Why Do Firms Announce Open Market Repurchase Programs

Empirically, the announcement of an open-market stock repurchase program is accompanied by a price increase even though the announcement is not a commitment. In fact, for many announced programs no shares are ever actually repurchased. This paper explores this puzzle. Our model shows that the option that a firm grants itself by announcing a program cannot, by itself, generate announcement returns. In equilibrium, long-run gains from the adverse selection that this option creates are offset by short-run costs from the market's accounting for this adverse selection. Based on this trade-off, we construct a signaling model that does deliver announcement returns. In the separating equilibrium, good firms do not incur any cost when they announce a program. Their gains from adverse selection in the long run offset the cost of announcement incurred in the short run. Mimicry is costly because a bad firm's long-run gains from adverse selection cannot compensate for the short-run cost of announcing. The other main predictions of our model are that the post-announcement expected return will be relatively low in the short run but relatively high in the long run and that the post-announcement long-run return will be correlated with the level of actual repurchase. These predictions are broadly consistent with the empirical evidence.