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Ethical Issues Around Share Repurchase Announcements: The Role of Social Capital

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Abstract

We examine whether social capital mitigates managerial opportunism around share repurchase announcements. We find that firms headquartered in high social capital states are associated with: (i) higher repurchase completion rates, and more so in environments where governance is weak and the potential for misleading investors is high, (ii) a smaller likelihood of information manipulation such as revealing bad news before repurchases, and (iii) lower completion rates when shares are less undervalued. By documenting that firms’ external social environments help curb managerial opportunism, our study suggests that the location of headquarters facilitates trustworthiness and affects ethical considerations in corporate announcements.

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Data availability

The details about sourcing of data and variable construction are included in the published article.

Notes

  1. While the focus of this paper is on managerial opportunism around repurchases, there are also a number of traditional explanations in the literature for why firms repurchase shares, including signaling undervaluation, distributing excess cashflows, and controlling earnings dilution.

  2. Likewise, Kracher and Johnson (1997) contend that firms with low repurchase completion rates create “distrust in the investment community and intentionally mislead the public in violation of the SEC’s antifraud provisions.” In a similar vein, Chan, Ikenberry, Lee, and Wang (2010) suggest that managers at firms with poor earnings quality face pressure to boost stock price and consequently use repurchase announcements to mislead investors.

  3. Coleman (1988) suggests that social capital is a public good whereby people in a region accrue social capital through their relationships and interactions with each other, and everyone in the region benefits from this social capital. Examples of social capital cited by Putnam (2000) include neighbors informally keeping an eye on one another’s homes, a tightly knit community of Hassidic Jews who trade diamonds without having to test each gem for purity, barn-raising on the frontier, and e-mail exchanges among members of a cancer support group. Social capital can be found in friendship networks, neighborhoods, churches, schools, bridge clubs, civic associations, and even bars. The motto in Cheers, “where everybody knows your name,” captures one important aspect of social capital (http://bowlingalone.com/?page_id=13).

  4. The relocation of headquarters is an endogenous decision by the firm, as firms may change headquarters to avail of economic benefits such as lower tax rates, favorable economic environment, lower wages. This possibility raises the concern that firms may experience an increase in their profitability and free cash flows following headquarter relocation, which in turn may lead to higher repurchase completion rates. In our difference-in-difference analysis, we control for return on assets (ROA) and free cash flow (among other variables) to assuage the concern that changes in these variables resulting from the choice of relocation might drive changes in the repurchase completion rate following relocation. A second concern with our difference-in-difference analysis may arise if headquarter relocation impacts cash flows and profitability differently for high and low social capital firms. To address this concern, we formally test and find (in unreported tests) that the free cash flow or return on assets for firms relocating to states with higher social capital is not significantly different from that of firms relocating to states with lower social capital. Collectively, these tests mitigate the concern that the endogenous nature of relocation decisions explains our findings.

  5. The sample size declines significantly from 824 observations when we use institutional ownership to 516 observations when we use the entrenchment index as an alternate measure of governance.

  6. The undervaluation index is computed as the sum of quintile ranks of size, prior six-month returns, and book-to-market ratios. Following prior research, we attribute undervaluation as a primary motive for infrequent repurchasers (e.g., Dittmar and Field, 2015).

  7. To calculate repurchase completion rate we need actual repurchases during eight quarters following repurchase announcements. Consequently, we do not include repurchase plans announced after 2017.

  8. For prior studies that use this measure, see, e.g., Gupta, Raman, and Shang (2018, 2020), Huang, and Shang (2019).

  9. Nain and Vijh (2021) find that forecast errors (i.e., management forecast minus actual earnings) are not significantly different between repurchasing firms and matched firms, and hence conclude that managers do not mislead investors by releasing bad news prior to repurchase announcements. However, in the context of our study, to the extent that firms in low social capital regions may opportunistically manage both forecasted earnings and actual earnings, examination of forecast errors could mask the attempt by managers to mislead investors.

  10. Our results are similar when we define firms with above median discretionary accruals as suspect firms.

  11. E-index is sum of the indicator variables based on the following six provisions: staggered board, limits to shareholder bylaw amendments and charters, poison pill, golden parachute, and supermajority requirements for mergers and acquisitions. E-index can take a value from 1 to 6.

  12. Following Peyer and Vermaelen (2009) we define U-index as the sum of quintile ranks of market value of equity (with firms in the smallest quintile assigned a rank of 5, and firms in the largest quintile assigned a rank of 1), prior six-month stock returns (with firms in the lowest return quintile assigned a rank of 5, and firms in the highest return quintile assigned a rank of 1), and book-to-market ratio (with firms in the highest book-to-market quintile assigned a rank of 5, and firms in the lowest book-to-market quintile assigned a rank of 1).

  13. Using repurchases in the year prior to repurchase announcement, we classify firms that repurchase in three or four quarters as “frequent” repurchasers, in two quarters as “moderate” repurchasers, in one quarter as “infrequent” repurchasers, and in zero quarters as “no repurchases”.

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Acknowledgement

We thank Alice Bonaimé, seminar participants at Financial Management Association (FMA), and Bentley University for helpful comments and suggestions. We would also like to thank two anonymous referees and Hao Liang (Section Editor) for valuable comments that helped us improve the paper significantly. Any remaining errors are our own.

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  1. Bentley University, Waltham, MA, USA

    Atul Gupta, Alok Nemani & Kartik Raman

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  1. Atul Gupta
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Correspondence to Alok Nemani.

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Appendix: Variable Definition and Data Sources

Appendix: Variable Definition and Data Sources

Compustat

Asset tangibility: Tangible assets (AT-INTAN), divided by total assets (AT).

CAPEX: Capital expenditures (CAPX), divided by total assets (AT).

Cash: Cash and short-term investments (CHE), divided by total assets (AT).

Dividend: Total common stock dividend (DVC), expressed as a fraction of firm’s assets at the end of the previous year.

Free cash flow: Operating cash flow (OANCF) minus capital expenditure (CAPX) divided by total assets (AT).

Leverage: Sum of Long-term debt (DLTT) and short-term debt (DLC), divided by total assets (AT).

Market capitalization: Shares outstanding (CSHO) times stock price (PRCC_F).

Market to book: Market capitalization plus long-term debt (DLTT) plus debt in current liabilities (DLC) plus preferred stock (PSTK), divided by the book value of assets (AT).

Operating income: Operating income (OIBDP), divided by book value of assets (AT).

Income volatility: The standard deviation of OIBDP in the past five fiscal years.

Return on Assets: NI divided by book value of assets (AT).

R&D: XRD divided by book value of assets (AT).

Accruals: ΔCurrent assets (ACT) – ΔCash (CHE) – ΔCurrent liability (LCT) – ΔShort-term debt (DLC) – ΔTax payable (TXP) – Depreciation (DP), divided by assets (AT).

Discretionary accruals: Residual from the Jones (1991) model.

$$\frac{Accruals}{TA}=a0\frac{1}{TA}+a1\frac{\Delta sales}{TA}+a2\frac{PPE}{AT}+\varepsilon$$

CRSP

Repurchase announcement return: CAPM abnormal returns during the 3-day window [-1, + 1] around repurchase announcement.

Return volatility: The standard deviation of daily returns during past one year.

Lagged returns: Buy-and-hold return over the prior year.

SDC

Repurchase program size: Value of authorized repurchases divided by book value of assets (AT).

Repurchase completion rate: The percentage shares repurchased from SDC. SDC calculates it as dollar amount of shares repurchased divided by value authorized. If completion rate is missing in SDC, we estimate actual repurchases from Compustat and divide it by dollar value of authorized repurchases to calculate completion rate. Following Bonaimé (2012) we measure actual shares repurchased under the plan as total shares repurchased during the eight quarters following repurchase announcements. However, if the firm made a second announcement within next two years, we include only the shares repurchased between the two announcements.

Prior completion rate: Completion rate for the last repurchase announcement made by a firm. To prevent loss of observation if the prior complete rate is missing we replace it with zero in the regression analysis.

I/B/E/S guidance

Forecast announcement returns: CAPM abnormal returns during [− 1, + 1] days around management forecast release.

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Gupta, A., Nemani, A. & Raman, K. Ethical Issues Around Share Repurchase Announcements: The Role of Social Capital. J Bus Ethics (2023). https://doi.org/10.1007/s10551-023-05552-4

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