A share repurchase involves a voluntary transaction by individual shareholders in which they tender their shares to the firm at a price, which is higher than the prevailing market price of the stock. A stock repurchase leads to a decrease in the number of shares outstanding. Share repurchases are interesting because they combine changes in capital structure with cash payments to the shareholders.

Several motives have been identified for a firm, which plans a LBB. The objective could be to raise the stock price (Dan, 1981; Masulis, 1980, 1983; Cornett and Travalos, 1989; Varaiya and Badrinath, 2001) or to further some other interest of management. Possible stock price related motives include:

1. To use repurchase as a signaling device to send positive signals to the market concerning the financial health of the firm. (Guthart, 1965; Chirelstein, 1969; Norgaard and Norgaard, 1974; Stewart, 1976; Ross, 1977; Ahrony and Swary, 1980; Dann, 1981; Vermaelen, 1981; Asquith and Mullins, 1983; Handjinicolaou and Kalay, 1984; Ofer and Thankor, 1987; Mitchell and Robinson, 1999)

2. To decrease the number of outstanding shares to increase the EPS. (Barrons, 1989; Mitchell and Robinson, 1999; Varaiya and Badrinath, 2001).

3. To provide a tax benefit to the shareholders (Bierman and West, 1966; Chirelstein, 1969; Miller and Scholes, 1978; Ramaswamy, 1979; Vermaelen, 1981; Varaiya and Badrinath, 2001).

4. To benefit from the tax deducibility of interest payments on debt raised to repurchase shares. (Modigliani and Miller, 1958, 1963).

5. To correct stock price-value divergences. (Wu, 1963; Guthart, 1965; Young, 1967; Pratt and DeVere, 1968, Lorie and Niederhoffer, 1968; Jaffe, 1968; Nantell and Finerty, 1974; Stewart, 1976; Dittmar, 2000; Varaiya and Badrinath, 2001)

6. To provide an agency problem solution (Torabzadeh and Bertin, 1986; Davidson and Garrison, 1989; Gupta and Radhakrishnan, 1991; Gupta and Rosenthal, 1991; Sinha, 1991; Garvey, 1992).

7. To benefit corporate insiders who can detect and exploit price-value divergences. (Wu, 1963; Jaffe, 1968; Lorie and Niederhoffer, 1968; Pratt and DeVere, 1968).

8. To attain an optimum leverage position, (Masulis, 1980; Dittmar, 2000; Varaiya and Badrinath, 2001).

9. To use excess cash flow, which otherwise would be wasted by management. (Jensen, 1986a; Nohel and Tarhan, 1998; Barth and Kasznik, 1999; Dittmar, 2000; Varaiya and Badrinath, 2001).

Non-price considerations include:

1. To consolidate the ownership of the company's stock. (DeAngelo, 1988; Mitchell and Robinson, 1999).

2. As a defensive strategy to avoid a takeover (Sliver and Vishny, 1986; Dittmar, 2000).

3. Flexibility offered by repurchase plans compared to dividends (Mitchell and Robinson, 1999, Jagannathan and Stephens, 2000).

4. This research will focus on the stock price related reasons for share repurchase.

In the absence of market imperfections, the tender price does not affect the total wealth impact of a LBB. It does, however, effect the distribution of wealth between the tendering and non-tendering shareholders. The wealth distribution effects of a LBB are discussed in this section. First, a model of the wealth distribution effects of the tender price is developed. Then, practical considerations in price setting are summarized.

The purpose of this section is to examine how the price will be expected to respond around the announcement of a LBB. Previous research has shown that the announcement of a share repurchase has a positive effect on the price of the stock in the time immediately after the announcement.

We assume that an amount of total wealth "w" is created by the LBB. The expected relationship between the stock price before and after the LBB announcement is:

P_a = P_b + w/N_b (1)

where:

• P = price of the stock.

• N = number of shares outstanding.

• b = time period immediately before the announcement of the LBB.

• a = time period immediately after the announcement of the LBB.

Let K be the daily rate available on investments of comparable risk. If P_a > P_b(1+k)^d, where d is the number of days in the event window, we can say that the LBB created wealth in the short term. We can also say that non-tendering shareholders gained in the short term.

In order to motivate some of the existing shareholders to tender their shares for repurchase, the firm must offer them an incentive, or in other words some gain which represents present value of the expected future gain to the company. The value of the premium, which is paid over and above the prevailing market price of the firm's shares, has to be carefully decided by the firm. It should not be so low that an insufficient number of shareholders tender their shares. At the same time it should not be so high that the remaining shareholders do not get any share of the increase.

The two commonly used methods of pricing are a fixed tender price, set by the company after consulting its investment bankers, and a Dutch auction. In either case all tendering shareholders receive the same price. Thus the previous wealth distribution model holds for either pricing method (Gay, Kale and Noe, 1991). Research conducted by Comment and Jarrell (1991) showed that the signal was stronger for fixed price tender offers than for Dutch auction offers. They concluded that the fixed price tender offer sent a more powerful signal. Hausch, Logue and Seward (1992) confirmed their results. Lie and McConnell (1998) studied the earnings signals in fixed-price and Dutch auction sell-tender offers and found no difference in earnings improvements between the two types of offers.

The shareholders of the firm consist of different types of investors with individual investment preferences, different tax brackets, and different risk preferences. Thus investors in each category will tender only if the premium paid out to them compensates them for their transaction costs and results in a profit, net of taxes.

The firm, in consultation with its investment bankers, decides on the number of shares it wants to repurchase and decides on a premium, which will motivate a sufficient number of shareholders to tender their shares. Because the firm faces a supply curve of shareholders, the premium will be such that it will motivate investors with a certain risk-return preference.

An event study methodology was used to test the hypothesis. Event studies have been used in the past (Brown and Warner, 1980; Jensen and Ruback, 1983; Trifts and Scanlon, 1987; Mikkelson and Partch, 1988; Cornett and Sankar De, 1988; Schweitzer, 1989; Trifts, Sieherman, Rosenfeldt and Cossio, 1990) to explore abnormal returns accrued to shareholders during mergers, re-capitalization and restructurings, to measure the extent to which bad news affects banks stock returns, and to measure response to new information concerning a group of firms in a particular industry. The event studied in this research initiative is a substantial LBB. An ordinary least squares market model was used to estimate the expected returns. Market model coefficients were calculated using the estimation period t = -30 to t = -180. As the announcement relating to the event could be spread around in a number of days, three alternative event windows, t = (-10,10), t = (-10,0) and t = (-1,0) were investigated. The performance of the sample stock was studied in relation to the performance of a benchmark for the market, in this case the CRSP equally weighted market index with dividends.

The main hypothesis focuses on the question of whether average excess returns are realized in a LBB. The remaining hypotheses are designed to provide evidence with regard to the possible reasons for a positive response to a LBB.

Hypothesis: There is no difference between the stock price before the announcement of a LBB and the stock price immediately after the LBB.

In the second part of the analysis cumulative excess return for each security (CERi) were used as a dependent variable to run a regression analysis. The independent variables in the analysis were variables that may have an impact on the LBB. These have been discussed earlier. The regression equation used is:

(CERi) = a0 + a1X1i + a2X2i + a3X3i + a4X4i +a5X5i + a6X6i + a7X7i +a8X8i + a9X9i+a10X10i + a11X11i + a12X12i + a13X13i + a14X14i + a15X15i + Ei (2)

The following definitions for the independent variables was used in the regression analysis. These variables were calculated using the four quarters of financial statements immediately preceding a date 30 trading days before the announcement of the LBB. The data was taken from the Compustat files.

1. Cash Flow: (X1) The cash flow measure will be the sum of the net income, depreciation and amortization divided by the total assets of the company.

2. Size of the company: (X2) The size of the company can be determined by the total assets of the company.

3. Debt Ratio: (X3) The Debt Ratio is obtained by dividing the total liabilities by the total assets.

4. Percentage of Management Ownership: (X4) This is obtained by dividing the number of common shares owned by management by the total number of common shares outstanding.

5. Defensive/Non-defensive Repurchase: (X5) This is a dummy variable. The value "1" will be used in case the buyback was a defensive repurchase and the value of "0" will be used to denote a non-defensive repurchase. The information concerning defensive/non-defensive share repurchase will be obtained from the Wall Street Journal Company News Index.

6. Effect of Tax Law of 1986: (X6) This dummy variable will study the effect of he 1986 tax law change on the excess returns.

7. Percentage of Shares Repurchased: (X7) This is given by dividing the number of common shares repurchased in the buyback by the total number of common shares outstanding.

8. Return on Assets: (X8) This variable is obtained by dividing the net income by total assets of the company.

9. Market to Book Value: (X9) This is given by dividing the market value of common stock by the book value of common stock. The market price of the stock is its price 30 days prior to the announcement; adjusted for all stock splits, stock dividends etc.

10. Earnings to Price Ratio: (X10) The earnings to price ratio is the earnings per share divided by the price of the stock 30 trading days prior to the announcement.

11. Stock Price Growth: (X11) This is the geometric mean HPR for the estimation period t = -30 to t = -180.

12. Retention Ratio: (X12) This is the earnings per share dividend by dividends per share.

13. Previous Announcement: (X13) This dummy variable will identify those companies, which repurchase shares on a regular basis.

14. Dividend Yield to Total Return: (X14) Dividend yield is given by dividing the dividends for the 12 months starting 30 days prior to the announcement by the total return for the stock.

15. Return on Assets/Free Cash Flow Ratio: (X15) This dummy variable will identify those companies in the sample, which had low profitability; measured by return on assets, and high free cash flow relative to the median of the sample.

The sample for the research were selected from the Wall Street Journal General News Index between the years 1983 to 1991. Some of the major criterion included; the company should have repurchased at least 5% of its common stock from the market by raising at least 50% of the repurchase cost through raising debt. The company should also have been listed on either the New York Stock Exchange or the American Stock Exchange. The study did not include companies that repurchased their stock because of a greenmail threat. These companies were omitted from the sample by tracking them down in the Wall Street Journal Company News Index and checking for any news of a greenmail offer. The event date was decided to be the first announcement of the LBB in the Wall Street Journal. Initially 180 companies were targeted but the list was narrowed down to 31 companies that met the sampling criteria.

Most of the data was obtained from the Compustat Data Retrieval System at the St. Louis University's School of Business Computer Laboratory. Some of the variables were collected manually from the St. Louis University's Pius Library, Washington University's Business School Library, University of Chicago's Library, and also by writing directly to the companies. The following table provides a list of companies used.

This study consisted of a sample of 31 companies. Originally 180 companies were targeted, but the list was narrowed down to the 31 companies in light of the criteria of the research design. The study only used those companies in the sample that traded their stock on either the New York Stock Exchange or the American Stock Exchange. The time frame for the study spanned nine years, from 1983 to 1991. The study also selected those companies that repurchased their stock through public tender offers and not through any other means. An estimation period of 150 days was used for the calculating the expected returns for the sample.

The sample was not restricted with regard to any other financial or economic information, apart from the announcement of a greenmail offer, which might have had an effect on the excess returns generated in a LBB. In cases where there was a public record of a greenmail offer the study excluded those companies from the sample.

Because of these criteria, the sample is not randomly drawn from the universe of LBB's. Obviously there is no way to be certain that the results of this sample can be extended to the LBB population as a whole.

In view of the limitations discussed earlier, a number of possibilities exist for further research. The first could be to increase the sample size by studying a much longer time frame. Another option could be include those companies whose stock is traded over the counter.

The excess returns were significant for the three event windows studied. A new study could be focused on finding more precisely the time when news of the announcement is actually incorporated into the price by the shareholders.

The study focused on companies which repurchased more than 5% of their stock through a LBB, further research could be directed towards studying the impact of very large and comparatively small scale LBB's.

Share repurchase transactions have been on the increase and in recent years have leap-frogged the corporate issues of new stock. In early 2000 over $ 50 billion worth of buyback deals were announced in the United States. In view of these developments it will be interesting to explore if the results of this research can be compared for a later time frame.

Ikenberry, Lakonishok and Vermaelen (2000) studied stock repurchases in Canada and found abnormal performance over a three year holding period. Future research can be directed at looking at the Canadian repurchases and the factors that may be responsible for this result on similar lines of investigation as this research.

A new study could also incorporate the effect of other financial and economic news that may have an effect on the stock price during the LBB announcement time frame. This study could evaluate the true impact of the LBB announcement after discounting for the price effect of other financial and economic news concerning the company.