“Understanding equity repurchase motives for different firm set-up: Indian evidence”

Corporates express their intention to reward shareholders during repurchase an- nouncements by maximizing their wealth. However, most empirical research finds that stocks’ performance is poor when repurchase announcements are made, and there are no significant abnormal returns. In the Indian context, the present study examines firms’ real intention behind repurchase decisions. The sample comprises 132 firms listed on the Bombay Stock Exchange (BSE) from 2012 to 2018. A Tobit regression model has been used on different firm set-up. The empirical results reveal that low stock valuation is the prominent reason for buybacks among corporates. Firms prefer repurchases to provide abnormal returns to the investors; however, the Indian market does not react much positively to the repurchases, and this might be the reason for less encouraging buybacks in the Indian market. Further, the tender offer is the most pre- ferred mode to open market repurchases. In the case of service firms, undervaluation, low earnings, and low debt ratios are the contributing factors impacting repurchases. Firms with low dividend intend to have more buybacks to reduce their tax burden.


INTRODUCTION
A previous study has also tested the impact of buyback announcements on stock performance for the given set of 132 firms. The results are on similar lines indicating negligible abnormal returns to the shareholders. Further, small windows (pre and post) were created to explore the opportunity to make an abnormal profit. Interestingly, the significant results were observed in the pre-event window of −15 to −1 with cumulative abnormal returns of 6 percent. After that, there was a decline in the returns.
Generally, firms intend to provide positive returns through repurchases, however, most research in the Indian context tested the buyback announcements' impact on stock returns using market timing theory. The evidence corroborates that the performance of stocks is poor in the case of repurchase announcements 1  , and there are no significant abnormal returns post repurchase announcements (Grullon & Michaely, 2004). Here the question arises: "If returns are negligible post announcements and the market discounted the information much in advance, then how the companies meet the objective of rewarding shareholders?" Regarding the above question, the study first examines firms' real motivation behind buyback decision. Following Dittmar's (2000) work, the paper tries to capture the effect of various hypotheses by examining the actual repurchases using the Tobit regression model for the whole set of 132 firms from 2012 to 2018 in the Indian capital market. The present study deviates from Jena et al. (2016) that it has an extensive focus on different firm set-ups for controlling. Previous work in literature focused on firm size (Andriosopoulos & Hoque, 2013), life cycle stages (Liang et al., 2013), and buyback frequency (Varma et al., 2018;Jagannathan & Stephens, 2003). Therefore, most studies control a few situations, and thus, researchers limit the findings by ignoring varying firm set up that may significantly impact the repurchase decision. For instance, studies focusing on firm size, age, sector, etc., indicate their influence on repurchase amount. However, the deep impact within that set-up has been ignored in terms of cash availability within those firms, dividend-paying capacity, stock valuation, earnings per share, and leverage ratios. For example, if large firms consider more repurchases, it would be interesting to explore which specific factors contribute towards their decision to buy back shares. Therefore, the second motivation of this paper is to analyze the explicit dynamics subsidizing the drive for buyback in the different firm set-up.
It is believed that the data derived from the Indian market explain the buyback intentions well. The study finds that stock undervaluation is the main contributing factor for repurchases. ,The firm asset size hypothesis supports this evidence and due to information asymmetry, small firms have a negative association with buybacks.

LITERATURE REVIEW
Corporate firms use a wide range of financial options to reward shareholders (Bagwell & Shoven, 1989), and share repurchases are generally taken to improve stock returns (Ikenberry et al., 1995). Therefore, stock undervaluation is considered the prominent reason for repurchases ( Another value-enhancing drive of undervalued firms is to adjust their capital through share repurchase to have an optimal capital structure (Dixon et al., 2008). Bonaime et al. (2014) noted that low valued and underleveraged firms are most benefitted from the buybacks; hence, they come out with more buybacks. In India, firms that issue or buyback equity generally have low debt ratios (Hovakimian, 2004). If the leverage is low among firms, adjustments can be made to increase the leverage due to the tax advantage.

BUYBACK HYPOTHESES
H1: As cash presumes to have a relationship with the repurchase amount, the study hypothesizes that excess free cash flow motivates firms to issue a higher amount of repurchases.
H2: The study hypothesizes that under levered firms come out with more buybacks to increase their leverage ratios.
H3: The study also hypothesizes that variables like valuation, earnings, cash availability, size, age, dividend payout, and leverage ratio impact the firm's intentions for buyback decisions.

Methodology
The study tests the various repurchase hypotheses with the following Tobit regression model for the given repurchase year: (dividend payout ratio), the ratio of dividend payments to net profit in the year before the repurchase has been included. It is expected that firms with higher repurchases pay fewer dividends.
The leverage hypothesis predicts firms' tendency to buyback equity when the leverage ratios are low. This is to adjust back to a little higher debt ratio; however, the debt ratio should not exceed 2:1 after buyback as mandated by SEBI. Therefore, it is expected that firms with low leverage prefer to have a higher amount of repurchases. For this purpose, it LOG ASSETS − measured by natural log of total assets at the end of the year before the buyback. The rationale behind these two predictors is the undervaluation hypothesis that firms intend to buyback equity when the stock prices are below their real value, and thus, managers are better informed than market about the real value of stock. This creates an information asymmetry issue. According to Liang et al. (2013), growing firms announce buybacks to signal their stock's underval- 3 A sample of 132 firms has been selected on the buyback announcements impact of these firms. In the previous study, the results were not significantly in favor of positive abnormal returns post buyback. This motivated to examine the actual rationale behind repurchase issuance for a similar set of firms. Initially, the data were available for 180 firms; however, it was reduced to 136 firms due to sample selection criteria and other missing values. This analysis further reduced to 132 final sample firms for the current study on account of missing data for few variables.
uation. Similarly, Vermaelen (1981) believes that information asymmetry is more prevalent among small firms. Due to these reasons, it is expected that small and growing firms have undervalued stock and thus prefer to repurchase stock.
To check the impact for different firm set-up, firms have been bifurcated using median in each case.

Data and statistics
The sample comprises 132 firms 3 listed on the Bombay Stock Exchange (BSE) from 2012 to 2018. Before this period, the number of successful buybacks in India was negligible, and the data were also missing. The data have been extracted from CMIE Prowess. Table 1 provides the total number of equity buybacks for the given period, which indicates a sharp rise in the repurchases post 2015. The preference of firms for tender offer repurchases shifted drastically from 2015. As shown in Figure 1, within various firm set-ups, tender offer buybacks are the most preferred mode of buyback compared to open market repurchases.  It is also interesting to note that small and medium firms have relatively more cash (2% of assets) than large firms (−1% of assets); however, these firms pay fewer dividends. This corroborates the fact that small and medium firms, in comparison to large firms, prefer to use excess free cash to reward shareholders by repurchasing equity, whereas, large firms despite their negative cash flow, pay more dividends using reserves. The debt ratio mean values are statistically significant across large, mature, and manufacturing firms. These firms deploy the nearly double amount of debt in their capital structure concerning another set of firms.    Note: The table presents the independent t-statistical values for different firm set-up based on buyback offer method, firm sector, firm size, and firm age. Across all groups, firms are divided into two further sections. Firm size and firm age are categorized using the median. The dependent variable repurchases are % of the market value of equity. Independent variables are MKBK, earnings, DPR, leverage, and cash. MKBK is the market-to-book ratio. Earnings are the profit after taxes divided by total assets. DPR is the dividend payout ratio, where cash dividends are divided by earnings of a similar year. Leverage is the total debt to asset ratio. Cash is cash and cash equivalents divided by total assets. ***, **, and * indicate significance level at 1%, 5%, and 10%. Note: The table presents the independent t-statistical values for different firm set-up based on valuation, cash, leverage, and dividend. Across all groups, firms are divided into two further sections using the median. The dependent variable repurchases are % of the market value of equity. Independent variables are MKBK, earnings, DPR, leverage, and cash. MKBK is the market-to-book ratio. Earnings are the profit after taxes divided by total assets. DPR is the dividend payout ratio, where cash dividends are divided by earnings of a similar year. Leverage is the total debt to asset ratio. Cash is cash and cash equivalents divided by total assets. ***, **, and * indicate significance level at 1%, 5%, and 10%.    Note: This table displays the Tobit regression results for all firms and firms across different groups. Firms based on size, age, valuation, cash, leverage, and dividend are categorized into two groups using the median. The dependent variable repurchases are % of the market value of equity. Independent variables are MKBK, earnings, DPR, leverage, and cash. MKBK is the market-to-book ratio. Earnings are the profit after taxes divided by total assets. DPR is the dividend payout ratio, where cash dividends are divided by earnings of a similar year. Leverage is the total debt to asset ratio. Cash is cash and cash equivalents divided by total assets. ***, **, and * indicate significance level at 1%, 5%, and 10%. Table 4 provides the t-statistical analysis of firms segregated based on valuation, cash, leverage, and dividend. The repurchase mean values of low valued firms indicate that these firms make a substantial amount of equity buybacks than high valued firms; the mean values are 11% for low valued and 2.8% for high valued firms. The motivation to have large repurchases is due to the fewer earnings among low valued firms; the lower earnings continue to keep the stock valuation low. Therefore, to improve the valuation of their stock prices, these firms come out for buybacks. Another interesting fact is that firms with low debt have more earnings, and thus these firms are left with more cash and pay a higher amount of dividends. The mean dividend values, 41% among low and 29% among high levered firms, are statistically significant. As far as dividend groups are concerned, firms having a higher amount of earnings prefer paying more dividends. Log assets also support the above findings; the coefficient is negative with a value of −0.35. The undervaluation hypothesis explains that firms intend to repurchase equity when it is below it's real price. Hence, the managers are better informed about stock's actual value, which creates information asymmetry. Therefore, it was expected that small firms repurchase more equity due to higher information asymmetrical issues. The findings evidence that small firms indicate low valuation of their stock and are more likely to repurchase stock. As the size increases, firms have a higher valuation of their stock, giving less preference to repurchases.

T-stat of different firm set-up
The above inferences create a surprising connection with the literature evidence related to buy- 4 The study has also examined post buyback announcement impact on undervalued firms' stock returns. This is to check if undervaluation is the major reason, then do buyback announcements help firms improve the value of their stock by providing abnormal returns. The findings indicate negligible returns, which sustains a maximum of one day. After that, the returns are negative. However, in the case of service firms and asset size, lower earnings and low debt ratios are other contributing factors impacting repurchases. These facts convey that as the firm size decreases, the earnings also decline, and firms do not have much debt in their capital structure. Therefore, more repurchases among these firms provide corrections to stock valuation and debt ratios. Similar observations have been made for growing firms, which is in tune with Liang et al.'s (2013) findings.
Another assumption of the study is that low dividend and low levered firms prefer more repurchases. The findings reveal that the coefficient value is −0.332 for low dividend firms, corroborating that firms with low dividends intend to have more buybacks to reduce their tax burden.

CONCLUSION
In this paper, firms' real intention behind repurchase decisions using Tobit model has been postulated. The results have been examined for a whole set of firms and different firm groups. The study finds that the prominent reason for repurchase is the low valuation of stocks, and firms repurchase equity when they are potentially undervalued. The findings are supported by asset size due to information asymmetry issue. Small firms have low valuations and are more likely to repurchase stock. As the size increases, firms have a higher valuation of their stock, giving less preference to repurchases.
In connection with the literature evidence related to buyback announcements, firms intend for more repurchases due to low valuation to reach the intrinsic worth of stock by providing abnormal returns to the investors. However, the market does not react much positively, and returns are for a very short period. This could be one reason that Indian buybacks are not very encouraging as the firms' objective to reward shareholders by providing additional gains does not fulfill.
Across different firm set-up, stock undervaluation is the prominent reason behind buyback. Further, the tender offer is the most preferred mode to open market repurchases. For service firms, low earnings and low debt ratios impact repurchases providing corrections to stock valuation and debt ratios. Firms with low dividends intend to have more buybacks to reduce their tax burden.
The study has implications for investors and academicians. The findings provide a fair idea to the investors that trading near the buyback announcements is generally less encouraging, and hence, returns are less attractive during those days. To the academicians, the study provides Indian evidence on the real motivation behind repurchase decisions, which has been a major gap in other similar studies. The study provides evidence on how the buyback varies among different firm set-ups.