Heterogenous Shareholders and Signaling with Share Repurchases
John C. Persons
This paper presents an asymmetric information model of share repurchases when shareholders have heterogeneous reservation values. Consistent with empirical evidence, managers in the model repurchase shares at a premium above the post- repurchase share value - transferring wealth from shareholders who do not tender to those who do - in order to signal that the firm is undervalued. Such dilutive repurchases would not occur under the classical assumption of perfectly elastic share supply; they depend critically on shareholder heterogeneity. It is also shown that repurchases are more efficient signals that other strategies like dividends and "burning money." The model's implications are consistent with much empirical evidence regarding announcement returns, repurchase size, repurchase premiums and expiration-day price drops.
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