Share Repurchases
Handbook of Corporate Finance, forthcoming
Alice Bonaimé
Eller College of Management
University of Arizona
alicebonaime@arizona.edu
Kathleen Kahle
Eller College of Management
University of Arizona
kkahle@arizona.edu
Abstract
Share repurchases have reached record values – almost $1 trillion in 2018 – and surpassed dividends to
become firms’ preferred payout method. Understanding their causes and consequences is thus more
important than ever. We survey the share repurchase literature with an emphasis on the last decade.
Traditional repurchase motives such as dividend substitution, agency costs, signaling, and taxes generally
remain true but are complex. For instance, firms do not directly substitute repurchases for dividends; often
these payouts complement one another. In fact, it is repurchases’ distinctions from dividends – namely,
their perceived flexibility relative to sticky dividends – that has likely made them so popular. Another
reason some firms repurchase is to reduce agency costs associated with excess cash. Managers, however,
also use repurchases to meet short-term earnings and compensation goals. These repurchases do not solve
agency problems but are their symptom. Repurchases in the 2000s are weaker undervaluation signals than
in the 1980s and 1990s. Although stock prices still tend to jump at the announcement of repurchases, they
no longer consistently rise in the long-term. Further, the firms that buy back the most (large firms) do not
advantageously time repurchases. Shareholder tax preferences affect payouts, and payout influences which
investors are drawn to the firm. Corporate taxes, specifically repatriation taxes, also significantly impact
repurchases. New repurchase motives have emerged too: Payout policy is closely intertwined with other
firm characteristics and policies including liquidity, investment decisions, hedging policy, product market
competition, and labor contracts. Though recent studies have significantly enriched our understanding of
repurchases, many interesting questions remain for future research.
Keywords: Share repurchases, share buybacks, payout policy, dividends, agency costs, signaling
We thank Heitor Almeida, Monica Banyi, Matt Billett, Peter Cziraki, Harry DeAngelo, Amedeo De Cesari,
Slava Fos, Fangjian Fu, John Graham, Jarrad Harford, Sheng Huang, Mathias Kronlund, Inmoo Lee,
Evgeny Lyandres, Alberto Manconi, Bill Megginson, Roni Michaely, David Moore, Alok Nemani, Stefan
Obernberger, Jacob Oded, Martin Schmalz, Shawn Thomas, Yuri Tserlukevich, Emre Unlu, Theo
Vermaelen, and Ellie Yin for comments and suggestions. All errors and omissions are our own.
Electronic copy available at: https://ssrn.com/abstract=4074962
Corporate payouts have reached record levels. Over the past half-century, publicly-held U.S. firms have
more than tripled inflation-adjusted dividends, and real share repurchase values have ballooned from $5
billion in 1971 to almost $1 trillion in 2018, in the process becoming the dominant form of payout. Given
the magnitudes of these distributions, it is perhaps not surprising that they have garnered the attention of
researchers—not to mention the skepticism of regulators. This chapter surveys the academic literature on
repurchases, with a particular emphasis on research undertaken in the last decade.1 Recent regulatory
actions both within the United States and internationally have caused sea changes in payout policy, and the
availability of new and better data has opened new avenues of study. These regulations, along with new
accounting standards such as FAS 123R, have allowed for some interesting natural experiments. Moreover,
innovations in econometric techniques have been used to improve identification and allow for better claims
regarding causality. Of course, an examination of repurchases is often incomplete without examining
payout policy in general, so when necessary, we discuss repurchases in the context of payout policy and
compare/contrast with dividends.2
This chapter begins by examining trends in payout policy over the past half-century with a focus on
cash dividends and open market repurchases. While both dividends and share repurchases have increased
in real dollars, repurchases have outpaced dividends. Apart from during the Great Recession, firms spent
more cash on repurchases than on dividends in every year since the turn of the century. Repurchases even
exceeded dividends amid the Covid-19 pandemic. Repurchases vary more than dividends, however; they
tend to rise and fall with the business cycle, while dividends usually increase steadily over time. We also
document an uptick in the proportion of firms repurchasing, both in isolation and as a complement to
dividend payments. In contrast, firms that only pay dividends have become rare. Although the real dollar
value of payouts has grown and a larger fraction of firms are paying out cash, payout yields, defined as
payouts scaled by market capitalization, have remained stagnant. We observe a similar phenomenon with
repurchase announcements: Although the aggregate dollar value of repurchase announcements has
increased over time, the frequency of repurchase announcements has remained stable since the turn of the
century. Taken as a whole, these patterns suggest that large firms account for the bulk of payout growth. In
other words, payouts are increasingly concentrated within fewer firms.
Next, we review the literature related to repurchase motives. Section II discusses one of the most
commonly cited repurchase motives: dividend substitution. The dividend substitution hypothesis contends
that, because dividends and repurchases both represent distributions from the firm to shareholders, firms
1
For a more thorough review of earlier literature, see Allen and Michaely (2003), Vermaelen (2005), DeAngelo,
DeAngelo, and Skinner (2008), and Farre-Mensa, Michaely, and Schmalz (2014).
2
For a more detailed look at dividends, we refer the reader to Chapter 3.
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use these types of payouts interchangeably. Substitution between dividends and repurchases is not obvious,
however, due to important distinctions between these two forms of payout. For example, historically they
have been taxed differently. Moreover, managers do not view dividends and repurchases as close substitutes
(Brav, Graham, Harvey, and Michaely, 2005).
One of the main benefits of repurchases over regular cash dividends is flexibility. While regular
dividends are associated with an expectation of continuation, managers view repurchases as less rigid (Brav,
Graham, Harvey, and Michaely, 2005). Allen and Michaely (2003) suggest that the rise in the popularity
of repurchases increased both overall payout and firms’ financial flexibility. Indeed, during recessions and
in response to credit supply shocks, firms pull back on repurchases more so than on dividends (Dittmar and
Dittmar, 2008; Bliss, Cheng, and Denis, 2015; Floyd, Li, and Skinner, 2015). Firms also tend to make
dividend payments from permanent earnings but make repurchases from more transitory earnings (Guay
and Harford, 2000; Jagannathan, Stephens, and Weisbach, 2000; Lee and Suh, 2011). This evidence is
consistent with repurchases being more flexible than dividends.
More recent research focuses on the tradeoff between signaling commitment and retaining a flexible
payout structure. Not surprisingly, investors prefer stronger commitments to distributing cash and react to
payout announcements accordingly. Firms must therefore weigh the benefits of payout flexibility against
the costs of a weaker signal. The advent of preset repurchase plans, such as accelerated share repurchase
plans (“ASRs”) and Rule 10b5-1 plans, provides managers with an opportunity to signal a stronger
commitment to distribute cash than open market share repurchases do, but with a more flexible payout
structure than a regular dividend (Bargeron, Kulchania, and Thomas, 2011; Bonaimé, Harford, and Moore,
2020). These advantages certainly help explain the popularity of preset plans.
A major advantage of a more flexible payout structure—for example, one favoring repurchases over
dividends or one with lower payout levels—is that it may increase a firm’s ability to invest in profitable
projects as they arise. Therefore, firms may substitute payout flexibility for other means of maintaining
financial flexibility. Recent work supports this claim. Payout flexibility substitutes for hedging (Bonaimé,
Hankins, and Harford, 2014) and payout levels correlate positively with debt capacity (Kumar and VergaraAlert, 2020) and internal capital markets (Jordan, Liu, and Wu, 2018) but negatively with product market
threats (Hoberg, Phillips, and Prabhala, 2014). Debt-financed repurchases also reduce firm flexibility and
increase financial fragility by constraining firms’ ability to raise capital and invest during economic
downturns (Farre-Mensa, Michaely, and Schmalz, 2021).
Section II concludes by discussing whether repurchases are responsible for “disappearing dividends.”
Though there is evidence that fewer firms pay dividends today than had done so decades ago (e.g., Fama
and French, 2001), firms do not explicitly cut dividends and replace them with repurchases. Rather,
repurchases now supplement dividends; over time, firms use cash that would have been used to increase or
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initiate dividends to instead increase or initiate repurchases (Grullon and Michaely, 2002; Banyi and Kahle,
2014). Meanwhile, dividends themselves have become increasingly concentrated in large profitable firms
(DeAngelo, DeAngelo, and Skinner, 2004; Kahle and Stulz, 2017; Kahle and Stulz, 2021). The life cycle
theory of the firm along with the changing composition of firms going public in more recent decades help
explain the growth in repurchases relative to dividends (e.g., DeAngelo, DeAngelo, and Stulz, 2006; Julio
and Ikenberry, 2004; Banyi and Kahle, 2014).
Section III examines agency conflicts and payout policy. Theoretically, payout can reduce the agency
costs associated with free cash flow by removing excess cash from managerial control (Jensen, 1986). In
an earlier survey, Allen and Michaely (2003) conclude that dividends and repurchases seem to be used to
reduce potential overinvestment by management. More recently, John, Knyazeva, and Knyazeva (2011)
show that firms with greater agency costs of free cash flow, proxied as firms in remote locations, tend to
make larger payouts. Other studies use cross-country data and find a positive relation between corporate
governance and payout, however; these studies suggest that better governed firms pay out more (La Porta,
Lopez-de-Silanes, Shleifer, and Vishny, 2000; Alzahrani and Lasfer, 2012). Another strand of literature
examines whether managers use corporate payouts to transfer wealth from bondholders to shareholders,
with mixed results.
Although the above literature suggests that repurchases are used to solve agency problems, recent
research suggests that repurchases may be a symptom of agency problems. Consequently, Section III
continues to explore agency concerns and payout by examining managerial incentives for repurchases,
beginning with the dilution and dividend protection hypotheses. The dilution hypothesis predicts that
repurchases are intended to fund the exercise of employee stock options, possibly to avoid dilution. The
dividend protection hypothesis suggests that executive options provide managers an incentive not to pay
dividends, since payment of dividends reduces the value of options held by managers. While Kahle (2002)
finds evidence consistent with both hypotheses, more recent results from Bonaimé, Kahle, Moore, and
Nemani (2020) only support a positive relation between compensation and share repurchases via the
dilution channel. Bens, Nagar, Skinner, and Wong (2003) also find evidence consistent with managers
being concerned about dilution but suggest that executives use repurchases to manage diluted (rather than
basic) earnings per share (EPS). Further evidence that repurchases are used as an earnings management tool
comes from survey evidence (Brav et al., 2005; Graham, Harvey, and Rajgopal, 2005). Because repurchases
motivated by managerial considerations such as compensation and EPS management are not associated
with free cash flow, firms have increased the tendency to finance them using debt (Farre-Mensa, Michaely,
and Schmalz, 2021).
The above findings that firms use repurchases to meet EPS thresholds have caused some researchers to
question the opportunity cost of repurchasing. Specifically, do managers cut investments in long-term
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projects to fund repurchases motivated by short-term goals? If so, this behavior suggests managerial
myopia. A survey of CFOs by Graham (2022) explores the tension between payout versus investment and
finds that dividends are more likely than repurchases to crowd out investment, consistent with dividends
being sticky. Empirically, repurchases tend to negatively correlate with investment (Grullon and Michaely,
2004; Boudry, Kallberg, and Liu, 2013), but this correlation does not necessarily imply a causal relation; a
dearth of investment opportunities could drive both low investment and high distributions to shareholders.
To examine this issue, Almeida, Fos, and Kronlund (2016) exploit the discontinuity in repurchase likelihood
around EPS thresholds. Consistent with a causal link between repurchases and investment, they find that
repurchases lead to decreases in investment, research and development, and employment. Related work
shows that repurchases increase when managers’ equity in the company vests (Edmans, Fang, and Huang,
2021; Moore, 2020). Because vesting is highly correlated with equity sales, this evidence suggests managers
may use repurchases to prop up stock prices at times when they personally benefit from high prices. Yet,
following these and other seemingly myopic repurchases, there is no evidence of shareholder value
destruction in the long term (Moore, 2020; Bargeron and Bonaimé, 2020). Thus, while new research
suggests repurchases can have real effects on firm policies such as investment and may correlate with
insider sales, future research may focus on whether this behavior exists only on the margin or is widespread,
and whether the impacts of such repurchases are temporary or lasting.
Section IV reviews the literature related to the signaling and free cash flow hypotheses. The signaling
hypothesis claims that managers, who possess inside information about the future earnings of the firm, use
payouts to signal news to market participants (Miller and Rock, 1985). As previously mentioned, the agency
costs of free cash flow hypothesis posits that investors like payouts because they reduce the amount of
excess cash under managers’ control (Jensen, 1986). Importantly, both theories predict positive (negative)
reactions to announcements of payout increases (decreases). Empirically, studies confirm this prediction.
Dividend initiations are associated with abnormal returns of around 3% (Michaely, Thaler, and Womack,
1995) while dividend omissions and cuts generate abnormal returns ranging from -3.5% to -7% (Michaely,
Thaler, and Womack, 1995; Kahle and Williams, 2018). Open market repurchase authorizations, which
represent a weaker signal and less of a commitment to distribute cash to shareholders relative to repurchase
tender offers or regular cash dividends, are associated with abnormal returns of 2.6%, but repurchase
suspensions evoke 1.4% price drops on average (Bargeron et al., 2022). Repurchases are also associated
with long-run abnormal returns, particularly for value firms (Ikenberry, Lakonishok, and Vermaelen, 1995;
Peyer and Vermaelen, 2009; Manconi, Peyer, and Vermaelen, 2019) although post-repurchase long-run
returns appear to have declined in recent years (Obernberger, 2014; Fu and Huang, 2016; Lee, Park, and
Pearson, 2020). Despite the significant abnormal returns to the announcements of dividends initiations and
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repurchase authorizations, signaling theories have found only weak support, both empirically and in survey
evidence (Allen and Michaely, 2003; Farre-Mensa, Michaely, and Schmalz, 2014).
At the core of the signaling theory is the underlying assumption that managers possess private
information about the firm and use it when making payout decisions. Although they reject the notion that
the purpose of the repurchase is to provide a signal (Brav et al., 2005), CFOs themselves say that “taking
advantage of an undervalued stock price” is the most important motive for repurchasing stock. The
aforementioned long-run abnormal returns following share repurchase announcements suggest that
managers may incorporate positive, private information when deciding to repurchase stock. A 2004 change
in SEC reporting requirements resulted in more granular and reliable data on repurchase prices, which has
allowed researchers to test managerial timing ability even more directly. Studies using these data generally
document evidence of managers repurchasing at advantageous prices, although skilled repurchase timing
is concentrated within certain subsets of firms: less frequent repurchasers, small firms, high growth firms,
and firms with more liquid stock and lower institutional ownership (De Cesari, Espenlaub, Khurshed, and
Simkovic, 2012; Ben-Rephael, Oded, and Wohl, 2014; Dittmar and Field, 2015). Bonaimé, Hankins, and
Jordan (2016) even document suboptimal repurchase timing by comparing dollar-weighted internal rates
of return on actual repurchases with a hypothetical strategy that mechanically smooths repurchases evenly
across longer time periods. It therefore appears that, while some firms successfully time the market when
they repurchase, these advantageous transactions tend to be small and infrequent.
Section V examines the impact of investor preferences and taxes on repurchases. Moser (2007) finds
that in periods in which the dividend tax penalty is higher, firms are more likely to repurchase than to pay
dividends. This relation is strongest when there is a higher proportion of dividend tax-disfavored
shareholders. Desai and Jin (2011) show that the tax preferences of institutional shareholders impact
payouts and payout influences which investors are drawn to the firm. On the other hand, Farre-Mensa,
Michaely, and Schmalz (2014) say that differences in the taxation of dividends and capital gains have only
a second-order impact on setting payout policy. Consistent with investor horizons also influencing payout,
Gaspar, Massa, Matos, Patgiri, and Rehman (2012) find that firms with more short-term investors favor
repurchases over dividends, while Lee, Park, and Pearson (2020) show that recent buybacks seem to be
more motivated by managerial incentives and short-term investor pressures.
Section VI examines how repurchases impact liquidity and market efficiency. Hillert, Maug, and
Obernberger (2016) show that repurchases improve liquidity, particularly when outside investors sell or
during times of crisis. Studies in non-U.S. countries with more rigorous disclosure requirements find similar
results (Chung, Isakov, and Pérignon, 2007; De Cesari, Espenlaub, and Khurshed, 2011). The exception to
the liquidity improvement story is Ginglinger and Hamon (2007), who find that the repurchases by French
firms increase the bid-ask spread. Other studies examine price support and conclude that repurchases
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stabilize prices but find no evidence of price manipulation (De Cesari, Espenlaub, and Khurshed, 2011;
Busch and Obernberger, 2017; Chan, Ikenberry, Lee, and Wang, 2010; Bargeron and Bonaimé, 2020;
Bargeron and Farrell, 2021).
We conclude with Section VII, which summarizes our observations and proposes potentially fruitful
avenues for future research. We note that, while the literature on share repurchases has reached maturity,
many important research questions are still open for debate. For instance, given the substantial policy
implications and the current interest by regulators, it is important to pin down whether firms use available
funds to repurchase in lieu of investing in long-term projects or increasing employment. Moreover, as
repurchases become increasingly common in countries where repurchase regulation and disclosure
requirements differ from those in the United States, more granular data or new regulatory shocks may allow
researchers to better identify the causes and consequences of share repurchases.
Theoretical work by Miller and Modigliani (1961) established the conditions under which payout policy
does not matter, i.e., perfect capital markets, and in doing so indirectly highlighted the capital market
frictions under which payout policy might matter. Past research on repurchases, surveyed by Allen and
Michaely (2003), Vermaelen (2005), DeAngelo, DeAngelo, and Skinner (2009), and Farre-Mensa,
Michaely, and Schmalz (2014), heavily focuses on substituting for dividends, alleviating the agency costs
of free cash flows, signaling undervaluation, and taking advantage of preferential tax rates.
Without completely uprooting these foundational theories, recent research brings to light their nuances.
To begin, studies show that repurchases now substitute for dividends imperfectly at best. Instead, it is likely
that repurchases’ differences from, rather than similarities to, dividends have driven their popularity.
Today’s managers prefer the flexibility of repurchases to the stickiness of dividends. Considerable new
research shows how this flexibility serves as an operational hedge, increasing financial flexibility and thus
impacting other corporate policies. And for firms for which additional financial flexibility provides little
benefit, a new menu of repurchase options—including preset ASR and Rule 10b5-1 plans—allows them to
commit to more regular, dividend-like payouts, while using repurchases. Paradoxically, although
repurchases’ flexibility has led them to become more popular, because firms now repurchase more
consistently, investors have come to expect their continuation (though still not to the same extent they
expect dividends to persist).
Further, new research shows that repurchases do not necessarily mitigate agency problems and may
potentially add to them. Repurchases do not alleviate agency costs if firms finance them with debt instead
of cash on hand, as many firms now do. Additionally, there is a notion that repurchases may exacerbate
conflicts of interest between shareholders and bondholders, between managers and shareholders, and
between short-term shareholders and long-term shareholders. There is solid evidence to suggest that
managers consider repurchases a useful tool to decrease dilution (and thereby increase earnings per share),
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and to provide liquidity (in particular when managers themselves are selling company stock). Such
repurchases come at the expense of investment and employment, at least at the margin.
New research also revisits signaling theory. It teaches us that, while investors still tend to react
positively to repurchase announcements, repurchases are not systematically well-timed or followed by
favorable performance. A repurchase program’s ex post abnormal returns and timing ability depend on its
setting, type of firm, and decade of implementation. Finally, while prior research generally deemed taxes
only a second-order determinant of payout policy, new research exploits recent tax shocks to show that
reductions in corporate tax rates, particularly tax rates on repatriated income, meaningfully impact share
repurchases.
Our fresh review of the payout policy literature sheds new light on why repurchases are popular, both
in absolute terms and relative to dividends. We also highlight open debates in the academic literature, not
to mention among regulators. Given their importance and policy implications, more work is needed to
explore research questions such as the extent to which repurchases come at the expense of long-term
investments and employment and whether repurchases can be used to manipulate stock prices, implying
insiders can time repurchase to benefit themselves. Precise answers to these questions are necessary to
inform the broader conversation among regulators about corporate short-termism. Furthermore, future work
should challenge extant theories about why firms repurchase and advance new theories. For instance, the
fact that firms that have never paid dividends now initiate repurchases is difficult to reconcile with the
theory of dividend substitution; and the fact that the majority of firms now repurchase in any given year,
and many repurchase every quarter, runs contrary to the theory of signaling undervaluation. In addition to
continuing to explore why repurchases have become the predominant payout choice, future theoretical and
empirical work should also investigate how the ubiquity of repurchases influences how managers use them
and how academics think about them.
I.
Trends in Payout Policy
In this section, we examine trends in payout policy using data from the CRSP/Compustat merged
database over fiscal years 1971 to 2020. To remain in our sample, a firm’s stock must trade on the NYSE,
NASDAQ, or AMEX, be associated with CRSP share code 10 or 11, be incorporated in the United States,
and have non-missing total assets (Compustat variable AT) data. We measure dividends using the value of
cash dividends on common stock (DV), which we set equal to zero if missing.3 Repurchases are the purchase
of common and preferred stock (PRSTKC) minus any decrease in preferred stock. Preferred stock is
3
We choose Compustat variable DV (Cash Dividends - Cash Flow) over DVC (Dividends Common/Ordinary) because
we want to focus only on cash dividends paid. In addition to cash dividends paid, DVC also includes dividends owed
on restricted shares but not yet paid.
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measured as redemption (PSTKRV), liquidation (PSTKL), or par value (PSTK) of preferred stock, in order
of preference. Missing repurchase values are assumed to be zero.
[Insert Figure 4.1 here.]
Figure 4.1 plots aggregate dividends and repurchases in inflation-adjusted 2020 U.S. dollars. Solid lines
represent aggregate payout for all firms. Dotted lines plot payout for industrials, which excludes banks (SIC
codes 6000-6999) and utilities (SIC codes 4900-4999), whose payouts are often subject to regulatory
constraints. Aggregate dividend payments have generally followed an upward trend over the past five
decades, climbing from $106 billion in fiscal year 1971 to $523 billion in 2018. The only large dips in
dividends occurred during the Great Recession (fiscal years 2008–2010) and the Covid-19 pandemic (fiscal
year 2020). Dividends within industrial firms follow a similar, though smoother, upward trend from $103
billion in 1971 to $382 billion in 2018, with less of a drop around the Great Recession and the Covid-19
pandemic.
Repurchases have also grown over the past few decades. Repurchases of equity securities are regulated
by the Securities and Exchange Commission (SEC) under the Securities Exchange Act of 1934, which
makes it unlawful for firms to use share repurchases to manipulate stock prices. Repurchases were rare in
the 1970s but took off in the early 1980s, after the SEC introduced Rule 10b-18 of the Exchange Act in
1982. Rule 10b-18 provides repurchasing firms safe harbor against liability for stock price manipulation,
provided they adhere to guidelines regarding the manner, timing, price, and volume of repurchases.4
Repurchases grew from around $5 billion in 1971 to $17 billion a decade later, before exploding after Rule
10b-18 to $97 billion by 1985. Repurchases continued their steady climb throughout the 1990s, surpassing
dividends as the preferred payout mechanism in 1997. Since then, repurchases have generally outpaced
dividends except during the Great Recession, when firms substantially reduced repurchases. Though firms
also reduced repurchases during the Covid-19 pandemic, repurchase dollars still exceeded dollars spent on
dividends. The trends we document here are consistent with the findings of previous studies, including
Dittmar and Dittmar (2008), who show that repurchases occur in waves correlated with GDP growth; Rau
and Stouraitis (2011), who find that repurchase waves are associated with the end of business cycles when
firms are undervalued; and Bliss, Cheng, and Denis (2015), who find that firms decreased payouts,
especially repurchases, during the Great Recession when credit was in short supply. Repurchases peaked
in 2018, reaching almost $1 trillion ($920 billion).
4
Until 2004, the Exchange Act did not require disclosure of actual repurchases, although most firms provided this
information in either the footnotes of the financial statements, the Management's Discussion and Analysis section, or
the statement of stockholders' equity. Since most databases do not extract this information from the firms' 10-Ks,
however, researchers had to estimate the number of shares repurchased. The safe harbor under Rule 10b-18 was
amended in November 2003 (effective December 2003). Firms must now disclose quarterly the number of shares
repurchased each month during the quarter, the average repurchase price, and whether the repurchase was part of a
publicly announced open market repurchase program.
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The difference in payout trends across all firms in our sample versus industrials suggests that banks and
utilities are responsible for a large portion of dividend payments and repurchases in recent years, as well as
much of their variability. For instance, around the Great Recession, although banks were reluctant to cut
dividends, they greatly reduced repurchases (Floyd, Li, and Skinner, 2015; Cziraki, Laux, and Loranth,
2021). We therefore include banks and utilities in our sample for the remainder of our study.
When comparing trends across dividends and repurchases, there are several important takeaways. The
first observation is that repurchase volume is more volatile than dividend volume. While dividends have
followed a fairly monotonic upward trend, repurchases vary more with the overall economy, rising during
economic expansions and falling during contractions. (NBER recessionary periods are shaded in Figure
4.1.) The second observation is that, although both methods of payouts have grown over the past halfcentury, the growth in repurchases has clearly outstripped the growth in dividends. In fact, Brav et al. (2005)
report survey evidence showing that the link between dividends and earnings, first documented in Lintner
(1956), has weakened over time. They find that managers in the 2000s favor repurchases because
repurchases are viewed as being more flexible than dividends and can be used to time the equity market
and to increase earnings per share. Skinner (2008) examines aggregate Compustat earnings, dividends, and
net repurchases for publicly held U.S. industrial firms from 1970 until 2005, and empirically studies the
relation between earnings and payout. Skinner (2008) finds that large, mature, profitable firms continue to
pay dividends, but that these firms’ dividend policies have become more conservative over time.
Repurchases increasingly absorb the variation in earnings, such that the overall relation between these
firms’ earnings and payouts is strong. This conservative approach is consistent with Brav et al. (2005), who
report that repurchasing firms do not view dividends as a close substitute for repurchases. Skinner (2008)
concludes that “while firm-level inertia in dividend payments is considerable, there may come a time when
dividends completely disappear.”
Despite the Skinner (2008) prediction, dividends have been resilient, and aggregate dollars paid out in
the form of dividends begin increasing in 2004, especially in non-industrials. Brown, Liang, and
Weisbenner (2007) attribute this increase to the Jobs Growth and Tax Relief Reconciliation Act of 2003,
which reduced the top marginal tax rate on dividends from 38.6% to 15%. They find that dividends increase
following this tax cut, particularly in firms whose top executives have greater stock ownership and thus
have the incentive to increase dividends for liquidity reasons. Kahle and Stulz (2021) find that aggregate
dividends also increase after 2002, although dividends as a percentage of operating income do not. They
find that in the aggregate, 38% of the increase in payouts in the 2000s is due to firms earning more, while
62% is explained by firms having higher payout rates; the increase in payouts is attributable to an increase
in repurchases, however.
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Payout increases may also be attributable to two tax laws that enabled firms to repatriate foreign income
advantageously in the 2000s. First, the Homeland Investment Act, part of the American Jobs Creation Act
(AJCA) of 2004, provided U.S. multinationals with a one-time tax holiday for the repatriation of foreign
earnings. Passed with the explicit purpose of promoting domestic investment and employment, the AJCA
significantly (but temporarily) lowered the cost of repatriating foreign capital and thus the cost of funding
domestic investments with internal foreign cash. In response to the tax incentives introduced by the AJCA,
U.S. corporations moved over $300 billion from their foreign subsidiaries to the United States; this amount
was substantially higher than the $60 billion or so they repatriated in the years before the Act (Kahle and
Stulz, 2021; Faulkender and Petersen, 2012; Dharmapala, Foley, and Forbes, 2011).
The second tax law that enabled firms to repatriate foreign income advantageously is the Tax Cuts and
Jobs Act (TCJA), which took effect on January 1, 2018, and resulted in tax windfalls from both a corporate
income tax cut and a repatriation tax cut. The 2018 surge in share repurchases we observe coincides with
the TCJA. Bennett and Wang (2021) study the effect of the TCJA on repurchases, leverage, and investment.
They find that the increase in repurchases after the TCJA is due to the repatriation tax cut, and not the
income tax cut. Increased repurchase activity around repatriation tax reductions also fits with the findings
of Kahle and Stulz (2021). They show that, despite concerns from the U.S. Congress about excessive
repurchase volume, abnormalities in repurchase volume are not widespread; rather, they are concentrated
around repatriation tax cuts.5
[Insert Figure 4.2 here.]
Next, we examine payout behavior at the firm level in Figure 4.2. Each fiscal year we classify firms
into four categories based on payout behavior: (i) firms that neither repurchase nor pay dividends, (ii) firms
that only pay dividends, (iii) firms that repurchase and pay dividends, and (iv) firms that only repurchase.
Two striking trends emerge from our analysis. The first is a relatively recent growth in the portion of firms
repurchasing. Even at the turn of the century, just 19% of firms repurchase as the only form of payout, and
15% repurchase and distribute dividends. Two decades later, 28% of firms repurchase only and more than
double (33%) the number of firms repurchase and pay dividends. The second trend is a long-term reduction
in the proportion of firms only paying dividends. While almost half (47%) of firms pay dividends alone at
the beginning of our sample period, by the end merely 9% rely solely on dividends to distribute cash to
shareholders. As noted in Floyd, Li, and Skinner (2015), however, after declining throughout the 1980s and
1990s, the percentage of firms paying dividends increases after 2002. While only 24% of firms pay
dividends in 2002, this figure grows to 42% in 2020. As mentioned earlier, this increase in dividend paying
5
Dividends and repurchases increased after Japan and the UK shifted from a worldwide tax system to a territorial tax
system in 2009, which reduced repatriation taxes for multinationals (Arena and Kutner, 2015), while payout decreased
within Canadian firms whose corporate tax rates increased due to the 2006 Tax Fairness Plan (Doidge and Dyck,
2015).
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firms coincides with the Jobs Growth and Tax Relief Reconciliation Act of 2003, which reduced the top
marginal tax rate on dividends.
Though our focus is on payout patterns in the United States, many of our documented trends extend to
Europe, where share repurchase restrictions have lessened. Von Eije and Megginson (2008) study payout
patterns in 15 European Union countries from 1989 to 2005 and document that the fraction of European
firms paying dividends has declined while real dividends and share repurchases have risen. These patterns
mirror the trends we observe in the United States.
[Insert Figure 4.3 here.]
Figure 4.3 also examines payout behavior at the firm level, now bifurcating our sample on concurrent
earnings. We measure earnings as net income (NI) and split our sample into positive and negative earnings
groups, similar to Fama and French (2001). The patterns documented in Figure 4.2 hold across both groups,
but segmenting on earnings provides several new insights. Perhaps not surprisingly, positive earnings firms
are more likely to distribute cash to shareholders in any form. Although Fama and French (2001) document
a declining propensity to pay (more on this later), since the end of their sample period in 1996, the fraction
of firms with no payout has declined significantly. More interestingly, negative earnings firms now clearly
prefer repurchasing as their primary means of distributing cash to shareholders. By the end of our sample
period, almost one-third of firms with negative earnings repurchase as their sole method of payout while
5% pay dividends only and 12% repurchase and pay dividends.
[Insert Figure 4.4 here.]
Figure 4.4 examines trends in payout yield within firms with positive payout. Yields represent the dollar
value of payout, expressed as a percentage of market capitalization (the number of share outstanding
(CSHO) times stock price (PRCC_F) at the end of the prior fiscal year). Dividend and repurchase yields
declined during the 1970s and 1980s but have hovered around 2–4% since the 1990s. Mean yields generally
exceed medians, consistent with skewness in the yield distribution. The lack of meaningful recent growth
in yields suggests that concurrent growth in aggregate payout is likely driven by large firms.
[Insert Figure 4.5 here.]
Next, we examine repurchase announcements in more detail. To do so, we rely on data from the
Securities Data Corporation Mergers and Acquisitions database, which begins recording repurchase
announcements in 1980. Figure 4.5 plots annual repurchase announcement frequency for U.S. firms, both
for all repurchases and for open market repurchases only. Repurchase announcement frequency grew
throughout the 1980s and 1990s but has stabilized since the turn of the century. The decline in repurchase
announcement frequency around the turn of the century is partially driven by the drastic decline in the
number of publicly traded companies, from approximately 7,000 in 1997 to under 4,000 in 2008 and
afterward. Announcements were particularly infrequent at the end of our sample in 2020. While low
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announcement volume could be a byproduct of the Covid-19 crisis, announcement frequency was already
low in 2019 prior to the pandemic.
Stock repurchases can be performed in a variety of ways, but 90% of announcements include an open
market repurchase component. In open-market repurchase programs, a firm announces its intention to buy
back shares and then repurchases shares in the open market over several years. The remaining 10% of
repurchase announcements include tender offers, Dutch auctions, privately negotiated repurchases, and
preset repurchases such as accelerated share repurchases and Rule 10b5-1 plans. In tender offer repurchases,
a firm offers existing shareholders the opportunity to sell their shares back directly to the firm within a short
period of time from the offer date (generally one month). A fixed-price offer specifies a single purchase
price in advance, the number of shares sought, and an expiration date. Because fixed-price tender offers
represent a commitment to repurchasing shares above going market prices, they send a strong signal to
investors that the company’s stock is currently undervalued. Recently, Dutch auctions have somewhat
displaced tender offers. The Dutch auction offer specifies a number of shares and a range of prices within
which tendering shareholders choose their minimum acceptable selling price. Dutch auctions may be
preferable to fixed-price offers because they generally result in lower repurchase prices (Vermaelen, 2005).
Preset repurchase plans have become more popular since the turn of the century. Accelerated share
repurchases (ASR) are preset plans that represent contracts with an intermediary, generally an investment
bank, to deliver company stock immediately. The investment bank then buys back shares in the open market
over a prespecified time period, at the end of which the firm settles the difference between the initial
purchase price and the subsequent stock prices. During this time the firm is essentially shorting its own
stock. Rule 10b5-1 plans are also preset plans that represent contracts with intermediaries to repurchase
stock on behalf of the firm. Their main purpose is to provide safe harbor against insider trading allegations.
To receive safe harbor, the firm must establish repurchase trading rules during open windows when insiders
are less likely to possess material, non-public information. After establishing a Rule 10b5-1 plan, a firm
may continually repurchase stock, even during corporate blackout windows. Though Dutch auctions and
tender offers generally substitute for open market transactions, privately negotiated transactions and preset
plans are often coupled with open market repurchases.
[Insert Figure 4.6 here.]
Figure 4.6 plots aggregate annual repurchase announcement values, which closely track the actual
repurchase volume presented in Figure 4.1. Open market repurchases are by far the dominant form of
repurchase in the United States., especially in recent years. During the first decade in our sample (the 1980s)
the announced dollar value of open market repurchases made up 76% of aggregate announced values
reported in the SDC database. This figure has jumped to 97% over the past decade. Another observation is
that repurchase volume (both announced and actual amounts) has increased over the past two decades while
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repurchase announcement frequency does not display the same clear, positive trend. The fact that larger
repurchase volumes align with the same number of announcements implies either that repurchase dollars
are increasingly concentrated or that fewer firms are announcing their actual repurchases. Kahle and Stulz
(2017, 2021) show that payouts became increasingly concentrated in the 2000s. Recent trends support their
claim and stress the enormity of repurchases within the largest firms. According to Bloomberg, in 2021,
Alphabet’s $50 billion announced repurchase plan exceeded the aggregate value of all repurchase
authorizations by S&P 500 companies at the same time in 2020, and Apple’s $90 billion repurchase
authorization surpassed the market capitalizations of more than 80% of S&P 500 companies.6
Although repurchase announcement frequency was similar in 2019 and 2020 (the height of the Covid19 pandemic), the aggregate value of repurchase announcements declined significantly. The total value of
repurchase announcements reported by SDC in 2020 was $177 billion, less than half of the $383 billion
announced in 2019. We can conclude that firms announced more modest repurchase programs during the
Covid-19 pandemic.
Taken as a whole, our analyses of trends in payout policy confirm several prior observations but also
extend our knowledge of these transactions. Payout volumes have continued to grow over the past few
decades, with repurchases continuing to dominate. Repurchases, however, are more volatile than dividends;
they exhibit significant dips during the Great Recession and Covid-19 pandemic, for example. Although
the portion of firms distributing payouts has not changed much since the 1970s, the composition of payout
has changed drastically. More firms repurchase, either alone or in conjunction with dividends; and of those
firms that pay out, only one in eight pay dividends only. In the next section, we explore why repurchase
popularity has soared as dividends use has waned.
II.
Do Repurchases Substitute for Dividends?
We begin our discussion of repurchase motives with one of the most commonly studied drivers of share
repurchases: dividend substitution. Dividends and share repurchases both represent distributions of excess
cash to the owners of the firm. The substitution hypothesis purports that firms use dividends and repurchases
interchangeably. Under the substitution hypothesis, repurchases should increase as dividends decrease and
vice versa. Yet, it is unclear whether firms view regular dividends and repurchases as substitutes because
dividends and repurchases differ along many dimensions. For example, historically the tax treatment of
repurchases has been advantageous compared to that of dividends (see, e.g., DeAngelo, DeAngelo, and
Skinner, 2009). Vermaelen (2005) points out other important discrepancies between dividends and
repurchases, including the fact that a repurchase is an investment decision while a dividend is not; firms
6
https://www.bloomberg.com/news/articles/2021-04-29/apple-and-alphabet-herald-return-of-buyback-boom-ascash-swells
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should not invest in company stock through a repurchase if current stock prices exceed fundamental values.
Below we review the prior literature examining the substitution hypothesis, with a focus on recent literature
discussing the commitment-flexibility tradeoff inherent in payout decisions and debating whether dividends
are “disappearing.”
A. Repurchases, dividends and the commitment-flexibility tradeoff
At the heart of the choice between dividends and share repurchases lies the tradeoff between
commitment and flexibility. On the one end of the commitment/flexibility spectrum are regular dividends.
Dividend announcements explicitly commit firms to distribute cash to shareholders over the short run, and,
given managers’ reluctance to reduce dividends as shown since Lintner (1956), dividend increases also
implicitly obligate firms to distribute cash to shareholders for years to come. Shareholders value these
commitments and reward dividend initiations and increases with positive announcement returns. (More on
announcement returns in Section IV.) On the other end of the spectrum lie share repurchases, in particular
open market share repurchases (OMRs). OMR announcements generate an option, not an obligation, for
firms to buy back stock in the open market. Managers report that flexibility is one of the primary advantages
of repurchases (Brav et al., 2005). Market participants react positively to repurchase announcements, but
after controlling for payout size and market expectations, returns to share repurchase announcements are
muted relative to dividend increase announcements (Guay and Harford, 2000).
In between rigid regular dividends and flexible open market repurchases on the commitment/flexibility
continuum, we find alternative payout instruments like special dividends and preset repurchase plans. As
the name connotes, special dividends are infrequent and thus resemble repurchases more than regular
dividends. Prior to the rise in open market repurchases, firms made large flexible payouts in the form of
special dividends. Special dividends have all but disappeared in recent years, however (DeAngelo,
DeAngelo, and Skinner, 2000). DeAngelo, DeAngelo, and Skinner (2009) point out that repurchases have
replaced special dividends as a transitory distribution vehicle. Similarly, when considering the tradeoff
between commitment and flexibility, preset plans (discussed below in more detail) fall between dividends
and open market repurchases. Preset repurchases remove an element of flexibility and are thus more similar
to dividends than OMRs.
Regular dividends’ “stickiness” implies that firms are unlikely to explicitly cut them and replace them
with repurchases. Instead, repurchases may gradually replace dividends over time if firms use funds that
would have been used to increase or initiate dividends to instead repurchase stock. Indeed, using the Lintner
(1956) model of expected dividends and controlling for firm characteristics, Grullon and Michaely (2002)
find that U.S. firms complete repurchases using funds they would otherwise use to increase dividends.
Importantly, market participants are aware of this substitution as evidenced by the insignificant impact of
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the announcement of dividend decreases on the share price of repurchasing firms. More recently, Wang,
Yin, and Yu (2021) reinvestigate the substitution hypothesis using the staggered legalization of share
repurchases across countries to provide identification. Using a difference-in-differences methodology, they
do not find significant dividend cuts after repurchase legalization. These findings are more consistent with
Dittmar (2000) and contribute additional evidence to the dividend stickiness theory (Lintner, 1956; Brav et
al., 2005; Guttman, Kadan, and Kandel, 2010). Other studies conclude that repurchases and dividends are
imperfect substitutes: Banyi and Kahle (2014) find evidence that repurchases are substitutes for dividends
for younger firms but are supplements to dividends for older firms that have historically paid dividends.
One reason repurchases and dividends are imperfect substitutes is because managers view dividends as
sticky but repurchases as flexible. Are repurchases indeed more flexible than dividends? Survey evidence
is consistent with dividends being more rigid and repurchases being more flexible: Firms are more likely
to set targets for dividends than for repurchases, and, among firms that set payout goals, dividend targets
are stricter (Brav et al., 2005). Further, firms tend to distribute permanent cash flows to shareholders using
dividends whereas they repurchase using transitory streams of cash (Guay and Harford, 2000; Jagannathan,
Stephens, and Weisbach, 2000; Lee and Rui, 2007; Lee and Suh, 2011). Skinner (2008) shows that, starting
in 1995, total payouts are more closely tied to earnings than are dividends, which he attributes to managers
using repurchases to absorb the variation in earnings. Dividends and repurchases also vary with the business
cycle in a manner consistent with dividend stability but repurchase flexibility. Dividend payments are less
volatile and appear to steadily increase over time. In contrast, repurchases fluctuate substantially, increasing
during economic expansions and contracting during recessions. Overall, this evidence suggests that
managers value and use repurchases’ inherent flexibility.
Repurchases may not provide managers with full flexibility, however. Bargeron et al. (2022) document
negative stock market reactions to voluntary announcements of open market repurchase suspensions.
Suspension announcements are associated with negative 3-day abnormal returns of -1.35%, on average.
This reaction is muted relative to the market response to dividend cuts, but economically meaningful
nonetheless. Further, a negative market reaction to repurchase suspensions stands in contrast to managers’
perceptions that, unlike cutting dividends, it is not costly to cut repurchases. Bargeron et al. (2022) also
show that voluntary announcements of repurchase plan completion are perceived as bad news by market
participants if those announcements are not accompanied by the initiation of a new open market repurchase
plan. While the literature has long accepted that dividends, once initiated, are expected to continue, this
study provides some evidence that shareholders expect repurchases to continue as well.
Although studies such as Guay and Harford (2000) and Jagannathan, Stephens, and Weisbach (2000)
provide evidence that firms distribute transitory cash flows via repurchases, more recent studies examine
firms that finance repurchases through debt issuance. Lei and Zhang (2016) propose that firms conduct
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debt-financed buybacks to optimize their capital structure.7 Consistent with this idea, they find that these
firms have more debt capacity, higher marginal tax rates, lower excess cash, and lower growth prospects.
Farre-Mensa, Michaely, and Schmalz (2021) find that firms use debt-financed repurchases to both manage
their capital structure and minimize corporate taxes. In contrast to Lei and Zhang (2016), however, they
find that firms with high investment opportunities are more likely to conduct debt-financed repurchases.
They also find that, among those firms that finance their payouts, 83% have payouts that are higher than
their free cash flows, and thus they could not sustain the payouts without raising capital. These debtfinanced payouts are inconsistent with firms distributing cash to alleviate free cash flow problems. Thus,
debt-financed repurchases may reduce firm flexibility and result in potential negative long-run
consequences for the firms’ productivity by constraining firms’ ability to raise capital and to invest.
Between regular dividends and open market share repurchases along the commitment/flexibility
continuum fall preset repurchase plans. One common preset plan is an accelerated share repurchase (ASR).
ASRs are contracts with third parties, generally investment banks, to deliver a certain number of shares to
the repurchasing firm immediately. In exchange, the firm pays the intermediary a specified price, which
generally corresponds to the most recent closing price. The intermediary then repurchases stock over an
agreed-upon amount of time, at the end of which the firm settles any differences between the initial stock
price paid and subsequent purchase prices. Hence, unlike other repurchases, in an ASR the firm is
essentially shorting its own stock and benefitting from declines in price. Though an ASR allows repurchase
prices to fluctuate over time, the total dollar amount of the repurchase remains fixed. ASRs therefore
provide firms with less flexibility than OMRs. Bargeron, Kulchania, and Thomas (2011) note that ASRs
reduce a firm’s ability to adjust repurchase quantities to fluctuating stock prices or liquidity concerns. They
go on to show that ASRs are more prevalent within firms with more stable share prices and more liquid
stocks. These firms arguably place less value on repurchase flexibility. Though firms forfeit some flexibility
when adopting an ASR instead of a traditional OMR, they are rewarded for their increased commitment
with greater announcement returns (Bargeron, Kulchania, and Thomas, 2011).
Another prevalent preset repurchase plan is a Rule 10b5-1 plan. Enacted in 2000, Rule 10b5-1 provides
corporate insiders a safe harbor for trading while in possession of material, non-public information if the
insider establishes a preset trading plan with a third party. In addition to allowing individual insiders to
trade when they possess inside information, 10b5-1 plans allow firms to repurchase stock safely and
continuously, including during corporate blackout windows. Rule 10b5-1 plans are more flexible than ASRs
because repurchasing firms and investment banks can establish a “price matrix” to adjust quantities
7
Vermaelen (1981) also proposes this idea and finds that abnormal returns to announcements of repurchases are higher
in debt-financed offers, which he concludes is consistent with the tax subsidy of interest payments being passed on to
shareholders.
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depending upon price. They are less flexible than traditional OMRs, however, because firms may only
modify these plans during open trading windows. Consistent with the prediction that firms that value
financial flexibility less would choose preset plans over more flexible OMRs, firms with more stable cash
flows, no dividend commitments, better prior stock performance, and more liquid stock have proven to be
more likely to adopt Rule 10b5-1 plans (Bonaimé et al., 2020). Preset plans indeed represent stronger
commitments: Rule 10b5-1 announcements are associated with greater completion rates and faster
completion, with more positive announcement returns, and with more dividend substitution than OMRs.
Choosing a more flexible payout policy increases a firm’s ability to invest in positive net present value
projects as they arise, with lower risk of financial distress. To the extent that dividend payments are a
constraint, a payout policy favoring repurchases over dividends increases financial flexibility and provides
an operational hedge. Because operational hedges often substitute for financial hedging, Bonaimé, Hankins,
and Harford (2014) hypothesize that payout flexibility and derivative use are jointly determined. Using
detailed derivative data from bank holding companies as well as coarser data on a broader sample of
publicly traded firms, they show results consistent with payout flexibility being a risk management device.
Other studies show that payout levels also relate to financial flexibility, firm risk, and even product
market competition. Using variation in real estate prices as a shock to firms’ debt capacity, Kumar and
Vergara-Alert (2020) show that increases in financial flexibility result in higher payouts but greater payout
flexibility. Jordan, Liu, and Wu (2018) compare conglomerates to single-segment firms and find that
conglomerates pay out more and their payouts are more sensitive to cash flows. Their findings are consistent
with conglomerates’ segments “co-insuring” one another; this natural hedge allows for larger distributions
to shareholders. Hoberg, Phillips, and Prabhala (2014) show that firms adjust payouts in response to product
market threats; as competition from rival firms increases, firms decrease dividends and repurchases and
instead hold more cash.
Recent studies show that firms facing greater labor market frictions adopt more conservative corporate
policies (e.g., Simintzi, Vig, and Volpin, 2015; Serfling, 2016; Bai, Fairhurst, and Serfling, 2020). These
frictions can undermine a firm’s operating flexibility and adversely affect corporate employment, capital
investment, and financial policies. Hwang and Kahle (2022) examine the interaction between employment
laws, operating leverage, and payout policy. Compared with regular employees, independent contractors
(IC) offer labor flexibility and cost savings. Using a difference-in-differences (DID) design around the 2004
Massachusetts law that discourages IC usage, Hwang and Kahle find that this exogenous decrease in IC
usage makes a firm’s earnings more sensitive to changes in sales, increases labor-related expenses, and
reduces profitability. Firms subsequently reduce share repurchases. The decrease is more pronounced for
firms with high operating leverage and financial constraints. They conclude that IC usage increases firms’
operating leverage; in turn firms’ payout policy becomes more conservative.
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Dang, De Cesari, and Phan (2021) exploit the staggered adoption of Wrongful Discharge Laws (WDLs)
by U.S. state courts as a quasi-natural experiment to examine the causal impact of firing costs and
employment protection on corporate payouts. They find that the greater employment protection imposed
by WDLs leads to higher share repurchases. In the cross section, the positive relation between WDLs and
stock repurchases is more pronounced for firms with greater financial resources as well as firms
characterized by better governance and stronger investor protection. These findings suggest that higher
firing costs enhance employee entrenchment and encourage rent extraction behavior, leading firms to
increase share buybacks to mitigate a wealth transfer from shareholders to employees. Dang, De Cesari,
and Phan also examine operating leverage, which may increase following the passage of WDLs and lead to
more conservative financial policies. They find that the effect of these laws on share repurchases is positive
but significantly weaker for firms with higher operating leverage. These results suggest that there is
heterogeneity in firm response to the adoption of employment protection laws; as a result, the relation
between these laws and corporate payout reflects the net effect of two different mechanisms: operating
leverage and rent extraction. While the operating leverage channel plays a role in moderating the positive
relation between WDLs and payouts, it appears to be dominated by the rent extraction channel.
B. Have dividends disappeared?
Prior literature often examines the substitution effect of repurchases in light of repurchases’ role in the
“disappearance” of dividends documented by Fama and French (2001). Grullon and Michaely (2002) show
that share repurchases in the United States grew at an average rate of 26.1% from 1980 through 2000, and
the dollar value of repurchases surpassed that of ordinary dividends in 1999 and 2000. We confirm that
repurchases have continued to grow substantially since the turn of the century. Is this growth in repurchases
responsible for the decline in the propensity to pay dividends? Or have other factors led to dividends’
demise?
Fama and French (2001) document a sharp decline in the proportion of dividend-paying firms after
1978 and show that firms with high profitability and low growth rates tend to pay dividends, while lowprofit/high-growth firms tend to retain profits. Numerous studies have since attempted to explain this
decreasing propensity to pay dividends. For example, Hoberg and Prabhala (2009) document a decline in
dividends from 1978 to 1999 and claim that risk is a primary driver of dividend disappearance. Another
factor contributing to the decline in the propensity to pay dividends in the 1990s is the increased number of
newly public firms over this time period (Julio and Ikenberry, 2004). Since IPO firms tend to be young,
risky firms with abundant investment opportunities but limited resources, they prefer the flexibility of share
repurchases over the commitment of paying dividends if they do have excess cash. Fama and French (2001),
Grullon, Michaely, and Swaminathan (2002), and DeAngelo and DeAngelo (2006) advance life-cycle
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explanations for dividends that rely, implicitly or explicitly, on the trade-off between the advantages (e.g.,
flotation cost savings) and the disadvantages (e.g., agency costs of free cash flow) of dividends. This tradeoff between retaining and distributing earnings evolves over time as profits accumulate and investment
opportunities decline; paying dividends becomes increasingly desirable as firms mature.8
DeAngelo, DeAngelo, and Stulz (2006) empirically examine this life-cycle story by assessing whether
the probability that a firm pays dividends is positively related to its mix of earned and contributed capital,
i.e., whether firms with relatively high retained earnings (as a proportion of total equity or total assets) are
more likely to pay dividends. They find that the fraction of publicly traded industrial firms that pay
dividends is high when retained earnings are greater and falls to near zero when equity is comprised mostly
of contributed rather than earned capital. The authors conclude that their findings are consistent with a lifecycle theory of dividends in which the probability that a firm pays dividends is positively related to its mix
of earned and contributed capital. Denis and Osobov (2008) extend DeAngelo, DeAngelo, and Stulz (2006)
by examining firm-level data from six developed countries. They find international evidence that the
earned/contributed capital mix is an important determinant of the probability of paying dividends.
Grullon and Michaely’s (2004) evidence also corroborates a life-cycle explanation behind payout
decisions. They identify declines in systematic risk—and thus cost of capital—around share repurchases.
Firms experiencing the greatest reduction in risk also tend to decrease capital expenditures and research
and development expenses, consistent with a transition away from the high growth stage toward a more
mature phase in the life cycle. Michaely, Rossi, and Weber (2021) examine risk changes around changes in
payouts by decomposing stock returns into news about cash flows versus news about discount rates. They
find changes in discount rates, not cash flows, around dividend and repurchase events, which is also
consistent with payouts signaling maturity.
According to DeAngelo, DeAngelo, and Stulz (2006), the life-cycle theory partially explains the
relation between the dividend payout decision and a firm’s earned/contributed capital mix, but it does not
explain the declining propensity to pay. In fact, they find that firms whose earned equity makes them
reasonable candidates to pay dividends have a propensity to pay reduction that is twice the overall reduction
estimated by Fama and French (2001). Banyi and Kahle (2014) reexamine this life-cycle theory of
dividends and find that the earned/contributed capital mix used by DeAngelo, DeAngelo, and Stulz (2006)
also explains the likelihood of both repurchases and overall payouts. However, its influence declines if the
firm went public in more recent decades.
8
A second explanation, proposed by Baker and Wurgler (2004), is that investors have temporary fads for dividends
and that firms cater to these fads. However, Hoberg and Prabhala (2009) find that risk explains roughly 40% of the
disappearing dividends puzzle. They find no evidence that dividend fads explain changes in the propensity to pay.
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Grullon, Paye, Underwood, and Weston (2011) reexamine the disappearing dividend puzzle and find
that while the conditional propensity to pay dividends has declined over time, the conditional propensity to
return cash to shareholders in some form remains relatively stable. They conclude that, although firms are
just as likely to return cash in 2003 as they were in 1978, the form of payment has changed. Banyi and
Kahle (2014) find that the declining propensity to pay is a function of the changing composition of firms
over time and that the decade in which a firm went public is a major determinant of its payout policy. Firms
that went public prior to the 1980s tend to pay dividends, and their propensity to pay has not declined over
time. The more recently a firm has gone public, however, the less likely it is to pay dividends in its initial
years and the weaker the relation between retained earnings and dividend payments. Using a prediction
model that incorporates many factors known to influence payout policy and an estimation period after the
enactment of the Rule 10b-18 Safe Harbor, they find little evidence that the conditional propensity to return
cash to shareholders has declined over time.
The conclusions of Fama and French (2001) and Skinner (2008) that dividends are disappearing may
have been premature, however. Michaely and Moin (2020) examine both the decrease in dividends from
the 1970s through 2000 and the recovery of dividends in the 2000s. They suggest that, after accounting for
repurchases, the gap between expected and actual payers was short-lived, and that while substitution
contributed to the disappearing dividends phenomenon, the reappearance of dividends was driven by nonpaying firms dropping out of the sample. Similar to Banyi and Kahle (2014), they find that firms that went
public before 1978 do not exhibit the disappearing dividend phenomenon. Firms whose IPO took place
more recently are less likely to pay dividends, even if they have high earnings and low earning volatility.
Moreover, as pointed out in DeAngelo, DeAngelo, and Skinner (2004), while the percent of listed firms
that pay dividends declined from the 1970s to the 1990s, total dollars paid in dividends did not. They show
that earnings became more concentrated in a smaller group of firms, and with that increase in concentration
of earnings came an increase in concentration in dividends. This phenomenon has not changed over time.
Kahle and Stulz (2017) show that the concentration of both earnings and dividends increased from 1975 to
2015. Kahle and Stulz (2021) examine the payouts of the 200 firms with the largest dollar payout and
similarly show that these firms account for an increasing percentage of aggregate payouts over time.
III.
Agency Problems and Conflicts of Interest
The agency costs hypothesis proposes another motivating factor behind payouts: Distributions to
shareholders remove excess cash from managerial control, thereby reducing agency costs associated with
free cash flow (Jensen, 1986). In this section we begin by discussing how repurchases alleviate agency costs
related to corporate governance. Repurchases can also exacerbate agency problems, however. Specifically,
papers have examined whether repurchases can be used by managers to transfer wealth from bondholders
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to stockholders, to manage earnings, or to avoid the dilutive effects of employee compensation. Finally,
researchers have studied whether an increase in market-induced short-termism can lead firms to increase
payouts and cut long-term investment.
A. Governance and investor protection
According to the free cash flow hypothesis, dividends and share repurchases mitigate agency conflicts
between the owners and managers of the firm by extracting excess cash from the control of managers and
returning it to shareholders. In traditional agency models, both debt and dividends can be used as a
disciplinary device that reduces free cash flows and overinvestment (see Easterbrook (1984), Jensen (1986),
and Stulz (1990)). By removing excess cash from the hands of management, repurchases serve a similar
purpose, although they represent less of a commitment than dividends to continue payouts in the future.
Consistent with this hypothesis, John, Knyazeva, and Knyazeva (2011) show that U.S. firms with
greater agency costs of free cash flow tend to make larger payouts. They identify firms in remote locations
as “high agency costs firms” because they are more difficult to monitor. These firms pay higher dividends
and favor regular dividends over special dividends or share repurchases.
Other papers have used cross-country data to examine the impact of agency costs on payouts. They
explore whether managers’ propensity to distribute cash to shareholders rather than investing in
unprofitable ventures, such as excess executive compensation or empire building, may be related to the
strength of a country’s corporate governance or investor protection. On the one hand, because bettergoverned firms are less likely to spend wastefully, they may distribute more cash to shareholders. La Porta
et al. (2000) refer to this positive relation between governance and payouts as the “outcome model.” On the
other hand, their “substitute model” predicts an inverse relation between governance and payouts; investors
with fewer protections may demand higher payouts out of fear the firm will otherwise squander excess
cash. La Porta et al. (2000) find that dividends are positively associated with a country’s minority
shareholder rights, which supports the outcome model. Alzahrani and Lasfer (2012) confirm that the
positive relation between country-level governance and payout holds for share repurchases as well. They
also incorporate taxes and show that the difference in dividends between high and low investor protection
countries is mitigated when dividends are tax-disadvantaged.
In addition to governance structures at the country-level, corporate-level ownership structures may
attenuate agency concerns and therefore impact payout policy decisions. Specifically, institutional
shareholders are likely to better monitor managers and thus reduce agency costs. Crane, Michenaud, and
Weston (2016) exploit discontinuities in institutional ownership around the Russell indices to identify the
effects of agency costs on payout policy. They find that increases in institution ownership are associated
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with significant increases in dividends with no significant change in repurchases. Total payout increasing
as agency concerns fall is consistent with the outcome model.
B. Conflicts of interest between shareholders and bondholders
Conflicts of interest also exist between shareholders and bondholders. With respect to payout policy,
the concern is that managers use corporate payouts to transfer wealth from bondholders to shareholders.
Maxwell and Stephens (2003) find evidence consistent with repurchases resulting in wealth transfers, which
increase in the size of the repurchase and the riskiness of the firm’s debt. Further, following repurchase
announcements, bond ratings are twice as likely to be downgraded versus upgraded. Chu (2018) also
presents evidence consistent with conflicts of interest between shareholders and bondholders inducing
higher payouts. He exploits potentially exogenous variation in shareholder-creditor conflicts of interest by
studying mergers between lenders and shareholders of the same firm and shows merging firms reduce
repurchases and dividends to a greater extent than control firms. In contrast, when Jun, Jung, and Walking
(2009) disentangle the negative wealth-transfer effects of repurchases on bondholders from the potential
positive signaling effects, their evidence generally supports signaling. Nonetheless, wealth transfers are
present within subsamples of option-funded repurchases and firms with weaker shareholder rights.
Similarly, Alderson, Halford, and Sibilkov (2020) find no evidence of wealth transfers when they study
changes in debt values and credit ratings around share repurchases using daily bond data (versus the
monthly data used in previous studies). In sum, the evidence on whether repurchases transfer wealth from
bondholders to stockholders is mixed.
C. Repurchases and managerial incentives
Incentives generated through executive compensation may exacerbate agency problems. Kahle (2002)
suggests that one explanation for the increasing popularity of open market share repurchases in the 1990s
is that innovations in compensation policy, in particular the growing use of stock options by companies,
caused changes in payout policy. Consequently, she proposes two hypotheses for how employee stock
options may affect the decision to repurchase shares. The option-funding (or dilution) hypothesis predicts
that repurchases are intended to fund the exercise of employee stock options, possibly to avoid dilution.
Thus, the decision to repurchase should be related to recently exercised options and to options expected to
be exercised in the near future. The substitution (or dividend protection) hypothesis predicts that executive
options create different incentives than do employee options. While employee options provide firms with
incentives to repurchase shares to avoid the earnings dilution that could be caused by option exercise,
executive options provide managers an incentive to not pay dividends, since payment of dividends reduces
the value of both exercisable and unexercisable options held by managers. Kahle (2002) finds that firms
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announce repurchases when executives have large numbers of options outstanding and when employees
have large numbers of options currently exercisable. Once the decision to repurchase is made, the amount
repurchased is positively related to total options exercisable by all employees but independent of managerial
options. These results are consistent with managers repurchasing both to maximize their own wealth and to
fund employee stock option exercises. The market appears to recognize this motive, however, and reacts
less positively to repurchases announced by firms with high levels of nonmanagerial options.
Bens et al. (2003) investigate whether executives’ incentives to manage diluted earnings per share affect
stock repurchase decisions. They note that repurchases can be accretive or decretive: Repurchases increase
EPS only if the foregone return on the cash paid out is less than the firm’s earnings-to-price ratio at the time
of the buyback. Bens et al. (2003) find that managers use open-market repurchases to sustain EPS growth
when dilutive employee stock options (ESOs) are exercised. Thus, executives’ incentives to manage diluted
EPS help explain their firms’ stock repurchase decisions. Moreover, executives’ repurchase decisions are
not associated with actual ESO exercises, suggesting that they are driven by incentives to manage diluted
but not basic EPS. They also find that the dilutive effect of ESOs on repurchases is stronger for firms with
high P/E ratios; this result is consistent with the hypothesis that the financial reporting benefits of meeting
EPS targets will be larger for these firms. They conclude that repurchase decisions are driven by executives’
financial reporting incentives.
Although papers such as Kahle (2002) and Bens et al. (2003) document a positive association between
stock options and share repurchases, in the time since these studies were undertaken, the popularity of
option-based compensation has declined while the popularity of repurchases has increased. These trends,
along with recent studies (Ferri and Li, 2020; Canil, 2017) examining changes in payout around FAS 123R,
which requires firms to expense options at fair market value, call into question the causal relation between
options and payout policy. However, Carter, Lynch, and Tuna (2007) and Hayes, Lemmon, and Qiu (2012)
document that many firms replace option grants with restricted stock around the adoption of FAS 123R.
Because restricted stock is generally dividend-protected, it should be unrelated to payout decisions if
dividend protection is the primary channel through which employee compensation relates to payout policy.
In contrast, if dilution primarily motivates repurchases, then restricted stock should positively impact
repurchase levels. Hence, it may be that repurchases do not decline following FAS 123R because many
firms replace options with restricted stock. Bonaimé et al. (2020) reexamine the dividend-protection and
dilution channels under this light, and their results strongly support a positive relation between stock-based
compensation and share repurchases via the dilution channel; dividend protection no longer has first-order
effects on payout. Difference-in-differences analyses using a shock to compensation around mandatory
option expensing (FAS 123R) and an instrumental variable approach suggest that the relation between
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dilution and payout is likely causal. Further, as the dilution channel predicts, equity compensation positively
relates to repurchase frequency and timing.
Babenko (2009) documents another relation between share repurchases and managerial incentives. She
hypothesizes that repurchases increase the pay-performance sensitivity of employees with unvested shares.
This boosts incentives for employees to provide effort and exposes them to greater risk. Unlike
announcement returns around dividend increases, which do not impact share count or pay-performance
sensitivity, returns around repurchase announcements increase in the amount of unvested employee
ownership and in human capital intensity. These results are consistent with repurchases impacting employee
pay-performance sensitivity.
D. Repurchases as an earnings management device
Kahle (2002) and Bens, Nagar, Skinner, and Wang (2003) investigate the use of stock repurchases to
offset EPS dilution when employee stock options are exercised and conclude that managers use repurchases
to offset dilution and manage earnings. Consistent with the importance of repurchases in managing EPS,
survey evidence in Brav et al. (2005) finds that over 76% of the CEOs, CFOs, and treasurers say that
increasing EPS is an ‘‘important’’ or ‘‘very important’’ consideration in their firms’ stock repurchase
decisions. Moreover, Graham et al. (2005) find that 12% of executives would engage in repurchases to
either meet EPS forecasts or avoid EPS falling below the same quarter last year, while 80% would cut
investment to do so.
Empirically, the accounting literature identifies a valuation premium associated with meeting or beating
analysts’ forecasts (Bartov, Givoly, and Hayne, 2002; Kasznik and McNichols, 2002) and shows that
missing the forecast by even a penny can lead to a loss in firm value (Skinner and Sloan, 2002). Hribar,
Jenkins, and Johnson (2006) extend these findings to examine whether firms use stock repurchases to meet
or beat analysts’ EPS forecasts. They find a higher-than-expected proportion of accretive stock repurchases
among firms with small negative pre-repurchase earnings surprises, consistent with the idea that some firms
use repurchases to compensate for earnings shortfalls. They also find a lower-than-expected proportion of
EPS decreasing repurchases among firms with small positive pre-repurchase earnings surprises, which
implies that other firms avoid stock repurchase that would induce an earnings shortfall. Farrell, Unlu, and
Yu (2014) confirm that repurchases are a widely used tool to increase EPS but show debt-financing
constraints are a major friction in earnings management. Almeida, Fos, and Kronlund (2016) exploit the
discontinuity in repurchase likelihood around salient EPS thresholds to document a negative impact of
repurchases on investment, R&D, and employment. We discuss their work in more detail in the next section.
Given the results of the Graham, Harvey, and Rajgopal (2005) survey that executives would engage in
repurchases to meet EPS forecasts, it is clear that managers are aware of the impact of repurchases on the
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denominator of EPS. Cheng, Harford, and Zhang (2015) note that CEO bonuses are often linked to EPS
and suggest that EPS-linked bonuses can create an incentive to repurchase even in the absence of managerial
options. They find that when a CEO’s bonus is directly tied to EPS, the company is more likely to
repurchase and to repurchase more. Studying S&P 1500 firms, they simulate what EPS would have been if
the firm had not repurchased, and find that, when this estimated counterfactual EPS is just below the EPS
threshold that triggers the bonus, 75% of firms conduct buybacks, compared to only 60% of other firms
repurchasing. Moreover, they find that while repurchasing firms on average have positive long-run
abnormal returns following the repurchase announcement, firms with EPS-based bonus plans do not. Thus,
their work provides evidence of opportunistic behavior by managers who expend corporate liquidity on
repurchases for personal gain.
E. Repurchases and managerial short-termism
The above literature suggests that firms at the margin of salient quarterly EPS thresholds may use
repurchases to meet these short-term goals. A common concern with this behavior is the opportunity cost
of repurchasing in this case. Specifically, do repurchases come at the expense of profitable long-term
investments? The media and politicians have been increasingly vocal about this concern. For example,
Senator Marco Rubio complains that “Wall Street rewards companies for engaging in stock buybacks,
temporarily increasing their stock prices at the expense of productive investment” and suggests taxing
repurchases.9 Similarly, Senators Chuck Schumer and Bernie Sanders have suggested restricting
repurchases because companies, “rather than investing in ways to make their businesses more resilient or
their workers more productive, have been dedicating ever larger shares of their profits to dividends and
corporate share repurchases.”10 In line with these concerns, in October 2021, the House Rules Committee
proposed to impose a 1% excise tax on stock repurchases by publicly traded companies starting in 2022;
Congress has not yet voted on the issue.
Managerial surveys also explore the tension between returning funds to shareholders via payout versus
using the funds to invest. Brav et al. (2005) find that that maintaining the existing level of dividend
payments may be as important as funding corporate investment. Graham (2022) updates Brav et al. and
finds that about half of surveyed CFOs say that they choose investment policy before choosing payout
policy, with fewer choosing investment policy before dividends (45%) than before repurchases (58%).
Further, according to CFOs, dividends are more likely than repurchases to crowd out investment: The
majority (61%) of CFOs indicate they would not reduce dividends to finance an alternative project-regardless of its return on investment--while only 23% of CFOs would not cut repurchases to fund an
9
“America needs to restore dignity of work,” by Marco Rubio, The Atlantic, December 13, 2018.
“Limit corporate buybacks,” by Chuck Schumer and Bernie Sanders, New York Times, February 3, 2019.
10
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attractive project. Overall, this evidence is consistent with dividends being stickier than repurchases, even
to a point of sacrificing profitable investments.
Researchers have studied the relation between payout and investment. While Grullon and Michaely
(2004) find a negative correlation between share repurchases and investment, they suggest that the relation
is driven by variation in growth opportunities, i.e., firms with poor growth options use their free cash flow
to repurchase shares. Indeed, Boudry, Kallberg, and Liu (2013) confirm that repurchases negatively
correlate with investment opportunities. Brav et al.’s (2005) survey finds that CFOs make investment
decisions first and then undertake repurchases from the leftover cash, rather than making repurchase
decisions first and then undertaking investment from residual cash. This finding again suggests that a
negative correlation between repurchases and investment likely results from a lack of investment
opportunities leading to repurchases, rather than repurchases leading to low investment. These same CFOs
admit to cutting investment to maintain current dividends, however. Dittmar (2000) finds that repurchases
occur when firms have excess capital, which is also consistent with repurchases being driven by declining
investment opportunities, rather than repurchases causing investment declines.
More recently, Gutiérrez and Philippon (2016) note that private fixed investment in the United States
has been lower than expected despite high profitability and Tobin’s Q. They test several theories and
conclude that, given the increase in institutional ownership and the shift towards stock-based compensation,
an increase in market-induced short-termism may lead firms to increase payouts and cut long-term
investment. Yet, Fried and Wang (2019, 2021) find no evidence of managerial short-termism in the United
States or the European Union. They show that, while total payouts by S&P 500 firms have grown in recent
years, net payouts (dividends plus repurchases minus equity issuances) have remained relatively stable and
investment has increased.
Kahle and Stulz (2021) show that the sharp increase in payouts from the pre-2000s to the 2000s results
from both an increase in payout rates and an increase in free cash flow available for payouts. While they
do find that the increase in free cash flow results from a decrease in investment, this decrease is not specific
to payers or top payers. Capital expenditures fall for all firms over this period, and in fact fall more for nonpayers than for payers. The difference between payers and non-payers is that non-payers use the cash
released by the reduction in investment to increase R&D, whereas payers (and especially the top payers)
use it to increase payouts.
Edmans, Fang, and Huang (2021) examine whether managerial short-termism drives payout using an
instrumental variable for short-termism proposed by Edmans, Fang, and Lewellen (2017): vesting equity,
measured as the amount of stock and options scheduled to vest in a given month. Vesting equity is highly
correlated with equity sales, and thus leads to short-term stock price concerns—satisfying the relevance
criterion for a valid instrument. Because it depends on the magnitude and vesting schedule of equity grants
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made years in the past, it is unlikely to be driven by current economic conditions—thus meeting the
exclusion restriction for a valid instrument. Edmans, Fang, and Huang (2021) examine the relation between
vesting equity and both repurchases and M&A. They note that repurchases can either be myopic (if financed
at the expense of value-increasing investments projects or if company stock is overvalued) or efficient (if
financed by excess cash and if company stock is undervalued). They use post-repurchase long-term
abnormal returns to diagnose the value implications of the repurchase. A one standard deviation increase
in vesting equity is associated with a 1.2% increase in a firm’s likelihood of repurchasing shares, compared
to the unconditional repurchase probability of 24.5% and is associated with lower returns three years after
the repurchase. They also find that CEOs concentrate their equity sales in a short window after announcing
repurchases, which is difficult to reconcile with common justifications for repurchases such as
undervaluation. Also using equity sales to instrument for short-termism, Moore (2020) echoes the causal
relation between CEO equity sales and repurchases. The link between equity sales and repurchases is
stronger when the CEO is also chairman of the board, the governing body approving share repurchase
authorizations. Moore (2020) does not, however, find evidence that these repurchases destroy shareholder
value.
Almeida, Fos, and Kronlund (2016) exploit the discontinuity in the likelihood of share repurchases
caused by earnings management considerations to test whether a repurchase has a causal effect on firm
investment. Using an indicator for whether or not a firm would announce a negative EPS surprise in the
absence of a repurchase as an instrument for a repurchase, Almeida, Fos, and Kronlund (2016) regress
changes in investment (capital expenditures and R&D) and employment on instrumented repurchases to
compare firms that just miss the EPS consensus forecast with firms that just beat it. They find that firms
that would have experienced a small negative earnings surprise before the impact of the repurchase tend to
decrease employment, capital expenditures, and R&D in the four quarters after the increases in EPSmanagement induced repurchases. This relation is weaker among financially constrained firms that are less
able to engage in repurchases to manage EPS. However, the magnitudes of the decreases are small and
generally short-lived. Consistent with this, an examination of the value consequences indicates that EPSinduced repurchases are not detrimental to shareholder value or subsequent performance, on average. It
should also be noted that their study focuses specifically on the subset of repurchases driven by a desire to
meet EPS forecasts, not repurchases in general. Further, a PwC study commissioned by the UK government
studies managerial short-termism during the decade spanning from 2007 to 2017. In addition to failing to
identify a link between investment decisions and share repurchases, the study finds no evidence of firms
successfully using repurchases to meet EPS thresholds.11
11
https://www.pwc.co.uk/economic-services/documents/share-repurchases-executive-pay-investment.pdf
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Multiple studies examine the impact of tax cuts on repurchases and investment. Because policymakers
often claim tax cuts will lead to increases in investment and employment opportunities, it is important to
trace the use of funds around these events. Both Blouin and Krull (2009) and Dharmapala, Foley, and
Forbes (2011) examine the use of funds repatriated under the American Jobs Creation Act (AJCA) and
conclude that the majority (50% to 90%) of repatriated funds were used to increase shareholder payments,
mostly in the form of repurchases. Dharmapala, Foley, and Forbes (2011) find no increase in investment
due to repatriation. In contrast, Faulkender and Petersen (2012) conclude that, at most, 25% of firms’
repatriated cash goes to higher payouts in the years following repatriation. The differences between the
papers arise from how the treated and control groups are formed in the difference-in-differences
methodology.12 Faulkender and Petersen (2012) note that a crucial assumption underlying the motivation
of the Act is that firms were unable to finance all available domestic investment opportunities prior to the
Act. If a firm can access external capital or generate sufficient internal domestic capital to fully fund their
domestic investments, the Act should not have any effect on the firm’s investment. Faulkender and Petersen
(2012) find that the AJCA led to significant increases in investment in capital constrained firms and to small
increases in payouts, and particularly repurchases, in unconstrained firms.
Bennett and Wang (2021) study the effect of the Tax Cuts and Jobs Act (TCJA) of 2017 on repurchases
and investments. The TCJA generates tax windfalls through a repatriation tax cut and an income tax cut. A
cut in the corporate income taxes increases the expected future cash flows of projects, thereby increasing
the number of positive-NPV projects available to firms. Ceteris paribus, this should lead to an increase in
corporate investment. Using monthly repurchase data collected from SEC filings, they find that the surge
of repurchases following the TCJA is driven by the repatriation tax cut, not the income tax cut. They also
find that financially constrained firms with high pre-TCJA income taxes increase investments moderately,
whereas highly levered firms reduce leverage.
12
Faulkender and Petersen (2012) divide the sample of firms into three groups. Group 1 consists of firms with little
or no foreign earnings in low tax jurisdictions and thus having a low probability of repatriating under the AJCA. Group
2 contains firms that could repatriate foreign income under the AJCA, as they have foreign income in low-tax
jurisdictions, but that chose not to repatriate this income. Group 3 also has unrepatriated income in low-tax foreign
jurisdictions; these firms chose to repatriate income under the AJCA. In contrast, the Blouin and Krull (2009) DID
regression includes a dummy variable equal to one in the year a firm repatriates and all years afterward, and zero
otherwise. Thus, their coefficient measures the increase in the response variable for the firms that repatriate (Group 3)
versus the increase in the response variable for firms that do not repatriate (Groups 1 & 2). Dharmapala, Foley, and
Forbes (2011) note that the decision to repatriate is endogenous, and thus they use an instrumental variable approach.
As instruments, they use whether the firm’s foreign tax rate is lower than the U.S. rate and whether the firm’s foreign
subsidiaries are in tax havens. This effectively replaces the AJCA dummy variable used in Blouin and Krull (2009)
with the probability that the firm repatriates. Firms that have unrepatriated income in low-tax foreign jurisdictions will
have a high probability of repatriation. Their coefficient thus measures the increase in the response variable for firms
with a high probability of repatriation (Groups 2 and 3) independent of whether they actually repatriate income, versus
the increase in the response variable for firms with a low probability of repatriation (Group 1).
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IV.
Signaling and stock returns around payout announcements
A. The signaling hypothesis
Miller and Modigiani (1961) show that in perfect capital markets a firm’s payout policy is irrelevant to
its value. Yet, study after study documents positive abnormal returns around announcements of payout
initiations and increases and negative returns around payout omissions and decreases. If payouts are
irrelevant to firm value, why, then, do investors react to payout news? The most commonly accepted
rationale for significant market reactions to payout announcements is the signaling theory. This theory
exposes capital markets imperfections that generate links between payout policy and returns: The signaling
theory shows that, in the presence of asymmetric information, firms may use various signaling devices—
including changes in payout policy—to convey insider information to the public. Specifically, managers
may use payout announcements to signal changes in their expectations about future prospects of the firm
(Miller and Rock, 1985). For instance, signaling theory predicts dividend increases may reflect managers’
upward revision of their future earnings expectations, or repurchase program initiations may indicate
managers’ perception that company stock is undervalued at the current market price. It follows that the
strength of the signal should increase with the firm’s expected level of future payouts. Larger payouts and
payouts representing more solid commitments should thus elicit more enthusiastic responses from
investors.
B. Announcement returns
Early work in the payout policy literature focuses on announcement returns and shows that markets
respond positively to dividend initiations and increases and negatively to omissions and cuts (see Aharony
and Swary (1980), Woolridge (1983), Healy and Palepu (1988), Asquith and Mullins (1983), Grullon,
Michaely, and Swaminathan (2002), among others). Historically, dividend initiations have been associated
with abnormal price jumps around 3% while dividend omissions result in 7% price dips on average
(Michaely, Thaler, and Womack, 1995). Sharp reactions to dividend decreases still prevail. Studying
dividend cuts and omissions between 1994 and 2014, Kahle and Williams (2018) find that the average
abnormal return to the announcement of dividend cuts is -3.5%, while the average abnormal return to the
announcement of dividend omissions is -5.2%. As a result of the negative market reaction to cuts, managers
are reluctant to cut regular cash dividends (Brav et al., 2005; DeAngelo, DeAngelo, and Skinner, 1992,
2009). Because managers resist dividend cuts except in extreme circumstances, dividend cuts are
concentrated in firms that experience poor operating performance.13 The signaling theory states that the
13
See Woolridge (1982, 1983), Eades, Hess, and Kim (1985), Healy and Palepu (1988), Benartzi, Michaely, and
Thaler (1997), Grullon, Michaely, and Swaminathan (2002), Lie (2005), and DeAngelo and DeAngelo (1990) for a
review of the literature on the market reaction to and determinants of dividend cuts.
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stock market reacts to dividend announcements because they signal future earnings. Indeed, Healy and
Palepu (1988) find subsequent earnings changes are positively related to the dividend announcement
returns, indicative of investors interpreting dividend announcements as forecasts of future earnings.
Alternatively, Benartzi, Michaely, and Thaler (1997) show that dividend announcements are more
informative about past earnings than future earnings.
The signaling theory posits that repurchases constitute a revelation by management of favorable new
information about the value of the firm’s future prospects. Anecdotal support for the signaling theory comes
from companies themselves, who often cite “undervaluation” as the motive for their open market
repurchases. Early empirical studies of repurchases focused on market reactions to tender offer repurchases
(Dann, 1981; Vermaelen, 1981; Bagwell, 1992; Comment and Jarrell, 1991). Because tender offers
represent commitments by the firm to repurchase shares at a premium, they represent a costly and thus
strong signal of undervaluation. Comment and Jarrell (1991) purport that fixed price tender offers are the
most costly signal, followed by Dutch auctions, which specify a range of purchase prices, and finally by
open market share repurchases. Consistent with their signaling predictions, market reactions to share
repurchase activities increase monotonically with the predicted signal strength: They are strongest for fixedprice offers and weakest for OMRs, with average returns around Dutch auctions falling in the middle.
Comment and Jarrell (1991) also find that abnormal returns around repurchase announcements are
positively associated with the percent of outstanding shares repurchased, also consistent with signal strength
driving market reactions to repurchase announcements.
Because they outnumber tender offers by about ten to one, the literature now places more emphasis on
open market stock repurchases. Early studies of OMRs document positive abnormal returns of 3–4% at the
announcement (Vermaelen, 1981; Dann, 1981). More recent studies confirm positive market reactions to
announcements of repurchase authorizations and continuations and additionally demonstrate negative
reactions to repurchase suspensions. Bargeron et al. (2022) document mean positive abnormal returns of
2.6% around repurchase authorizations and 2.2% around resumptions of suspended programs. While firms
do not cut repurchases per se, suspending previously announced repurchase programs is a close equivalent.
Bargeron et al. (2022) show that repurchase suspension announcements are associated with negative and
significant abnormal returns of -1.4%. Though lower in magnitude than the negative reactions to dividend
cuts, negative returns around repurchase suspension announcements call into question the supposed
flexibility of share repurchases, i.e., that firms can stop repurchases without investors discounting stock
prices.
Much work has focused on the cross-sectional variation in market responses to repurchase
announcements. One main takeaway is that the strength of the signal inherent in repurchase announcements
increases with information asymmetry. For instance, opaque firms with lower quality financial reporting—
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and therefore higher information asymmetry—experience twice the OMR announcement returns as
transparent firms with high quality disclosures (Billett and Yu, 2016). Returns to share repurchases also
positively correlate with economic policy uncertainty and financial uncertainty (Anolick, Batten, Kinateder,
and Wagner, 2021). Because information asymmetry likely increases with uncertainty, this provides further
evidence that repurchases represent a stronger signal when information asymmetry is high. The signaling
strength of a repurchase announcement also depends upon its perceived credibility. Insider purchasing prior
to repurchase announcements adds credibility to the undervaluation signal (Babenko, Tserlukevich, and
Vedrashko, 2012; Cziraki, Lyandres, and Michaely, 2021) as do high prior repurchase plan completion
rates (Bonaimé, 2012; Ota, Kawase, and Lau, 2019). Insider purchasing around repurchase announcements
increases the perceived likelihood the stock is undervalued, and prior completion rates strongly predict
future completion rates, consistent with a reputational effect.
In addition to sending a positive signal about the repurchasing firm, a repurchase announcement sends
a negative signal about competing firms (Massa, Rehman, and Vermaelen, 2007). This negative signal
causes rivals’ stock prices to decline, which in turn encourages them to repurchase themselves. This
“mimicking repurchases” effect is strongest within concentrated industries, in which strategic interaction is
more likely. Adhikari and Agrawal (2018) and Grennan (2019) echo that peer firms influence payout policy.
While Grennan (2019) only observes substantial peer effects in dividends policy, Adhikari and Agrawal
(2018) document peer effects for both dividend and repurchase policies. They show that the peer effect is
more pronounced not only in more competitive product markets but also in richer information environments
and within large and mature firms.
C. Long-run returns
Studies have also suggested that dividend and repurchase announcements are associated with abnormal
stock performance in the long run, consistent with these announcements signaling news about the firm’s
intrinsic value but with the market initially underreacting to this news. For example, Michaely, Thaler, and
Womack, (1995) use buy-and-hold returns to examine long-run performance following dividend initiations
and omissions. They find that in the year following the announcements, prices continue to drift in the same
direction, but the drift following omissions is stronger and more robust. This drift is not the same as that
which follows the earnings announcement; it is more pronounced, lasts longer, and does not appear to occur
primarily around subsequent earnings announcements. They find no evidence of important changes in
volume or clientele, which mitigates price pressure as a potential explanation for the anomalous drift.
Similarly, Desai and Jain (1997) look at long-run performance following stock splits and reverse splits and
find evidence consistent with the market underreacting to these announcements. Ikenberry, Lakonishok,
and Vermaelen, (1995) use buy-and-hold returns to examine the long-run performance of companies
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following open market repurchase program announcements. They find that repurchasing firms that are more
likely to be undervalued exhibit positive abnormal returns of 45.3% in the four years after the
announcement.
While these early studies use buy-and-hold returns to examine long-run performance, Fama (1998) and
Mitchell and Stafford (2000) point out problems with the interpretation of these results, including the fact
that the methodology assumes independence of multi-year abnormal returns. After accounting for the
positive cross‐correlations of event‐firm abnormal returns, they find inconsistent evidence of abnormal
performance in their samples. However, Peyer and Vermaelen (2009) show that, even when using the FamaFrench (1993) three-factor model combined with Ibbotson’s Returns Across Time and Securities (“RATS”)
methodology or the Fama-French (1993) calendar time approach to compute abnormal returns, the
repurchase anomaly exists, especially for value firms. They form an undervaluation index (“U-index”) and
suggest that open market repurchases are a response to market overreaction to bad news such as analyst
downgrades and overly pessimistic earnings forecasts. Manconi, Peyer, and Vermaelen (2019) show that
this repurchase returns anomaly extends to stock markets outside of the United States. Analyzing buyback
announcements across 31 non-U.S. markets from 1998 to 2010, they show that long-run abnormal returns
follow these announcements on average.
Other studies examine the cross-sectional variation in long-run post-repurchase abnormal returns.
Abnormal returns are greater within firms with insider net buying (Cziraki, Lyandres, and Michaely, 2021),
more volatile stock prices (Evgeniou, de Fortuny, Nassuphis, and Vermaelen, 2018), less female board
representation on boards (Evgeniou and Vermaelen, 2017), and lower financial constraints (Chen and
Wang, 2012).
More recent evidence casts doubt upon the persistence of the buyback anomaly. For instance, Fu and
Huang (2016) and Obernberger (2014) find that the long-run abnormal returns following stock repurchases
disappear after 2002. Their evidence suggests that the disappearance is associated with the changing market
environment, including increased institutional ownership, decreased trading costs, improved liquidity, and
enhanced regulations regarding corporate governance and information disclosure. Lee, Park, and Pearson
(2020) also show that long-run abnormal returns following repurchases have decreased. They conclude that
buybacks are no longer motivated by fundamental factors such as undervaluation, but rather by nonfundamentals like managerial self-interest or pressures from short-term oriented institutional investors.
Moreover, Bargeron, Bonaimé, and Thomas (2017) find that even prior to the 2000s, returns between
program authorization and completion announcements are indistinguishable from zero. Any abnormal
returns occur after completion announcements and are largely attributable to the announcement returns at
subsequent repurchase authorizations and takeover attempts, which positively correlate with repurchase
activity because firms use repurchases to deter takeovers (Billett and Xue, 2007).
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D. Repurchase timing
At the core of the signaling hypothesis is the assumption of information asymmetry: that insiders
possess different and better knowledge about the firm’s future prospects than outside investors do. If
insiders possess such information, they should be able to identify instances in which the current stock price
does not reflect the true value of the firm after incorporating this inside information. Managers should
therefore be able to use inside information to “time the market.” With respect to share repurchases, timing
the market implies buying back stock at low prices. Though successful market timing results in a wealth
transfer from selling to non-selling shareholders, it is generally viewed positively from the shareholders’
perspective. One caveat is the notion that, because market timing is a zero-sum game, it benefits long-term
shareholders only if other (selling) shareholders suffer losses (Babenko, Tserlukevich, and Wan, 2020).
Recent work focusing on the ability of managers to time repurchase activity proliferated following
amendments to SEC Rule 10b-18 in 2004 that require U.S. firms to report detailed information about their
repurchase activity in their quarterly reports. Within the quarterly report, firms must disclose the number
of shares repurchased in the open market and the average price paid per share in each month of the quarter.
Using this post-2004 repurchase data, several studies document that firms repurchase at prices below
average market prices (De Cesari et al., 2012; Ben-Rephael, Oded, and Wohl, 2014; Dittmar and Field,
2015). De Cesari et al. (2012) find repurchase timing improves with stock liquidity but deteriorates with
ownership by institutions, which are often considered informed investors. The relation between repurchase
timing and insider ownership is more complex, following an inverted U-shape. Ben-Rephael, Oded, and
Wohl, (2014) show that timing ability is concentrated in small and high growth firms. Since small firms
repurchase less frequently, the authors argue these repurchases are more strategic. They also find a positive
and significant relation between repurchase activity during the quarter and the subsequent earningsannouncement return, and between insider net buys and actual repurchases. Examining a portfolio that is
long repurchasing firms and short the risk-free rate, they find that repurchase activity is followed by positive
and significant alphas.
Dittmar and Field (2015) compare the average monthly repurchase prices with average market prices
for the same stock over various horizons. They show timing ability is concentrated in less frequent
repurchasers, firms that repurchase at the same time that insiders buy on their own account, and firms that
experience low stock returns prior to the repurchase. Using Fama-French (1993) calendar time portfolios,
they find that repurchasing firms have a positive and significant alpha over the three years after the
repurchase. This alpha is significantly higher for infrequent repurchasers than for frequent repurchasers.
Nemani (2020) follows up on the idea that repurchase frequency provides information and demonstrates
that the frequency of share repurchase can disentangle programs driven by undervaluation versus alternative
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motives, such as controlling dilution. He shows that irregular repurchases are more likely to signal
undervaluation while regular repurchases are more likely motivated by dilution concerns.
In contrast to the above literature, Bonaimé, Hankins, and Jordan (2016) study repurchase timing by
comparing firms’ actual repurchase patterns with a hypothetical strategy that mechanically smooths
repurchases evenly across time. Their findings are consistent with suboptimal repurchase timing; returns
on repurchase investments would have been approximately 2% greater had firms followed the naïve
smoothed repurchase strategy. This seemingly contradictory takeaway likely stems from methodological
differences between Bonaimé, Hankins, and Jordan (2016) and prior repurchase timing research. Although
other studies generally compare actual repurchase prices to average market prices over shorter time periods
(e.g., within the same month or quarter), Bonaimé, Hankins, and Jordan (2016) gauge repurchase timing by
comparing repurchase prices to stock prices over longer time periods (up to 4 years). Another important
difference is that prior studies implicitly equally weight all repurchase quarters, regardless of repurchase
volume, while Bonaimé, Hankins, and Jordan (2016) dollar-weight actual repurchases, resulting in quarters
associated with larger repurchases being assigned higher weights.
The above studies on repurchase timing focus on open market share repurchases or total share
repurchases, which are primarily composed of open market repurchases. In contrast, Peyer and Vermaelen
(2005) examine privately negotiated share repurchases to determine whether firms purchase shares at a
premium or a discount during these transactions. Out of need for liquidity, selling shareholders generally
initiate a privately negotiated share repurchase and are willing to sell at a discount. These transactions
therefore transfer wealth from selling shareholders to long-term shareholders, and the weighted-average
total excess return to all shareholders is approximately zero.
The repurchase literature generally assumes that low prices cause firms to repurchase more to take
advantage of undervaluation. Yet, a tangential literature notes that repurchasing firms may manipulate
information flows to depress prices. In this case, it is repurchases that lead to lower prices, not vice versa,
and this behavior contributes to a wealth transfer from selling investors to the repurchasing firms. Several
studies document evidence of downward stock price manipulation prior to share repurchases. Louis and
White (2007) show that firms engaging in Dutch auction repurchases appear to deflate their earnings prior
to the repurchases to further reduce the repurchasing price. Brockman, Khurana, and Martin (2008)
document a similar effect for other repurchase announcements: Consistent with manipulating information
flows, managers increase bad (good) news one month prior (after) repurchases. Gong, Louis, and Sun
(2008) also find that firms manage earnings downward prior to share repurchases. They show that the extent
of earning management increases with the size of the repurchase and with CEO ownership, and that prerepurchase downward earnings management helps to explain post-repurchase earnings improvements.
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Chen and Huang (2013) later reexamine earnings management around repurchases and find that pre-OMR
downward accrual-based earnings management disappears after the Sarbanes-Oxley Act (SOX).
In sum, there has been much research done that tests the signaling hypothesis. In an earlier survey,
Allen and Michaely (2003) conclude that changes in payout policies are not motivated by firms’ desire to
signal their true worth to the market. Consistent with this research, CFOs themselves reject the notion that
the purpose of the repurchase is to deliberately provide a signal (Brav et al., 2005). And recent long-run
performance studies find little evidence of positive long-run performance following repurchase
announcements, which is not consistent with signaling. To the extent that signaling may be a motive for a
subset of firms, it is concentrated in small firms that repurchase infrequently (Dittmar and Field, 2015;
Bonaimé et al., 2020; Nemani, 2020).
V.
Payout policy, taxes, and clientele effects
Payout decisions may also relate to taxes and investor preferences. Miller and Modigliani (1961) argue
that in a perfect world, firm value is determined by operating cash flows, not by whether a company retains
or pays out profits, nor by the form of payout. This line of reasoning suggests that taxes do not affect
corporate payout decisions. Allen and Michaely (2003) show that if different classes of investors are taxed
differently and if firms have different payout policies, then as long as the marginal price-setter is tax-free,
taxes may not affect payout. Alternatively, firms can have a tax incentive to distribute capital via share
repurchases rather than dividends if dividends are taxed more heavily than are capital gains for the marginal
investor. Statements by financial executives that repurchases are a “tax efficient means of returning capital
to investors” support this point of view, although Brav et al. (2005) ultimately conclude that taxes have
only a second-order impact on payout decisions.
Multiple papers in the past few decades examine the effect of taxes on the choice between dividends
and repurchases. Because dividends historically have been taxed at higher rates than capital gains, investors
in higher tax brackets, relative to investors in low tax brackets, may prefer payout policies favoring
repurchases. But the direction of the relation is unclear. On the one hand, based on their tax status, investors
may select firms whose payout policy best fits their tax situation. On the other hand, firms may choose
payout policies based on shareholder preferences and the type of clientele they wish to attract (i.e., retail
versus institutional). Strickland (1996) finds that taxable institutional owners are more likely to own lowdividend-yield stocks, but also reports that tax-exempt investors do not appear to show a preference for
either high- or low-yield stocks. Hotchkiss and Lawrence (2007) find that institutional investors seem to
have distinct “dividend clienteles,” in that some institutions persistently hold stocks with high dividends.
Desai and Jin (2011) provide empirical evidence that the relation between investor preferences and payout
goes in both directions: The tax preferences of institutional shareholders impact payouts, and payout
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influences which investors are drawn to the firm. Moser (2007) investigates whether the difference in
individual shareholder tax rates between dividend income and capital gains affects a firm’s choice between
distributing funds to shareholders through dividends or share repurchases. His results suggest that in periods
in which the dividend tax penalty increases, firms are more likely to distribute funds to shareholders through
share repurchases as opposed to dividends. He also finds that the results vary with the type of shareholder:
As tax-disfavored institutional ownership or senior management ownership increases, firms are more likely
to repurchase shares as opposed to distributing dividends when the dividend tax penalty increases. Kahle
(2002) and Bonaimé et al. (2020) find evidence that taxes on dividends can incentivize managers with nondividend-protected options to favor repurchases over dividends. However, researchers face several
problems when investigating how tax incentives affect corporate payout policy. Chief among these
problems is the difficulty of calculating precise corporate tax rates due to data problems (such as a lack of
transparent reporting of effective tax rates and differences between shareholder accounting and tax
accounting), taxation of foreign versus domestic earnings, and the complexity of the tax code.
The empirical impact of taxes on corporate payout policies can also be gauged directly by observing
the extent to which firms alter their payout decisions in response to shocks to taxes. For example, following
the 2003 Jobs and Growth Tax Relief Reconciliation Act (JGTRRA), which lowered the maximum
individual income tax rate on corporate dividends to 15%, Blouin, Raedy, and Shackelford (2011) find
evidence of a tax-induced substitution of dividends for buybacks; this redistribution was greatest among
those companies held disproportionately by individual investors, particularly directors and officers, and
among those firms where other individuals and mutual funds had large holdings. Similarly, Brown, Liang,
and Weisbenner (2007) report that about one-third of the firms that initiated dividends in 2003
simultaneously scaled back their level of stock repurchases. However, both Brav et al. (2005) and FarreMensa, Michaely, and Schmalz (2014) conclude that studies centered on the 2003 JTGRRA confirm that
differences in the taxation of dividends and capital gains have only a second-order influence on the payout
policies of most public companies.
More recently, payout increases have been attributed to two tax laws that enabled U.S. firms to
repatriate foreign income advantageously in the 2000s. Both the Homeland Investment Act, part of the
American Jobs Creation Act (AJCA) of 2004, and the Tax Cuts and Jobs Act (TCJA) of 2017 provided
U.S. multinationals with a one-time tax holiday for the repatriation of foreign earnings. Dharmapala, Foley,
and Forbes (2011) find that repatriations following the 2004 AJCA did not lead to an increase in domestic
investment, employment, or R&D, but did lead to an increase in payouts, mainly repurchases. Using a
different methodology, Faulkender and Petersen (2012) find a much smaller increase in payouts (see section
III.E for more detail on these papers.)
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Bennett and Wang (2021) study the effect of the TCJA on repurchases, leverage, and investment and
find that the increase in repurchases after the TCJA is due to the repatriation tax cut, not the income tax cut.
Increased repurchase activity around these acts are consistent with the findings of Kahle and Stulz (2021).
They show that, despite concerns from the U.S. Congress about excessive repurchase volume, abnormalities
in repurchase volume are not widespread but are concentrated around repatriation tax cuts.
Jacob and Jacob (2013) provide international evidence that the dividend-capital gains tax differential
impacts the choice between dividends and repurchases.14 Jacob and Michaely (2017) claim that the impact
of taxation on payout is first-order. Exploiting an exogenous shock to dividend taxation in Sweden in 2006,
they show that owners of firms with a tax preference for dividends over wage income increase dividends
significantly more than do owners with lower wage tax rates than dividend tax rates. Agency concerns and
conflicts of interest between management and shareholders, however, moderate the impact of taxes on
payout.
In addition to tax preferences, other investor preferences may also impact payout policy. Grinstein and
Michaely (2005) find that while institutional investors avoid firms that do not pay dividends, they prefer
firms that pay lower dividends and repurchase shares instead. Other papers show that firms with more shortterm investors favor repurchases over dividends, consistent with investor horizons influencing payout
(Gaspar et al., 2012). Becker, Ivković, and Weisbenner (2011) also conclude that investor base affects
payout policy; they show that demographics of the area in which firms are headquartered impact dividend
likelihood and yield.
Finally, some papers focus on whether firms “cater” to investor preferences. Baker and Wurgler’s
(2004) catering theory suggests that firms accommodate investors by paying dividends when investors place
a premium on dividend-paying stocks. Jiang et al., Kim, Lie, and Yang (2013) and Kulchania (2013) show
that Baker and Wurgler’s (2004) catering theory extends to share repurchases; the market’s time-varying
repurchase premium positively impacts repurchases. In addition, consistent with a substitution effect, the
dividend premium negatively impacts repurchases and vice versa (Jiang et al., 2013). Hoberg and Prabhala
(2009) find that Baker and Wurgler’s (2004) catering proxy has little power to explain disappearing
dividends once they account for risk, however.
VI.
Impact of repurchases on liquidity and market efficiency
Another strand of literature examines how repurchases relate to liquidity. Barclay and Smith (1988)
point out that the relation between share repurchases and liquidity is theoretically ambiguous: Firms could
provide liquidity by repurchasing stock from selling shareholders, or, as informed traders, firms could
14
Because thorough coverage of international variation in tax rates is beyond the scope of this survey, we point the
reader to Jacob and Jacob (2013) and LaPorta, Lopez, Shleifer, and Vishny (2000).
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increase the adverse-selection component of the bid-ask spread and thereby demand liquidity. These
theories suggest that a desire to provide liquidity may motivate repurchases, but also that liquidity may
change, either increasing or decreasing, as a result of repurchases. As more detailed repurchase data have
become available, empirical studies have sought to determine which liquidity effect dominates.
The general consensus is that repurchases improve liquidity. For example, Oded (2009) shows that
higher repurchase program completion rate is associated with lower bid-ask spread. Because firms that
repurchase strategically to benefit from adverse selection (information asymmetry) likely have lower
repurchase completion rates than firms repurchasing to disburse free cash, this is consistent with the
liquidity decreasing for firms that repurchase strategically and increasing for firms that do not. Hillert,
Maug, and Obernberger (2016) exploit the 2004 amendment to SEC Rule 10b-18 that requires monthly
repurchase disclosures in quarterly reports to show that repurchases improve liquidity, particularly when
outside investors sell or during times of crisis. Liquidity provision may be an important determinant of
share repurchase activity since institutional investors, who generally own large blocks of shares, are net
sellers during repurchase transactions (DeLisle, Morscheck, and Nofsinger, 2014).
Because repurchase disclosures in the United States were opaque until 2004 and because even after
2004 the monthly repurchase data are only disclosed quarterly, many other studies rely on non-U.S. data
from countries with more rigorous disclosure requirements. Chung, Isakov, and Pérignon, (2007) study
“second trading lines” Swiss firms use to repurchase. These trading lines are unique because repurchasing
is not anonymous and is publicly disclosed in real time. They find that firms are liquidity providers during
these repurchase transactions. Further, firms’ decision to repurchase relates to short-term price changes and
firm-specific new events. De Cesari, Espenlaub, and Khurshed (2011) examine the relation between
repurchases and liquidity in the Italian stock market, where companies have more leeway to buy and sell
their own stock. They also show that company trades increase liquidity. Several exceptions to the liquidity
improvement story include Brockman and Chung (2001) and Ginglinger and Hamon (2007), which find
that repurchases by firms in Hong Kong and France, respectively, increase the bid-ask spread.
In contrast to the above studies, which focus on the effect of repurchases on liquidity, Brockman, Howe,
and Mortal (2008) examine how liquidity impacts payout decisions, specifically the choice between
dividends and repurchases. They show that better market liquidity prior to the payout decision encourages
repurchases over dividends. Nyborg and Wang (2021) also show that liquidity impacts repurchases, but
their innovation is to link liquidity to repurchases through cash holdings. Their “cash as ammunition”
hypothesis suggests that firms with more liquid stocks also hold more cash, so that they can repurchase
when company stock is undervalued or when price support is needed.
A related question is whether repurchases provide price support. From a regulatory standpoint,
repurchases stabilizing prices would be viewed positively. In contrast, regulators would frown upon
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repurchases being used to manipulate prices, i.e., to push stock prices above fundamental values. Indicative
of repurchasing providing price support, Hong, Wang, and Yu (2008) show that firms that are better able
to repurchase shares when prices fall below fundamental values have lower short-run return variances.
More evidence of repurchases stabilizing prices comes from the Italian stock market, where repurchases
are associated with reduced volatility (De Cesari, Espenlaub, and Khurshed, 2011). Busch and Obernberger
(2017) show that repurchases increase price efficiency and reduce idiosyncratic risk, particularly during
down markets, when price support is essential. Liu and Swanson (2016) find a positive association between
increases in repurchases and short selling activity, often viewed as a sign of overvaluation; they interpret
this finding as evidence of managers using repurchases to support prices.
If repurchases provide liquidity and price support, do firms also use repurchases to manipulate stock
prices, artificially inflating them above fundamental values? Using earnings quality as a proxy for the
propensity to mislead investors, Chan et al. (2010) show that there are managers who appear to use buyback
announcements to mislead investors, possibly due to pressure to boost stock prices. This sort of “cheap
talk” is rare, however, and there is no long-run economic benefit to this behavior as these firms experience
worse long-term operating and stock price performance. Busch and Obernberger (2017) find no evidence
of firms manipulating prices through share repurchases. Using a sample of dual class firms to disentangle
private information from demand-driven price effects, Bargeron and Farrell (2021) show that the average
monthly repurchase of 0.30% of outstanding shares increases stock prices between 43 and 68 bps, but this
effect reverses the following month. Bargeron and Bonaimé (2020) use increases in short interest to identify
opportunities for myopic behavior, i.e., managers could repurchase to prop up prices in the short run at the
expense of long-term investors. They find no evidence consistent with the hypothesis that repurchases
concurrent with short selling represent firms’ attempts to manipulate prices. Instead, these transactions
appear to be based on managers’ private information about future material events. Overall, studies in this
area broadly conclude that repurchases provide price support and stabilize prices, but they find little
evidence of manipulation.
If repurchases successfully signal private information to the market, they may increase market
efficiency by reducing information asymmetry between managers and investors. Indeed, firms use
repurchase announcements to attract the attention of speculators, whose trades correct underpricing
(Bhattacharya and Jacobsen, 2016). Firms may also use repurchases to improve agreement between
managers and shareholders. Huang and Thakor (2013) show that, while firms are more likely to repurchase
when managers and investors disagree, repurchases improve manager-shareholder agreement by filtering
out investors who disagree with (optimistic) managers and thus tender their shares.
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VII.
Concluding remarks and future research
As corporate payouts to shareholders reach record high levels and garner the attention of policymakers,
understanding their causes and consequences is more important than ever. Previous surveys conclude that
payout policy is driven mostly by undervaluation and by firms’ desire to mitigate overinvestment caused
by Jensen’s (1986) free cash flow problem (Allen and Michaely, 2003; Vermalen, 2005; Farre-Mensa et
al., 2014). Allen and Michaely (2003) conclude that “repurchases should be used much more frequently
than they have been.” Since Allen and Michaely came to this conclusion in 2003, the dollar value of annual
share repurchases has skyrocketed and politicians have suggested that buybacks are used in ways that are
contrary to the health of the economy and workers. In fact, Democrats have proposed a one percent excise
tax on stock buybacks.
We survey the literature with a particular emphasis on research undertaken in the last decade. Our
review shows that, while traditional explanations of payout policy such as dividend substitution, agency
costs, signaling, and taxes generally continue to ring true, these motives are complex, and many new
motives have emerged as well. New research shows that firms do not directly substitute repurchases for
dividends; often these payouts complement one another. In fact, it is repurchases’ distinctions from
dividends—namely, their perceived flexibility related to sticky dividends—that has likely made them so
popular. The paradox of repurchase flexibility is that it led more firms to repurchase more regularly and
investors thus have come to expect them. Recent work also reexamines if repurchases are driven by agency
costs associated with excess cash flow. If so, repurchases would not have causal effects on investment and
would not require debt financing, as the latest research shows. Additionally, recent studies examine the role
of managerial incentives like executive compensation or attaining EPS goals in driving repurchases. While
agency-related, these types of repurchases do not solve agency problems of free cash flow but seem to be
a symptom of it. Recent evidence also suggests that repurchases may no longer signal undervaluation to the
same extent as before. Although announcements returns to repurchase authorizations are still positive on
average, repurchases are no longer consistently associated with the positive long-term returns they were
once known for. Further, the latest research shows that the largest and most profitable firms, which have
the least need to signal since information asymmetry is low, repurchase the most and do not advantageously
time repurchases. These findings are also inconsistent with signaling being a first-order driver of repurchase
activity. Finally, new research teaches us that both investor and corporate tax rates may impact payout
policy more than we thought. Depending on their tax status, investors select firms with their desired payout
policy, and firms choose payout policies to attract certain investor clienteles. Reductions in corporate tax
rates, specifically taxes on repatriated income, lead to significantly higher repurchase levels. In addition to
examining what motivates payout, recent work studies how payout policy and other firm characteristics and
policies are interrelated. For example, studies show repurchases tend to improve the liquidity of the firm’s
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stock and impact firm risk. Payout policy is also associated with investment policy and hedging policy, and
even relates to strategic product market competition decisions and labor contracts.
While the payout policy literature, and the repurchase literature in particular, are growing and maturing,
many interesting research questions are still open for debate in this area. For example, what are the effects
of government policies such as taxation, enhanced disclosure, or trading restrictions on repurchases and, in
turn, on other important firm decisions such as investment and R&D? Importantly, what changes in
regulation are necessary? An underlying assumption in the political debate is often that repurchases are an
effective tool to manipulate stock prices and that managers effectively employ repurchases to personally
benefit. But, given the importance to both policymakers and academic researchers of understanding these
issues, we know surprisingly little about the extent to which firms manipulate prices through repurchases
and managers abuse these transactions. Thus, despite recent progress, more research in this area is
warranted. At present, the SEC has proposed amendments to Rule 10b5-1 plans that would limit
multiple/overlapping plans, enhance “good faith” requirements, and modernize and improve repurchase
disclosure, including requiring daily disclosure on a new Form SR and requiring additional detail on a
company’s share repurchases. Such changes to disclosure could create additional avenues to examine
unresolved questions surrounding repurchases. In addition, the endogeneity of corporate payout decisions
remains a hurdle for researchers. But innovations in econometric techniques combined with regulatory
shocks within the United States and abroad will certainly present researchers with new and interesting
experiments. Avenues for exploration include corporate tax rate changes and the COVID-19 pandemic
government responses. International settings will also prove useful as more countries legalize repurchases
because repurchases are often regulated and disclosed differently outside of the United States. In sum,
though recent studies have significantly enriched our understanding of the causes and consequences of
repurchase transactions, many questions remain to be answered by future researchers.
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Figure 4.1: This figure plots aggregate payout in inflation-adjusted 2020 U.S. dollars. Our sample consists
of the CRSP/Compustat annual universe covering fiscal years 1971–2020. The firm’s stock must trade on
NYSE, NASDAQ, and AMEX, be associated with CRSP share codes 10 or 11, be incorporated in the
United States, and have non-missing total assets (AT) data. Dividends are defined as the cash value of
dividends on common stock (DV). Repurchases are the purchase of common and preferred stock (PRSTKC)
minus any decrease in preferred stock. Preferred stock is given by redemption (PSTKRV), liquidation
(PSTKL), or par value (PSTK) of preferred stock, in order of preference. Solid lines represent aggregate
payout for all firms. Dotted lines plot payout for industrials, which excludes banks (SIC codes 6000–6999)
and utilities (SIC codes 4900–4999). Shaded areas are NBER recessionary periods.
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Figure 4.2: This figure plots the portion of firms in our sample falling into each payout category. Figure
4.1 describes our sample construction and payout definitions.
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Figure 4.3: This figure plots the portion of firms in our sample falling into each payout category across
subsample segmented on earnings. Positive earning firms (Panel A) have non-negative net income (NI),
and negative earnings firms (Panel B) have negative net income. Figure 4.1 describes our sample
construction and payout definitions.
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Figure 4.4: This figure plots mean and median payout yields. Yields are the dollar value of annual payouts,
as defined in Figure 4.1, scaled by market capitalization (CSHO*PRCC_F) in the prior year.
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Figure 4.5: This figure plots the number of repurchase announcements each year between 1980 and 2020.
Our sample consists of all U.S. repurchase announcements reported in the Securities Data Corporation
Mergers and Acquisitions database.
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Figure 4.6: This figure plots the aggregate value (in inflation-adjusted 2020 U.S. dollars) of all repurchase
announcements each year between 1980 and 2020. Our sample consists of all U.S. repurchase
announcements reported in the Securities Data Corporation Mergers and Acquisitions database with
available data on transactions value.
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