Opportunistic Stock Repurchases for Owner–Manager Control: Evidence from the Korean Stock Market

• Author: Jin Hwon Lee,Kyung Soon Kim,Seun Young Park,Chune Young Chung
• Published date: 01 April 2016
• DOI: http://doi.org/10.1111/ajfs.12131
• Date: 01 April 2016

Opportunistic Stock Repurchases for

Owner–Manager Control: Evidence from the

Korean Stock Market*

Kyung Soon Kim

College of Business, Chosun University

Chune Young Chung**

College of Business and Economics, Chung-Ang University

Jin Hwon Lee

Department of Business Management, Osan University

Seun Young Park

College of Business Administration, Ewha Womans University

Received 30 August 2015; Accepted 15 February 2016

Abstract

We examine whether opportunistic earnings management before a repurchase and long-term

performance after a repurchase depend on repurchase options and insider ownership. We

find that the negative association between pre-stock repurchase earnings management and

abnormal long-term performance after stock repurchase is more pronounced when firms

choose the direct stock repurchase method over an indirect repurchase through a trust fund.

Our findings also show that the negative association between pre-repurchase accruals and

long-term performance under direct stock repurchases is only evident when the ownership

percentage of managers and their affiliates is less than 50%. In addition, our main findings

are more pronounced in firms with a high degree of corporate information asymmetry.

Keywords Earnings Management; Emerging Market; Information Asymmetry; Opportunistic

Behavior; Stock Repurchase

JEL Classification: G14, G24, G32, M41

*The authors are grateful for the comments of an anonymous referee and Yong H. Kim (the

special issue editor). This study was supported by a research fund from Chosun University,

2015

**Corresponding author: Chune Young Chung, School of Business Administration, College

of Business and Economics, Chung-Ang University, 84 Heukseok-ro, Dongjak-gu, Seoul

156-756, Korea. Tel: +82-2-820-5544, Fax: +82-2-815-7001, email: bizfinance@cau.ac.kr.

Asia-Pacific Journal of Financial Studies (2016) 45, 309–335 doi:10.1111/ajfs.12131

©2016 Korean Securities Association 309

1. Introduction

A stock repurchase can be considered an alternative way to pay dividends, because

a firm is able to return cash to investors through the repurchase. A firm can buy

shares directly from the market or offer to buy back shareholders’ shares at a fixed

price. Firm managers may execute a stock repurchase program when they find no

better investment. In general, a stock repurchase increases earnings per share and

tends to lift the market value of the remaining shares by reducing the number of

outstanding shares.

However, investors may prefer the dependability of stocks with cash dividends

to stocks that might experience transient repurchasing and, thus, invest more heav-

ily in the former option. More importantly, firm managers may utilize stock repur-

chases when they believe that their firms’ shares are undervalued. Hence,

stockholders who tender their shares during a repurchase may be taking a risk if

they do not possess all relevant information about the offer.

Existing research shows that in an asymmetric informational market, a manager

uses stock repurchases as a tool to signal to the market that the firm’s share price is

currently undervalued (Dann, 1981; Ofer and Thakor, 1987; Ikenberry et al., 1995;

Lie, 2005; Oded, 2005; Ben-Rephael et al., 2014). This signaling process may assist

in mitigating the information asymmetry between inside and outside shareholders

with regard to the firm’s fundamental share price. However, studies also show that

managers might exploit their informational advantage to realize proprietary benefits

when executing stock repurchases (Chan et al., 2006; Louis and White, 2007; Gong

et al., 2008). For example, a manager may have an incentive to inte ntionally lower

the firm’s share price by manipulating its earnings before a stock repurchase, thus

transferring wealth from outside shareholders to inside shareholders. Although

firms’ motivations for signaling and manipulating share prices may differ, we expect

positive long-term performance in firms conducting stock repurchases.

In particular, relative to more developed markets, firms and groups of investors

in emerging stock markets tend to have high information asymmetry because of a

lack of robust financial systems, weak institutional investor monitoring, and high

firm-ownership concentration. In this distinctive market environment, managers are

more likely to avoid delivering correct information to the market and to engage in

opportunistic behavior as they exploit their informational advantage. Therefore,

firms’ positive long-term performance after a stock repurchase is more likely in an

emerging stock market than in a developed stock market. Furthermore, opportunis-

tic stock repurchases could be more evident in emerging markets, and may signifi-

cantly explain a firm’s positive long-term performance.

We focus on stock repurchases in the emerging Korean stock market. We exam-

ine whether stock repurchases are related to a firm’s long-term performance and, if

so, determine the drivers of that relationship.

First, we examine whether opportunistic earnings management plays a role in

pre-stock repurchases and subsequently affects the firm’s long-term performance.

K. S. Kim et al.

310 ©2016 Korean Securities Association