RIJBFA Volume 1, Issue 4(April 2012) ISSN: X. Research Consortium RIJBFA RADIX INTERNATIONAL JOURNAL OF BANKING, FINANCE AND ACCOUNTING

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1 A Journal of Radix International Educational and Research Consortium RIJBFA RADIX INTERNATIONAL JOURNAL OF BANKING, FINANCE AND ACCOUNTING OPEN MARKET SHARE BUYBACKS IN INDIA Dr. Karamjeet Kaur Head, Department of Commerce ASSM College, Mukandpur (Constituent College of GNDU, Amritsar) SBS, Nagar PUNJAB-INDIA INTRODUCTION Share buybacks has become a buzzword today in Indian stock markets. Companies in India can buyback their share either through open market route or through tender offer route. Majority of companies have been using the open market route through stock exchange. A total of 172 events of share buybacks through open market have been found during March 2001 to March Many companies have announced share buybacks more than once during this period. Previous research has found that share buybacks announcements create positive market reaction suggesting thereby

2 that stock markets welcome share buybacks. Most of research has been done in developed markets. Since, share buybacks is a recent phenomenon in India, very few studies have been conducted in Indian context. Also, rarely any study is found on the impact of open market share buyback announcements in India. The objective of this paper is to study the stock market reaction to open market share buyback announcements in India for BSE listed companies. Rest of the paper is organised as follows: Section II reviews relevant literature. Section III discusses the research methodology. Section IV presents the analysis and interpretation. Section V concludes the study. Review of Literature There is a rich literature studying the price impact surrounding announcements of open market share repurchase programs in the US [Vermaelen (1981), Comment and Jarrell (1991), Ikenberry et al. (1995), Kahle (2002), Grullon and Michaely (2004)]. In the US, share repurchase programs are authorized by the board of directors and hence do not need shareholder approval as in European countries. Announcements of open market share repurchase programs in the US seem to be associated with a positive abnormal return of around 3%. The most prevalent explanation for this finding is that managers activate open market share repurchase programs when the stock is perceived as undervalued. The announcement is therefore, a signal of undervaluation of the firm s stock which exhibits a positive abnormal return. Prior studies that have examined the announcement effect of open market share repurchase programs in Europe have found a much smaller price impact than that found in the US e.g Lasfer (2000) find an announcement effect of 1.64% in the UK, 0.78% in France, and 0.63% in Italy. Rau and Vermaelen (2002) find an announcement in the UK of 1.14%. However, these studies differ from the US studies since they examine the announcement effect

3 surrounding announcements that the firms intend to ask for the shareholders approval to start a repurchase program at the next shareholders meeting. The smaller price impact is thus not surprising since all firms should request an authorization by the shareholders to be able to take advantage of buying undervalued shares whether or not the shares are undervalued at the time of the announcement. Ikenberry et al. (1995) found that average abnormal four year buy and hold returned measured after the initial announcement is 12.1% in US. Most of these studies have found undervaluation of shares as the motive of announcing share buyback programs, hence for positive stock market reaction. So far, no study on open market share buyback announcement has been conducted in Indian market. Hence, the need is felt to undertake this study. Data Base and Methodology The sample in this section consists of open share buy-back announcements of BSE listed companies for the period January-December The public announcement dates of open market share buy-backs are available on The companies showing infrequent trading are not included in the sample. A total of 21 events of open market share buy-backs are found where public announcements dates are available for BSE listed companies. For the purpose of present study, CPRA has been used to examine the market reaction to open market share buyback announcements. This approach has been used by Masulis (1980) in analyzing the stock price behavior around repurchase, Woolridge (1983) in analyzing the stock price change with dividend changes and Kaur and Singh (2003) in analyzing market reaction to share buyback announcements. In this approach, stock returns are analyzed around the

4 event announcement date. The announcement period is defined to include day 0 and +1 because sometimes announcements are made in the later hours of the day. If there is no trading on day 0, the next day s closing price is used as the day 0 closing price. Then a time series of stock returns is taken ten days before the announcement and 9 days after the announcement date, defining these returns as the comparison period returns (excluding the event period under study 0, +1). The mean return process is stationery and that the time series is representative of the security s return distribution. The means of return distribution for the event day and surrounding days are compared to ascertain the market s perception of event announcement. Then, student s t-test is applied to test the significance of the difference between the portfolio s announcement period mean daily return and comparison period returns. In short various steps involved are as follows: a) Daily return for security i from 10 trading days before to 10 trading days after the announcement (including day 0) of event announcement is computed by R i, t MP i, t MP MP i,( t 1) i,( t 1) Where MP i,t = Market price of security i on day t. MP i,(t-1) = Market price of security i on day t-1. b) Mean daily returns of all the securities is calculated for each relative day by using the following formula : n 1 n i 1 MDR t R i, t

5 Where n = No. of securities in the portfolio during day t. t = -10 to +10 days. c) Significance of MDR is tested through t-value by comparing MDR of comparison period with that of MDR of announcement period. Mean percentage of returns greater than zero (MPRZ) is calculated to find out the percentage of companies experiencing positive returns. Analysis and Interpretation Table 4.1 shows the CPRA results of open market share buy-back announcement for BSE listed companies for 21 days event window. The mean abnormal returns are positive from day 0 to day +3 but thereafter negative till day -7. Mean abnormal return on day -2 is 1.40% which is highest as compared to other days which shows that the market anticipates the event. Table 4.1 Market Reaction to Open Market Share Buy-back Announcements in BSE (CPRA) Trading Day Mean Daily Return Cumulative Daily Returns (CDR) Mean Percentage of Returns Greater than Zero (MPRZ) (MDR)

6 M D R M P R Z M D R MPRZ Observation Period

7 Comparison Period t value of MDR 2.38 The two days observation period (0 to 1) mean return is 1.38% whereas comparison period mean return is 0.07%. The difference between the mean returns is significant at 5% level of significance implying that announcement period returns are significantly higher than comparison period. This is due to mean daily return being highest on day 0. Also, two days observation period MPRZ is 54.76% as compared to comparison period MPRZ which is 18.70%. A total of 3.91% CDR is generated during 21-day event window. Figure 4.1 plots the mean daily returns and cumulative daily returns for 21 days event window. The mean daily returns are positive after day 0 to day +3. The mean daily return curve is highest on day -2 and thereafter with a short decline again reaches almost at the same point on day 0. After that, the curve shows a small decline. The CDR curve shows a sharp increase after day -4 and reaches at the peak on day +3 and shows decline thereafter. This analysis shows that the market reacts to the event before its formal announcement as mean daily returns are highest on day -4. It is so because, much of the information is already disclosed in board meetings for buy-back, media announcements and stock exchange announcements. So the public announcement of open market share buy-backs generates less positive returns.

8 Fig 4.1 Market Reaction to Open Market Buy-back Announcements in BSE (CPRA) Conclusion The present paper investigated the impact of open market share buy-back announcements on share prices of BSE listed companies. Significant positive mean daily returns (MDR) are observed for two days observation period. Cumulative daily returns curve reaches at the peak on day +3. About 55% of open market share buyback events experience positive returns on the announcement day. Returns are positive even before the announcements i.e from day -3 to -1. It is so, because much of the information about share buy-backs is announced in board meetings, shareholders meetings and media announcements resulting in hike in prices in pre-announcement period. Further, it is seen that post-announcement returns are very small and mostly negative, but insignificant. This shows that market quickly absorbs all the information implying market being efficient in semi-strong form. The findings of this study are consistent with earlier studies in other markets suggesting that open market share buybacks are welcomed by the markets.

9 References Comment, R. and Jarrell, G.A. (1991), The Relative Signaling Power of Dutch-Auction and Fixed-Price Self-Tender Offers and Open-Market Share Repurchases, Journal of Finance, 46, Dhatt, G. K. (2010), Impact of Buyback announcements on Share Prices in India, The Indian Journal of Commerce, 63(3), Grullon. G., Michaely, R. (2004), The information content of share repurchase programs, Journal of Finance, 59, Gupta, A (2006), Share Price Behaviour Around Buybacks in India, ICFAI Journal of Applied Finance, 12(2), Hyderabad, R L (2009), Market Reaction to Buyback Announcement in India, ICFAI Journal of Applied Finance, 15(12), Ikenberry, D. L., Lakonishok, J. and Vermaelen, T. (1995), Market Underreaction to Open Market Share Repurchases, Journal of Financial Economics, 3, Ishwar, P (2010), Stock Price Responses to the Announcement of Buyback of Shares in India, Indian Journal of Commerce and Management Studies, 1(1), Kahle, K.M. (2002), When a Repurchase isn t a Repurchase: Open Market Repurchase and Employee Options, Journal of Financial Economics, 63, Kaur, K. and Singh B. (2003), Buy-Back Announcements and Stock Price Behavior: An Empirical Study, Journal of Applied Finance, 9(5), 23-30, (August).

10 Lasfer, M.A. (2002), The market valuation of share repurchases in Europe, Working paper, City University Business School. Masulis, R.W. (1980), Stock Repurchase by Tender offer: An Analysis of the Causes of Common Stock Price Changes, Journal of Finance, 35, Rau, R., Vermaelen, T. (2002), Regulation, taxes and share repurchases in the United Kingdom, Journal of Business, 75, Vermaelen, T. (1981), Common Stock Repurchases and Market Signaling, Journal of Financial Economics, 9, Woolridge, J.R. (1983), Dividend Changes and Security Prices, Journal of Finance, 38(5), , (December).