Anomalous Price Behavior Around Repurchase Tender offers TORIo Josef Lakonishok: Theo Vermaelen The Journal of Finance, Vol 45, No. 2. (Jun, 1990), pp 455-477. Stable url: http://links.jstor.org/sici?sici=0022-1082%028199006%2945%03a2%03c455%03aapbart%3e2.0.c0%3b2-0 The Journal of finance is currently published by American Finance Association Your use of the JSTOR archive indicates your acceptance of JSTOR's Terms and Conditions of Use, available at http://www.jstor.org/about/terms.htmlJstOr'sTermsandConditionsofUseprovidesinpartthatunlessyou have obtained prior permission, you may not download an entire issue of a journal or multiple copies of articles, and you may use content in the JSTOR archive only for your personal, non-commercial use Please contact the publisher regarding any further use of this work. Publisher contact information may be obtained at http://wwwjstor.org/journals/afina.html Each copy of any part of a jSTOR transmission must contain the same copyright notice that appears on the screen or printed page of such transmission jStOR is an independent not-for-profit organization dedicated to creating and preserving a digital archive of scholarly journals. For more information regarding JSTOR, please contact support@jstor. org http://www」]stor.org Thu Apr2711:24:592006
THE JOURNAL OF FINANCE. VOL XLV, NO. 2.JUNE 1990 Anomalous Price Behavior Around Repurchase Tender Offers JOSEF LAKONISHOK and THEO VERMAELEN* ABSTRACT This paper reports anomalous price behavior around repurchase tender offers. buying shares before the expiration date of a repurchase tender offer and tendering to the firm roduces, on average, abnormal returns of more than 9 percent over a period shorter han one week. In addition, we find that repurchasing companies experience econo cally and statistically significant abnormal returns in, the two years after the repurchase The upward price drift is mainly caused by the behavior of the small firms in the sample STOCK REPURCHASE TENDER OFFERS have been analyzed extensively by Dann (1981), Masulis(1980), Rosenfeld(1982), and Vermaelen (1981, 1984).These event studies focus on explaining the abnormal price increase around repurchase tender offer announcements. After testing for the relevance of (personal and corporate)tax savings and benefits arising from expropriation of creditors Danr and Vermaelen conclude that the abnormal returns following the announcement are best explained by the information signalling hypothesis. Empirically, the signalling explanation seems to work well for relatively small firms. This is not surprising considering that small firms receive less attention from analysts and are more likely to be undervalued. However, casual empiricism suggests that, in recent years, repurchase tender offers have been made by much larger firms often in the context of hostile takeover bids. Jensen(1986a)argues that these repurchases are an effective way to eliminate excess"free"cash flow that would otherwise be wasted by management. Stulz(1988)argues that repurchases consolidate voting power in the hands of management. This might benefit shareholders by forcing bidders, in successful bids, to pay a higher price for the College of Commerce and Business Administration, University of Illinois at Urbana-Champaign and INSEAD, respectively. Theo Vermaelen is also Hoogleraar at the University of Limburg We are grateful to Peter Bossaerts, David Brown, Frank Buckley, Louis Chan, Harry De angelo, Steve oerter, Paul Halpern, Pierre Hillion, Myron Gordon, David Ikenberry, Han Kim, Chuck Link ene Stulz midt, and an anonymous referee for their helpful comments and to andy chen nd Mark Ready for research assistance. This paper has been presented at the Western Finane ssociation meetings in Seattle, at the European Finance Association meetings in Istanbul, at a nference on Reappraisal of the Efficiency of Financial Markets in Sesimbra, portugal, at a conference on portfol ent at the European Institute for Advanced Studies in Management ty of Alberta, Ur ty of California University, INSEAD at Urbana-ch School of Economics tration in Helsinki, University of michigan, University f Western Ontario, UCLA, the London Business School, and the Stockholm School of Economics. We would like to thank the seminar participants for their comm 455
The Journal of finance target shares. These theories imply that repurchase tender offers can increase real cash flows as opposed to the perceived cash flows of the signalling hypothesis While this paper sheds some light on the changing motivation behind buybacks we are mainly concerned with the implications for investment management: is it possible to make abnormal returns by trading around repurchase tender offers? There are two reasons why buybacks provide an interesting setting in which to examine market efficiency; these reasons correspond to the two types of trading strategies we test. First, a repurchase tender offer creates substantial price uncertainty and therefore more opportunities for potential mispricing. In order to price securities properly during the tender offer period, investors have te estimate 1)the fraction of shares tendered, 2)the subsequent repurchase decisions by the management, and 3)the market price after the expiration of the offer. Hence, the first trading rule tests for profit opportunities during the offer period Specifically, we test whether it is possible to make abnormal returns by buying shares before the expiration date and then tendering those shares to the company. This trading rule mimics the behavior of risk arbitrageurs who typically buy and tender during the offer period. For example, Weinstein(1984), a money manager, states that the investor must keep accurate statistics of the daily trading volume from the time of the announcement of the self-tender until the early pro rata date or registration date of the offer as an indication of how many shares are likely to be tendered. Most of the stock will have been bought by arbitrageurs Larcker and Lys(1987) conclude that risk arbitrageurs earn substantial returns n their trading activities around mergers, intra- firm tender offers, and voluntary liquidations. They argue that risk arbitrageurs are able to generate private information regarding the success of corporate reorganizations. Alternatively one could argue that these excess returns are fair compensation for the services that arbitrageurs provide in takeover bids(Jensen(1986b). Arbitrageurs 1)help to evaluate alternative offers, 2)provide risk-bearing services for investors who would rather sell than bear the uncertainty surrounding the offer, and 3)resolve the free-rider problems of small, diffuse target shareholders who cannot organize to negotiate directly with the bidder. In the case of repurchase tender offers mainly the second service is relevant The second reason for examining market efficiency follows from the result presented in previous studies. Vermaelen(1981)reports that, on average, tend- ering shareholders receive a premium of 23 percent, while nontendering share olders obtain a rate of return of only 13 percent. The nontendering group includes the management of the company which implies that insiders apparently give away"part of the firm to outsiders The increase in the bid price decreases the probability of a successful bic egative impact on firm value. Hence, according to Stulz, the repurchase might increase or decrease rm value, depending on which effect is more important. If managerial holdings are typical in larger firms, the bid price effect might dominate 2 See Weinstein(1984), p 5 At least part of the abnormal return can probably be attributed to illegal insider trading activity
Anomalous Price Behavior Around Repurchase Tender offers 457 One explanation for this behavior is that there might be offsetting benefits fo ent team to compensate for the expropriation of their persona holdings. For example, the repurchase may present an impediment for a potential takeover bid thereby permitting managers to preserve their jobs(Bagwell( 1988) Bagnoli, Gordon, and Lipman( 1987), and Vermaelen (1984). A further benefit to insiders might stem from buying shares before the announcement( Choi 1987)) An alternative to the offsetting benefit explanation is that the market does not fully adjust to the signal conveyed by the offer and therefore underestimates the true"value of the shares. This implies that buying shares after a repurchase tender offer might be a profitable investment, especially in cases where the signalling hypothesis may be most relevant, such as in small firms. 4 Hence, the second trading rule involves buying and holding shares after the expiration date of a repurchase tender offer. Interestingly, in a recent Fortune magazine article Loomis (1986)argues that buying stocks after a repurchase announcement generated annual abnormal returns (over the s&p 500)of 8.5 percent in the period 1974-198 The remainder of this paper is organized as follows In Section I we describe the data base. In Section II we test the first trading strategy: buying stocks before the expiration date whenever the market price is substantially below the tender price, tendering the shares to the firm, and selling the nonrepurchased shares in the market. This simple strategy generates economically and statistically signif- icant abnormal returns of 9 percent on average over a period shorter than one week In Section IIi we examine whether the abnormal returns can be explained by the behavior of management in oversubscribed offers. In Section IV we test the second trading strategy: buying shares after the expiration of the offer. This strategy, over a two-year period following the repurchase outperforms the value weighted index by 12 percent per year. After controlling for size and beta, the abnormal returns fall by more than half but are still significantly positive. Further investigation reveals that these abnormal returns are mainly caused by small firms. These firms were apparently able to buy back their shares at significant discounts from their "true"value. Section V summarizes our results I Data The data base consists of the announcement and expiration dates, the terms (fraction sought and tender price), and outcomes(fraction tendered and fraction purchased) of practically all 258 repurchase tender offers which occurred between 1962 and 1986 by firms traded on the NYSE, AMEx, and OTC. Data for the period 1962-1977 were adopted from Vermaelen( 1981)and include 131 obser vations. Data for 1978 and 1979 were taken from the Wall Street Journal Index Thich started summarizing repurchase announcements in 1978. From 1980 or we had access to all the 13-e4 filing and amendments made with the Security 4We assume that, eventually, with disclosure of financial information about the firm, the market ill be able to assess the"true"value of the shares S A small number of companies were eliminated from the sample because of missing data, mainly
The Journal of finance Table I Descriptive Statistics of the Sample Mean values (in percent)of the terms, the outcomes, returns to nontenderin shareholders, and returns to all shareholders for a sample of repurchase tender offers. The premium (in percent)is defined as the tender offer price minus the price five days before the announcement, divided by the price five days before the announcement. The CAR (in percent)is computed from five days before the an nouncement until ten days after the expiration. The benchmark portfolio is the equally weighted market index. TOTALR is the weighted average abnormal return (in percent)where the weights are Fp for tendering shareholders and(1-Fp)for Period 1962-19861962-1979 0-1986 Fraction of shares sought(Fs) 17.06 15.68 1907 Fraction of shares purchased 16.41 15.45 83.60 Premium 21.79 18.54 Cumulative abnormal return to 12.54 tendering and non-tendering and Exchange Commission. These filings contain basic information about the offer and the outcome of the offer. We used the filing date to track the announce ment date in the Wall Street Journal. If no record of announcement was found in the Wall Street Journal, a questionnaire was sent to the corporation. In these cases, we also searched for an advertisement of the offer in the Wall Street Journal and compared the announcement date to the filing date. Dutch auction repurchases, repurchases intended to reduce small shareholder servicing costs, or repurchases conditional on a minimum number of shares tendered were deleted from the sample. 6 The source for daily stock returns for NYSE and AMEX stocks was the CRSP data base. Data on the daily trading volume for NYSE and AMEX stocks were obtained from the Cornell University Price and Volume File (CUPV).(For a more detailed description, see Lakonishok and Smidt(1984). Data on the OTc stocks (including trading volume)were collected from the Standard and Poor's Daily Stock Price Record Table I provides a number of descriptive statistics for 221 observations for which all the data were available. On average, firms offered to buy back 17.06 percent of their shares at a premium of 21. 79 percent above the market price five During our sample period, we have very few cases in the offer was conditional on a inimum number of shares tendered. Such offers might be eived as more risky. Therefore, to control for risk of our trading strategy, these few cases were