The Researches on Stock Repurchase Motivation of Listing Corporation in China

EASTERN ACADEMIC FORUM
The Researches on Stock Repurchase Motivation of Listing
Corporation in China
WANG Qian, QIAN Weifang, HE Qing
College of Business and Administration, Zhejiang University of Technology, P.R.China, 310023
[email protected]
Abstract: In this paper, we take the stock repurchases in China’s Shanghai and Shenzhen stock markets
as the object of study, collect a total of 86 stock repurchase events from all listed companies that
declared to carry out stock repurchase during the period from June 2005 to the end of 2012, and adopts
multiple regression analysis to test the applicability and try to verify the classic stock repurchase theory
in the context of our country. The research results show that EPS theory and signal transmission theory
have good explanation effect in our country, and other theories’ explanation effects are weaker.
Keywords: Listed companies, Stock repurchase, Repurchase motivation
1 Introduction
Stock repurchase refers to the behavior that the listed companies use the way of debt financing or
retained earning to repurchase a certain amount of company shares those are in issue or circulating
outside in accordance with the procedures prescribed by law. It is very important for the listed
companies to optimize capital structure, to improve company’s governance structure, to stable
company’s stock, to coordinate with the company's equity incentive policy. Stock repurchase originated
in the nineteen seventies of the United States of America. Because at that time, the United States
government formulated restrictive clauses to hinder listed companies to carry out cash dividend policy
directly, many listed companies used stock repurchases instead of cash dividend policy. This makes that
stock repurchase activities boom in America. Due to the demonstration effect of American market,
developed countries in global capital market like England, German, Japan and so on, their stock
repurchase activities developed rapidly. It makes stock repurchase to be one of the daily operation
modes of more and more listed companies.
In the field of the motivation of stock repurchase, there are some classical theories, including signal
transmission theory, financial leverage theory, free cash flow theory, tax burden theory and so on. These
theories have very good applicability and explanation in the overseas capital market. However, because
of the shorter history of stock repurchase in our country, whether these theories have good applicability
and explanation for our country’s capital market is not certain. Therefore, we will aim at this problem in
this paper; adopt multiple regression analysis to test the applicability of these theories.
2 Theory and Hypotheses
2.1 EPS theory
EPS theory believes that shareholders are the owners of the listing companies, and the operation goal of
companies is to create economic benefits for shareholders and to maximize shareholder wealth, and the
direct measure index is earnings per share (EPS) maximization. Listed companies repurchase the stock
in issue to improve the market’s expectation on the company’s earnings per share. This result will drive
the company’s stock price rise, finally, it makes the earnings per share to improve better. In addition,
generally, the shareholders require increasing earnings per share as the management goal and one of the
company's performance evaluation criteria. Such requirements make the manager of the company to
increase earnings per share by the means of stock repurchasing. Andrdae (1999) found that within 18
months which is from the repurchase announcement and to the repurchase completed, the growth of EPS
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had a positive and significant influence on the abnormal return of the company. According to EPS
theory, the lower earnings per share will encourage listed company to repurchase shares, there is a
negative correlation.
Hypothesis 1: The lower earnings per share of listed company, the more likely to repurchase shares.
2.2 Free cash flow theory
Free cash flow theory believes that when the company lacks of good investment projects and reserve
excess cash capital, it will increase the agency cost between the manager and shareholders. Because of
the management’s personal purposes which are to diversify their investment risks or to expand their
scope of control over, the funds will be devoted to sub-optimal investment projects or inefficient
acquisitions. In order to reduce the agency costs brought by excess cash capital, improve capital
efficiency, the company shareholders may return these excess cash capital to themselves through the
way of share repurchases. Thus share repurchase is considered to be the way of dealing with the surplus
cash based on this target. Jensen (1986) proposed the concept of free cash flow earliest, it considered
when the company still has excess cash after meeting the needs of normal investment, and the company
can repurchase shares to allocate excess funds, enabling management to reduce discretionary cash and to
reduce the chances of wasting company resources simultaneously. So share repurchase is able to
generate positive abnormal return. Stephens and Weisbach (1998) also found that share repurchases and
the level of cash flow had a positive correlation. And Dittma (2000) found that companies would
repurchase share in order to deal with the excess funds. According to free cash flow theory, there is a
positive correlation between the listed company's cash capital and share repurchase behavior, the more
cash capital the more likely the company conducts share repurchase.
Hypothesis 2: The more cash capital listed companies retained, the more likely conducting share
repurchase.
2.3 Signal transmission theory
This theory insists that when the company's management believes that the company is undervalued by
the market, they will deliver the signal to the market by the way of share repurchase. This theory is
based on the hypothesis of information asymmetry between the management and outside investors. The
ordinary investors can only determine the company's value by the company's released information. They
can not get the internal information. Therefore, it is difficult to fully analyze the value of the company.
The company's management hopes to correct investors’ estimate about the value of the company through
the information by share repurchase, so that the price of stock will return to the rational level. Dann
(1981) first proposed the signal transmission hypothesis of offer to repurchase, which studied 143 share
repurchase cases implemented in 1962-1976 from 122 companies, and it believes that transmission of
information is the main motivation for share repurchase. Stephens and Weisbach (1998) think when the
value of the stock of listed companies did not get an accurate estimate of the market; companies will
repurchase its own shares. Dittma (2000) tested the signal transmission theory, the theory of financial
leverage, free cash flow theory, anti-hostile takeover theory, and management incentive theory and so on;
the results showed that the signal transmission theory is the motivation of the share repurchases which
has most explanatory power. According to signal transmission theory, this paper proposes:
Hypothesis 3: The higher the degree that listed company's share price is undervalued by the market are,
the more likely the share repurchase.
2.4 Tax burden theory
Tax burden theory is mainly based on that cash dividend income compared to capital gains got from
share repurchases will charge higher taxes. If the company paid cash dividends, the shareholders must
pay personal income tax, but share repurchase allows shareholders to pay a lower capital gains tax
instead of the higher personal income tax paid by cash dividends. Also, if the company share
repurchases by debt financing, the interest generated by the debt can be deducted before income taxes,
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indirectly increasing shareholders’ wealth. In addition, share repurchase unlike cash dividend that is
regular. In this regard, Bierman and West (1966) believed that share repurchase can increase the value of
the company, and that the only motivation of the share repurchase is because tax avoidance. However,
Dittmar (2000) insisted that although the share repurchase has more advantages, but it could not
completely replace the cash dividend. According to tax burden theory, share repurchase can avoid the
pressure of cash dividends caused by continued payment of cash dividends to shareholder, can improve
the company's financial flexibility, so the company management also wish to use share repurchases as a
method to distribute the profits. Accordingly, this paper argues that there exists negative correlation
between dividend payout ratio and share repurchase, we propose hypothesis 4.
Hypothesis 4: The lower listed companies' dividend distribution ratio is, the more likely share
repurchase.
2.5 Financial leverage theory
Financial leverage theory believes that there is an optimal leverage ratio, share repurchase can reduce
the company's equity capital, thereby adjusting the company's leverage ratio, optimizing the capital
structure, and ultimately achieve optimal leverage ratio. In addition, debt interest expense has a role of
tax deductibility; the company also can enjoy this part of the proceeds, thereby enhancing the value of
the company. Bagwell and Shoven (1988), Opler and Titman (1996), who found that the company share
repurchase is for the purposes which are to change the company's financial leverage and to optimize the
capital structure. Jam Pugh, JohnS. Jaheral & Jr (1990) empirical found that abnormal income arisen
from share repurchase is positively correlated with the amplitude of changes of asset-liability ratio, the
company can improve asset-liability ratio through open market stock repurchasing, optimize the capital
structure. Dittmar (2000) research indicates that when the company's asset-liability ratio is lower, and
the difference between the optimal asset-liability ratio is greater, the company is more inclined to share
repurchase. According to financial leverage theory, this paper considers that there exists negative
correlation between asset-liability ratio of listed companies and share repurchase. Here proposes
hypothesis 5.
Hypothesis 5: The lower the debt ratio of listed companies, the more likely share repurchasing.
3 Research Design
3.1 Analytical method
At present, in the various empirical models at home and abroad which study the motivation of listed
companies share repurchases, the dependent variables are mainly two types: the amount of repurchase or
repurchase ratio. This paper adopts repurchase ratio (REP) as the dependent variable, utilize multiple
regression analysis model to do theoretical testing. Specific model is as follows:
REPit = αit + β1 EPSi(t−1) + β2 CR i(t−1) + β3 PBi(t−1) + β4 POR i(t−1) + β5 LAR i(t−1)
i represents listed companies; t represents the year that listed company announced share repurchase; (t-1)
means the previous year before the year of share repurchase announcement.
3.2 Measure
3.2.1 Dependent variable
Repurchase ratio (REP) is the ratio that total number of shares repurchased to total equity, and it is used
to measure the degree of share repurchases. The greater the ratio, the higher the degree of repurchase;
the smaller the ratio, the lower the degree of share repurchases.
REP = the total amount of share repurchased / total equity
3.2.2 Explanatory variables
According to multiple regression analysis model, this model involves five explanatory variables which
are EPS, CR, PB, POR, LAR, their definitions and the corresponding theoretical of verifying are as
follows:
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1) EPS: Earnings per share, EPS = Net income / Total equity, we use the listed company's earnings per
share index to test the applicability of the theory of earnings per share, relevant data selects financial
data of a share repurchase company in the end of previous year.
2) CR: Cash capital to total assets ratio, CR = total cash / total assets. We uses cash capital to total assets
ratio as a proxy variable of the company's cash capital to verify free cash flow theory.
3) PB, PB=closing stock price of the end of the previous year / net assets per share, select PB as the
proxy variable to verify signal transmission theory. PB has good representation as an indicator to assess
the company's stock value, because the stock price of listed companies is one of the indicators to
measure the market value of the company, while net assets per share is one of the indicators to measure
the real value of the company. Therefore, the PB can very well measure the difference between the
market value and the book value of the company, and verify whether the value of the company is
undervalued.
4) POR: Dividend payout ratio, POR = dividend payment per share / earnings per share, select POR as
the proxy variable to verify tax burden theory. If the listed company repurchases shares as an alternative
to replace cash dividend in order to protect shareholders' interests and to improve financial flexibility,
the company is likely to maintain a low dividend payout ratio.
5) LAR: Asset-liability ratio, LAR= Total liabilities / total assets. Select LAR as the proxy variable to
verify financial leverage theory. Financial leverage theory believes that the main purpose of listed
companies’ share repurchase is to improve the financial leverage ratio, improve asset utilization,
optimize capital structure, so before conducting share repurchases, a listed company may has lower
asset-liability ratio.
3.3 Data
This paper uses shares repurchase of listed companies as the research object. Since our country start
split share structure reform in 2005, and on 16th June in that year, China Securities Regulatory
Commission issued the "public buy-back of shares of listed companies management approach (Trial)",
after this our public shares repurchases have formal legal rules to be based on. So this paper select 16th
June 2005 as the starting date of the sample collecting. The sample data and financial information
covered in the research is mainly obtained through the following ways: (1) RESSET financial research
database, access to share repurchase events of listed companies implementing in nearly three years; (2)
The company announcement released by the websites of Shanghai Stock Exchange and Shenzhen Stock
Exchange, access to the basic information of share repurchase of listed companies; (3) Hexun networks,
access to the relevant financial information of listed companies; (4) Baidu networks, find share
repurchase events of listed companies implemented over the years.
Through above ways, we obtain the basic data needed for this paper, this paper do data sorting and
screening in accordance with certain standards to determine the sample data that meets the requirements
of this study, the follow sample data will be removed: (1) The amount of share repurchases of listed
company is less than 0.1%. (2) The information of share repurchase is missing or difficult to obtain. (3)
Types of share repurchases belong to B shares and H shares. After all basic data screening, the number
of sample is 86.
4 Empirical Results
4.1 Descriptive statistics
From Table 1, the average value of REP, EPS, CR, PB, POR and LAR are 0.0851, 0.2886, 0.2173,
2.5515, 0.2509 and 0.4072. The standard deviation of PB compared to other variables is higher, at
1.9027, the standard deviation of REP is minimum, at 0.0982. In addition, it can be seen that there is a
big gap between the maximum and minimum values of the cash capital to total assets ratio, and the
average value is relatively small, indicating that the ratio of majority company's cash capital retained is
not high. The average value of REP is 0.0851, which indicates the number of repurchased shares in
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listed companies is not much, most at a low level.
Average value
Median
Maximum
Minimum
Standard deviation
Table 1 Statistical analysis of the explanatory variables
REP
EPS
CR
PB
POR
0.085092
0.288605
0.217326
2.551480
0.258088
0.045200
0.285000
0.165000
2.047800
0.198500
0.414200
1.120000
0.830000
10.48870
1.428600
0.001100
-0.750000
0.030000
0.527200
0.000000
0.098171
0.335588
0.167440
1.902740
0.296018
LAR
0.407209
0.410000
0.780000
0.030000
0.176653
The correlation coefficient test results between each variable are shown in Table 2. From Table 2, we
can see that the multi-collinearity between various variables is not obvious, and the correlation between
various explanatory variables is low, thus lower significantly impact to the detection model. In addition,
the variables CR and LAR have a high correlation, but these two variables in the regression model did
not pass the significance test, do not affect the overall analysis results of the model.
REP
EPS
CR
PB
POR
LAR
REP
1.000000
-0.413614
-0.267731
-0.223076
-0.200336
0.201689
Table 2 Correlation matrix of variables
EPS
CR
PB
-0.413614
-0.267731
-0.223076
1.000000
0.301593
0.356889
0.301593
1.000000
0.025310
0.356889
0.025310
1.000000
0.312192
0.312876
-0.029719
-0.293179
-0.581712
0.004340
POR
-0.200336
0.312192
0.312876
-0.029719
1.000000
-0.302404
LAR
0.201689
-0.293179
-0.581712
0.004340
-0.302404
1.000000
4.2 Regression results
According the multiple regression analysis model designed by this paper, REP is the dependent variables,
the explanatory variables include EPS, CR, PB, POR and LAR. We adopts Eviews data processing
software and the ordinary least squares method to estimate parameters, tests the applicability and
explanation of share repurchase motivation theory in China's capital market, the test results are as
follows:
Table 3 The results of multiple regression
Dependent Variable: REP
fMethod: Least Squares
Date: 04/16/13 Time: 15:09
Sample: 1 86
Included observations: 86
Variable
Coefficient
Std. Error
t-Statistic
C
0.148184
0.043486
3.407615
EPS
-0.090294
0.034496
-2.617485
CR
-0.087621
0.073621
-1.190165
PB
-0.005722
0.005597
-3.022235
POR
-0.019357
0.036449
-0.531068
LAR
0.003941
0.069591
0.056628
R-squared
0.745541
Mean dependent var
Adjusted R-squared
0.744888
S.D. dependent var
S.E. of regression
0.020195
Akaike info criterion
Sum squared resid
0.010810
Schwarz criterion
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Prob.
0.0010
0.0106
0.2375
0.0008
0.5968
0.9550
5.585092
0.798171
-4.106473
-3.735239
EASTERN ACADEMIC FORUM
Log likelihood
Durbin-Watson stat
37.97834
1.644981
F-statistic
Prob(F-statistic)
4.139489
0.002145
The empirical results in the Table 3 shows that the regression equation of REP and explanatory variables
is as follows:
REP=0.1482-0.0903EPS-0.0876CR-0.0057PB-0.0194POR+0.0039LAR.
(t=3.41) (t=-2.62) (t=-1.19)
(t=-3.02) (t=-0.53) (t=0.06)
From the perspective of the statistical tests of regression equation, R 2=0.7455, it means that 74.55% of
total sum of squared deviations are explained by the sample regression line, indicating that the model
has better goodness of fit. In addition, in the significance test of the regression equation, F=1.1395, in
the premise of the 5% confidence level, pass the test of significance, indicating that there was a
significant linear relationship in the overall regression equation. The linear relationship between REP
and proportion of earnings per share repurchases, dividend payout ratio and PB is significant.
5 Discussion and Conclusion
According to the empirical results above, the regression coefficient symbols of CR and LAR are
different from the expected directions, and they does not pass the significance test, the proposed
hypothesis 2 and hypothesis 5 have not been proved, which indicate that free cash flow theory and
financial leverage theory do not suitable to China's capital market, the motivation for share repurchases
of our country’s listed companies can not be explain by free cash flow theory and financial leverage
theory. This situation may include two main reasons: one is that the retained cash capital of China's
listed companies is already at a low level, with an average of 21.73 percent, the company did not keep
more cash capital so there would not be surplus cash capital for share repurchase; on the other hand,
listed companies want to improve asset-liability ratio, to realize maximum efficiency of capital
utilization, generally taking the way of debt financing, because in this way the control power of
shareholders is unchanged. In addition, the average asset-liability ratios of sample are 41%, though it is
not very high, but increasing asset-liability ratio by the way of reducing capital often is subject to the
opposition from the company's creditors. Because of the above reasons, free cash flow theory and the
theory of financial leverage are not applicable to the share repurchase cases of our capital market.
The results show that there is a negative correlation relationship between stock repurchase and earnings
per share, and the variable passes the significance test under the confidence level of 5%, it verify that the
hypothesis 1 is correct. This shows that listed companies will take share repurchase to improve the
company's earnings per share, earnings per share theory can be applied to China's capital market and
explain the motivation of listed companies’ share repurchases. At the same time, when management can
not improve the earnings per share by the way of increasing corporate earnings, they will turn to share
repurchase. However, this approach does not actually increase the company's value too much.
Also, the regression results show that there is a negative correlation relationship between stock
repurchase and PB, and the variable passes the significance test under the confidence level of 1%,it
verify the hypothesis 3. It indicated that the lower PB of listed companies, namely the higher the degree
that listed company's share price is undervalued by the market are, the more likely the share repurchase
will take place, which will convey the market the information that value of the company is undervalued,
signaling theory can be applied to China's capital market and explain the motivations of listed
companies’ share repurchases.
Although regression coefficients of Dividend payout ratio is consistent with the expected direction, but
it does not pass the test of significance, indicating that the tax burden theory can not explain the
motivations of listed company’s share repurchase in China. It also shows that China's listed companies
may not have realized that share repurchase policy can replace cash dividend, it can improve the
company's financial structure, on the other hand, shareholders of company can avoid high tax burden.
In summary, this paper uses the multiple linear regression models to verify the classic stock repurchase
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theory in the context of our country. The results show that EPS theory and signaling theory can be
applied to China's capital market, and have a better explanation force for the motivations of share
repurchase of listed companies, while explanatory power of free cash flow theory, tax burden theory and
the theory of financial leverage is still insufficient, these three theories are not suited for the case of
China's capital market. The reason is that the listed companies have not understood the behavior of stock
repurchase clearly, and have not realized the role of the existence of stock repurchase. Finally, this paper
only verified the EPS theory and signal transmission theory in our country, and other theories’
explanation effects are weaker.
Acknowledgment:
The paper is supported by the Zhejiang provincial natural sciences Foundation of China.
(LY13G030024).
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