1. Do managers time the market ? Evidence from open-market share repurchases Konan Chan, Univ. of Hong Kong and National Taiwan Univ. David Ikenberry, University of Illinois at Urbana-Champaign Inmoo Lee, National University of Singapore 2006 NTU International Conference on Finance, December 2006

2. December 2006 Chan, Ikenberry, Lee 2 Motivation Managers seem to have timing ability in making corproate decisions  IPOs: Ritter (1991)  SEOs: Loughran and Ritter (1995)  (Stock) Mergers: Loughran and Vijh (1997)  Repurchases: Ikenberry, Lakonishok, Vermaelen (1995)  Spin-offs: Cusatis, Miles and Woolridge (1993)  Splits: Ikenberry and Ramanth (2002)  Equity share in new issues: Baker and Wurgler (2002)

3. December 2006 Chan, Ikenberry, Lee 3 Motivation (continued) Two major concerns  Biased methodology Bad model problem: Fama (1998), Eckbo et al (2000) Wrong method: Brav et al (2000), Mitchell and Stafford (2000) Time dependence: Gompers and Lerner (2003) Statistical test: Brav (2000)  Pseudo market timing: Schultz (2003) Managers do not have timing ability and they make corporate decisions solely based on past market performance This will mechanically create the pseudo performance following managerial decisions

4. December 2006 Chan, Ikenberry, Lee 4 Pseudo market timing (Schultz (2003)) Assume no abnormal return in each period Issue when prices are high Abnormal return occurs only when in event-time, but not in calendar-time Poor-performed firms get more weight in event-time

5. December 2006 Chan, Ikenberry, Lee 5 Pseudo market timing Key implications of PMT  Strong relationship between corporate events and past market performance  The abnormal returns, if there is any, exist only when the event-time approach is used Debate  Support (Butler et al (2005)): return predictability of equity share in new issues is due to PMT  Against (Baker et al (2006)): PMT explains only a small portion of equity offering decisions

6. December 2006 Chan, Ikenberry, Lee 6 Goal of this paper Examine whether pseudo market timing can explain the share repurchases decision  Check if key implications of pseudo market timing hold  How much abnormal return can be explained by pseudo market timing?  Examine if the performance is affected actual buyback, an indicator of managerial perception of undervaluation

7. December 2006 Chan, Ikenberry, Lee 7 Why repurchases? Out-of-sample test: past studies of pseudo market timing focus on IPOs Examine the major motive to buy back: mispricing

8. December 2006 Chan, Ikenberry, Lee 8 Data Open-market repurchases (Chan et al (2004))  1980-1996: 5,508 obs Sample selection  Size  BM  Share price >= $3 prior to announcements Actual repurchase  Quarterly cash flow statement

9. December 2006 Chan, Ikenberry, Lee 9 Buy-and-hold abnormal returns Matching firms: control size, BM, stock exchange Poor performance prior to announcements Strong outperformance following buyback programs

10. December 2006 Chan, Ikenberry, Lee 10 Relationship between number of repurchases and past market performance Except the months in the highest past return quintile, there is no strong relationship between the number of repurchases and past market performance One would expect to observe many obs when past return is low

12. December 2006 Chan, Ikenberry, Lee 12 Calendar-time abnormal return Carhart (1997) four-factor model regressions Portfolios include firms announcing buybacks in past 4 years OLS assigns equal weight to each calendar month WLS uses # of obs as weight, and converts back to event-time

13. December 2006 Chan, Ikenberry, Lee 13 BHARs condition on actual buybacks Actual repurchase  Non-buy: no buyback at all  Buy-less: buy back <= 4% of shares outstanding  Buy-more: buy back > 4% of shares outstanding

14. December 2006 Chan, Ikenberry, Lee 14 BHARs condition on actual buybacks

15. December 2006 Chan, Ikenberry, Lee 15 CAR using RATS based on Carhart model

17. December 2006 Chan, Ikenberry, Lee 17 Conclusion Evaluate the key implications of PMT  Open-market repurchase decisions do not strongly depend on past market performance  Strong abnormal returns are still observed when the calendar-time approach is used Evaluate the performance condition on actual buyback activity  There is a strong relationship between actual buyback and future performance  The relationship is particularly strong in value firms

18. December 2006 Chan, Ikenberry, Lee 18 Conclusion (continued) Pseudo market timing can explain only a small portion of return drifts following repurchases The share repurchase decisions do not seem to be explained by pseudo market timing, but indicate the managerial timing ability