Open Market Stock Repurchase Signaling

Abstract

This paper presents a signaling model of open market repurchases that simulates the effects of a repurchase on the insiders' utility. If insiders refrain from tendering, then they are exposed to more risk. If insiders are risk averse, then the market can draw several inferences regarding the insiders' expectations of their firm's future earnings: 1) firms that repurchase more have higher earnings; 2) holding the repurchase proportion constant, riskier firms have higher earnings; and 3) holding proportion constant, firms where insiders have a greater ownership stake have higher earnings. I test the model's implications with a sample of over 700 US repurchases and find support for all three.