Corporations Do Not Optimize Share Repurchases

Despite possessing insider information, corporate executives would realize higher returns on share repurchase programs if they simply followed a dollar-cost-averaging approach, according to a recent study.

Despite possessing insider information, corporate executives would realize higher returns on share repurchase programs if they simply follow a dollar-cost-averaging approach, according to a recent study. Buying shares in equal dollar amounts over a period of time was found to be better than the discretionary purchase strategy used by corporations.

The study’s authors looked at nearly 5,500 U.S. corporations with at least one recorded event of share repurchases between 1984 and 2010. A firm was included if it bought back the equivalent of at least 0.1% of its outstanding shares during a quarter.

On average, companies realized a return of 7.66% during the one-year period following their share repurchases based on end-of-quarter prices. Though positive, it was less than what they would have realized by following systematic dollar cost averaging. Annualized returns for the “smoothed” approach were between 0.5% to 2.0% depending on the length of time over which purchases occurred (ranging from one year to the firm’s lifetime).

Actual data on share repurchases became available after 2004. When returns were calculated based on actual reported prices and amounts, discretionary purchases realized a higher one-year return than the systematic approach would have. This advantage was not lasting, with the dollar-cost-averaging strategy realizing higher annualized returns over periods of two years and longer. This disparity existed even when executives explicitly gave perceived undervaluation as the reason for buying back shares. As the study’s authors explain, “Even the group of firms that publicly assert that they are making a good investment in their stock could have made a better investment by just mechanically spreading out their repurchases evenly.”

Corporations do buy back stock for reasons other than valuation. One reason is to help meet earnings expectations or to offset potential share dilution (not uncommon sources of criticism). Doing so incurs costs relative to dollar cost averaging.

A few other observations of note from the study: The median repurchase amount for companies making repurchases is $5.08 million per quarter; the median proportionate amount of outstanding shares purchased each quarter for these companies is 0.84%.

Source: “The Cost of Financial Flexibility: Evidence From Share Repurchases;” Alice Bonaimé, Kristine Hankins and Bradford Jordan; Journal of Corporate Finance; February 11, 2016.