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 proï¬table 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 signiï¬cant beneï¬ts from eliminating the undervaluation of the ï¬rmâs 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 beneï¬t 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 ï¬ 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 stockâcash that management may expect to have proï¬table
Journal of Applied Corporate Finance – Wiley
Published: Jun 1, 2007
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