Stock buybacks and growth opportunities

Abstract

This study examines the role of growth opportunities on stock buybacks and provides evidence on the importance of signaling and agency theories in explaining stock buybacks. Both theories are required to fully explain stock buybacks. As per the signaling theory, we find that the announcement period returns are positive for stock buybacks, which indicates that the buyback firms’ stock is undervalued. Furthermore, consistent with agency theory, we also find that the announcement period returns are higher for firms with low growth opportunities and high free cash flow. We also examine buyback firms' long-run stock price performance for 12 months, 24 months, and 36 months following the buyback. We use the Fama–French five-factor model to study the long-run stock performance of buyback firms because of its better explanatory power than the three-factor model. Low growth-high free cash flow firms tend to outperform their benchmark portfolios during this period. Recent regulations such as the Stock Buyback Tax can discourage low growth firms from conducting stock buybacks, which could increase agency costs.