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Abstract
Does the implementation of a share repurchase strategy create long-run firm value? Do companies initiating a strategy of repurchasing shares outperform companies not implementing this strategy? These two questions provide the foundation for this empirical study. An objective of the study is to use Tobin's Q ratio to determine if there is a change in the pre and post performance of companies with stock repurchase programs. A second objective is to determine if companies that repurchase shares outperform companies that do not repurchase shares, based on the performance of Tobin's Q ratio.
The findings weakly support the hypothesis that a repurchasing strategy resulted in an improvement in firm performance, as reflected in a higher Tobin's Q ratio. The results did not support the hypothesis that firms repurchasing shares would have a higher Tobin's Q ratio than firms not repurchasing shares.
Introduction
AMERICAN COMPANIES BUYBACK shares in excess of US$2.6 billion per month1. This highlights the significance of share repurchases as a strategic alternative for corporate management. There is limited evidence, however, that these strategies create long-run firm value theoretically, successful capital investments create long-run firm value and therefore repurchasing shares, a strategic investment, should result in the generation of long-run value. In prior studies, Tobin's Q ratio has been used in a number of studies to measure the effect a firm's investment strategy has on its long-run value (Perfect, Peterson & Peterson 1995, Lang & Stultz 1994). This study investigates the efficacy of repurchasing shares in terms of the creation of firm value through changes in Tobin's Q ratio.
Prior studies present several explanations as to why firms initiate share repurchase programs. For example, it is suggested that a share repurchase is a managerial signal indicating, confidence in the future performance of the firm (Asquith & Mullins 1986), excess cash reserves (Perfect, Peterson, & Peterson 1995), an undervaluation or a lack of sufficient investment opportunities (Wansley, Lane & Sarkar 1989). Other explanations focus on the firm's target financial leverage (Tsetsekos, Kaufman & Gitman 1991).
Academic research has generally supported the information and signalling hypothesis. In other words that management possess information not known to the market and a cash distribution to shareholders indicates an expectation by the company that future cash flows...