Share Repurchases and the Need for External Finance

Share Repurchases and the Need for External Finance What is the appropriate payout policy for an undervalued company that, although lacking immediate uses for its cash holdings, may have promising growth opportunities and profitable uses for the capital one or two years down the road? In thinking about such a case, we reasoned that for undervalued companies that expect to raise more equity in the not too distant future, there could be significant benefits from eliminating the undervaluation of the firm’s shares by offering to buy back shares before issuing new ones. We also considered the possibility that share repurchases, after helping raise the value of the undervalued shares, could have the added benefit of dampening the normally negative reaction to the announcement of a new equity offering, given that the share repurchase itself reduces the information gap between managers and investors. If our hypothesis turned out to be right, a fi nancing strategy of seasoned equity offerings preceded by repurchases could represent an effective way for public companies to limit the information costs associated with raising outside capital. Or, to put this another way, the somewhat unusual, even paradoxical-seeming, corporate action of using cash to buy back stock—cash that management may expect to have profitable http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Journal of Applied Corporate Finance Wiley

Share Repurchases and the Need for External Finance

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Publisher
Wiley
Copyright
Copyright © 2007 Wiley Subscription Services, Inc., A Wiley Company
ISSN
1078-1196
eISSN
1745-6622
D.O.I.
10.1111/j.1745-6622.2007.00145.x
Publisher site
See Article on Publisher Site

Abstract

What is the appropriate payout policy for an undervalued company that, although lacking immediate uses for its cash holdings, may have promising growth opportunities and profitable uses for the capital one or two years down the road? In thinking about such a case, we reasoned that for undervalued companies that expect to raise more equity in the not too distant future, there could be significant benefits from eliminating the undervaluation of the firm’s shares by offering to buy back shares before issuing new ones. We also considered the possibility that share repurchases, after helping raise the value of the undervalued shares, could have the added benefit of dampening the normally negative reaction to the announcement of a new equity offering, given that the share repurchase itself reduces the information gap between managers and investors. If our hypothesis turned out to be right, a fi nancing strategy of seasoned equity offerings preceded by repurchases could represent an effective way for public companies to limit the information costs associated with raising outside capital. Or, to put this another way, the somewhat unusual, even paradoxical-seeming, corporate action of using cash to buy back stock—cash that management may expect to have profitable

Journal

Journal of Applied Corporate FinanceWiley

Published: Jun 1, 2007

References

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