:

I caught myself literally saying "Wow" when I read this....

Liu and Swanson look at the timing of stock repurchases. Past literature had shown that managers prefer share repurchases to dividends. One reason often given for this preference is the flexibility that buybacks have as opposed to dividends which, once set, are rarely lowered. We have known that this flexibility results in some market timing but what had only been speculated on, was that managers use buybacks to counter act short selling.

The Abstract: (emphasis is my own)

Motivated by the substantial capital used to repurchase stock and its potential to affect price discovery, we develop an empirical model of changes in corporate share repurchases. We find that several accounting measures of capital availability and firm performance influence repurchases, but our novel discovery is that corporate managers trade against shorts by increasing share repurchases in response to an increase in short sales. Trading against shorts appears to violate SEC regulations that price be set by “independent market forces without undue influence by the issuer.” We also examine how managers trade with their personal capital. In general, they trade with short sellers (i.e., selling when shorts sell); however, managers change their behavior and do not sell when the company is repurchasing shares. By not selling their personal stock holdings, managers maintain the credibility of the buy signal from the corporate share repurchases.

Two "Look-ins":
"We estimate that quarterly share repurchases increase by an average of $1,140,000 for each one percentage point increase in short interest. This trading is unlikely to result from reverse causation, whereby short sellers react to corporate repurchases (i.e., endogeneity), because (1) short sellers have no incentive to increase their position when a company is buying back its shares, and (2) the amount of corporate share repurchases is reported quarterly, so it is not readily available to shorts in a timely manner."
"Managers can easily monitor the aggregate short position in their company’s stock since short interest is publicly reported....managers’ could adjust share repurchases to counteract changes in short sales. International Bancshares Corporation (IBC) is one of the few companies to publicly admit to this practice. In a press release on March 25, 2009, IBC states that it “is particularly vulnerable to the harmful practices of short-traders because under CPP, the Company is prohibited from repurchasing its common stock. (CCP refers to the U.S. Treasury Department’s Capital Purchase Program.) The Treasury, which held stock warrants as part of TARP funding, responded by granting IBC permission to repurchase stock. "

Fascinating stuff! I^3 (Interesting, important, and informative!)

Liu, Harrison and Swanson, Edward P., Silent Combat: Do Managers Use Share Repurchases to Trade Against Short Sellers? (January 16, 2012). Available at SSRN:
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