Article · November 011 citations reads 10,107 2

Share repurchases, dividends and asymmetrical information

Within the signalling theory framework, and more particularly the POT framework (Pecking Order Theory), a share issue is a signal – sent by a firm – indicating share overvaluation. Consequently, shares repurchase means that a share is undervalued and contributes to increase the value of the remaining shares. From this point, Brennan and Thakor (1990) explain the choice between share repurchases and dividend payments using the informational asymmetry among investors. For Brennan and Thakor (1990) uninformed shareholders prefer dividends because a share repurchase involves a wealth transfer from uninformed to informed shareholders. Informed shareholders will sell their shares only if they are overvalued. Otherwise, they will not. If the ownership structure is made up of informed shareholders, share repurchases will be chosen. Share repurchases, in this case, can be viewed as a good investment opportunity.

The previous arguments lead us to wonder whether dividends and share repurchases are complementary or substitutable. Albouy and Morris (2006) point out that share repurchases increase when companies pay dividends. This shows that these two financial actions have common objectives, in particular to give back free cash flow (FCF) to shareholders. In

¹⁷ It is important to notice that share repurchases are mostly undertaken by large firms. ArcelorMittal, GDF Suez, Sanofi Aventis, Total and Oréal. 78% of the shares purchases are realized by these groups.

addition, Albouy and Morris (2006) stress that, during an economic expansion, the announcements of share repurchases are made by firms to avoid dilution of the EPS (earnings per share), whereas in a period of low economic growth (or recession), share repurchases are able to highlight the share value. In addition, there is no relationship between share repurchase and change in capital structure.

Informational asymmetry can be also analyzed ex-post. According to Dereeper and Romon (2006), share repurchase is related to the development of stock options. If Fenn and Liang (2001) show a negative relationship between dividends and stock options, the relationship becomes positive between stock options and share repurchases. Indeed, the existence of stock options leads managers to use share repurchases (rather than dividends) because this repurchase offsets the effect of exercised options; they preserve the share value by reducing capital dilution. For Fenn and Liang (2001), managers prefer share repurchases to dividends because the majority of option contracts do not take into account the change in exercise price at the date of dividend payment. The dividend payment leads to a decrease in option value.

3.