Paper_Agency Implications of Equity Market Timing
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NES 20th Anniversary Conference, Dec 13-16, 2012 ...

NES 20th Anniversary Conference, Dec 13-16, 2012
Article "Agency Implications of Equity Market Timing" presented by Yuri Tserlukevich at the NES 20th Anniversary Conference
Authors: Ilona Babenko, Yuri Tserlukevich, and Pengcheng Wan

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Paper_Agency Implications of Equity Market Timing Paper_Agency Implications of Equity Market Timing Document Transcript

  • Agency Implications of Equity Market Timing Ilona Babenko, Yuri Tserlukevich, and Pengcheng Wan August 14, 2012 Abstract We develop a rational expectations model to examine the con‡icts of interest between di¤erent groups of shareholders in …rms’ market timing decisions. We show that current shareholders bene…t from share repurchase timing, whereas future shareholders prefer issuance timing. Using a new empirical measure that captures the additional returns to shareholders from equity sales and stock repurchases, we document that managers of large …rms time the market primarily through stock repurchases and are rewarded with higher compensation when they beat the market. In contrast, managers of small …rms appear to cater more to future shareholders in their market timing decisions. JEL codes: G30, G32, G35 The authors are in the Department of Finance, Arizona State University, ibabenko@asu.edu,pengcheng.wan@asu.edu, yuri2@asu.edu, phone 480-965-7281. We thank Baozhang Yang (FIRS dis-cussant), Javed Ahmed, Oliver Boguth, Michael Faulklender, Michael Hertzel, Vincent Glode, the partic-ipants in the 2012 Financial Intermediation Research Society Meeting and the seminar at Arizona StateUniversity. The paper has been accepted for presentation at the American Finance Association Meetingin 2013. 1
  • Equity market timing has received much attention in recent academic articles. Thegeneral consensus in the literature is that market timing of share repurchases and equitysales is widespread and profoundly a¤ects …rm …nancing, capital structure, mergers andacquisitions, and other corporate decisions.1 It is further suggested that skillful managersshould engage in a dynamic equity timing strategy, exploiting both underpricing andoverpricing of their …rms’stock. But is dynamic policy always consistent with maximizingshareholder value? Do repurchases of undervalued shares and issuances of overpricedshares have the same e¤ect on current and future …rm shareholders? And are managersrewarded …nancially for successful market timing? We address these questions through a simple model of market timing built on therational expectations framework of Grossman (1976). Contrary to casual intuition, weshow that a …rm buying back undervalued shares takes advantage primarily of incomingshareholders, whereas a …rm issuing overvalued shares exploits selling shareholders. Ourstarting point is that, absent any actions by a …rm, shareholders trade in …rm stockwithout knowledge of over- or underpricing. The key is then to compute the changesin expected shareholder gains or losses associated with informed trading by the …rm.For example, shareholders who happen to sell stock when it is overvalued bene…t frommispricing. However, when the …rm issues additional shares to take advantage of stockovervaluation, both the price and the quantity of shares sold by these shareholders islower, resulting in a negative expected change in their wealth. In the model, a …rm manager is endowed with private information, long-term share-holders are passive, and selling and incoming shareholders can learn from the …rm’ de- s 1 For example, managers admit to market timing considerations a¤ecting corporate decisions (Grahamand Harvey (2001)), high valuation …rms use their own equity as in‡ated acquisition currency for takeovers(Shleifer and Vishny (2003)), market timing has a persistent e¤ect on …rm capital structure (Baker andWurgler (2002)), and a model with market timing better …ts the time-series of the data (Waruswitharanaand Whited (2011)). Additionally, a large empirical literature documents abnormal stock return patternsaround corporate events that could be symptomatic of market timing by …rm managers (see, e.g., Jenter,Lewellen, and Warner (2011), Ikenberry, Lakonishok, and Vermaelen (1995), Loughran and Ritter (1995),and Mikkelson and Partch (1986)). 2
  • cisions and trade their stock accordingly. Short-term shareholders diversify their existingholdings and prefer to sell the stock absent new information, whereas incoming share-holders prefer to buy the stock. Because some …rms in the economy issue or repurchaseequity for non-informational reasons, the equilibrium is not fully revealing and informedmanagers can take advantage of stock mispricing. The equilibrium price and quantitiestraded by each group of investors are determined by a market clearing condition. The model highlights two separate e¤ects of equity market timing on shareholders.First, the price e¤ect appears because a …rm’ decision conveys new information to the smarket. Stock repurchases tend to raise the stock price; equity sales lead to a pricedecline. Second, the quantity e¤ect appears because a …rm’ trading creates additional sdemand for or supply of shares. The resulting imbalance in trades must be absorbed, byde…nition, by either selling or incoming shareholders. This result implies, for example,that selling shareholders sell fewer shares when the …rm makes a seasoned equity o¤ering(SEO). We show that because of the price and quantity e¤ects, incoming shareholders areworse o¤ from the …rm’ timing repurchases and selling shareholders are worse o¤ because sof timing new equity sales. Finally, since losses for any group of shareholders must add upto a net gain for other shareholders, we conclude that current shareholders unambiguouslybene…t from equity timing with stock repurchases, whereas future shareholders prefer thatmanagers time equity sales. Determining how di¤erent shareholder groups are a¤ected by …rms’market timing isinteresting in and of itself, but it can also shed light on the objective functions of …rmmanagers. Speci…cally, by observing managers’ market timing strategies, it is possibleto infer whether managers are trying to create value for the …rm’ current or future sshareholders. To answer this question, we construct a new empirical measure of markettiming that captures the additional return earned by long-term shareholders because 3
  • of a stock issuance or repurchase.2 The complication is that, by its very nature, thestock return that would be realized had the …rm not issued or repurchased any stockis unobservable. We overcome this di¢ culty by assuming that all stock mispricing iscorrected in the long term and by backing out the necessary information from the realizedstock returns and net equity issuance by the …rm. This procedure gives us a simple andintuitive measure of market timing. For example, to calculate the repurchase timingmeasure, we multiply the post-repurchase one- or three-year risk-adjusted return by thefraction of repurchased shares. For equity issuance, we create two similar measures basedon seasonal equity o¤erings and total equity issuance. Overall, we …nd that market timing is prevalent in our sample. For example, theaverage additional return created for long-term shareholders by SEOs is 0:45% per year(t-stat = 2:28) or 3:21% over a three-year horizon (t-stat = 8:32). Importantly, thereis a di¤erence in the market timing strategies of di¤erent-sized …rms. Large …rms, onaverage, show a higher propensity to time their stock repurchases and seem to issue newequity in a way that is unrelated to future valuation. In contrast, small …rms are muchmore successful in timing equity sales. Given the predictions of the model, this evidencesuggests that the managers of small …rms try to maximize the value of future shareholders,whereas managers of large …rms try to create value for existing shareholders. Althoughwe do not attempt to model the corporate lifecycle, it is possible that because small …rmsplan to grow in the future they are looking to “leave a good taste in investors’mouths”inthe words of Allen and Faulhaber (1989). Our …ndings also suggest that the assumptionthat managers maximize the weighted average of the short-term and long-term prices ismore applicable to large …rms (see, e.g., the signaling models of Miller and Rock (1985)and Leland and Pyle (1977)). 2 Using conventional measures, such as market-to-book ratio in Baker and Wurgler (2002), does notallow us to quantify the shareholder wealth transfers or to separate the additional returns from issuancesand repurchases. 4
  • Managers who succeed at equity timing are surely heaped with praise, but they canalso bene…t …nancially. In their survey of …rms’CFOs, Brav et al. (2005) found that atleast some …rms claim to reward the people who implement the …rm repurchase policy and“beat the market.” Further, our model suggests that, if managerial pay is set by currentshareholders, executive compensation should increase with well-timed stock buybacks andbe lower when the …rm times equity sales. Using the executive compensation data on large…rms for the period 1992-2010, we con…rm that …rms’CEOs are rewarded for successfullytimed stock buybacks. A one standard deviation in the timing measure is associatedwith a 2:59% increase in CEO compensation in the following year. In contrast, CEOswho successfully time equity sales earn statistically lower compensation. Our resultsseem to be driven primarily by adjustments of bonuses and, to a lesser degree, newgrants of equity-based compensation. In all speci…cations, we include …rm …xed e¤ects toaccount for unobserved …rm heterogeneity and control for past and contemporaneous stockreturns, as well as the fraction of equity repurchased. Thus, our results cannot be simplyattributed to stock return patterns around equity issuance and repurchase decisions ormanagers being compensated for higher payout. The rest of this paper is organized as follows. The next section provides a brief overviewof the literature. Section 2 presents a simple model of equilibrium equity pricing in thepresence of informed trading by a …rm and analyzes wealth transfers between di¤erentgroups of shareholders. The data sources and empirical results are described in Section3. The …nal section o¤ers concluding remarks. 5
  • 1 Literature OverviewOur paper is related to the large literature documenting equity mispricing around corpo-rate stock issuance and repurchase decisions.3 For example, Loughran and Vijh (1997)…nd the negative price drift of …rms that complete stock mergers; Ikenberry, Lakonishok,and Vermaelen (1995, 2000) document positive abnormal returns following the announce-ment of open market share repurchases;4 and Loughran and Ritter (1995, 1997) provideevidence on the underperformance of …rms conducting IPOs and SEOs. Khan, Kogan,and Serafeim (2012) identify a setting with overvaluation exogenous to the …rm and …ndsupport for …rms timing their SEOs, whereas Ponti¤ and Woodgate (2008) document thatshare issuance exhibits a strong cross-sectional ability to predict stock returns. Baker,Wurgler, and Ruback (2007) provide an overview of this literature and describe some ofthe advantages and challenges in using the market-to-book ratios and post-event returnsas measures of stock mispricing. We contribute to this line of research by developing anew measure of market timing and documenting the di¤erences in timing strategies oflarge and small …rms. Most of the previous papers do not consider the welfare implications of market timingfor di¤erent groups of a …rm’ shareholders, which is at the heart of our theoretical sanalysis. One notable exception in the literature is Brennan and Thakor (1990), who showthat repurchases lead to a wealth transfer from uninformed to informed shareholders.They further argue that since the costs of gathering information are larger for smallshareholders, a repurchase is expected to bene…t large shareholders. Unlike in Brennanand Thakor (1990), in our model all shareholders (but not the manager) have symmetricinformation. Since shareholders have di¤erent motives for trading, our work also shares 3 Earlier theoretical work shows why deviations from e¢ cient prices can persist in equilibrium if arbi-trageurs are risk-averse, leveraged, or manage other people’ money (Shleifer and Vishny (1997)). s 4 Babenko, Tserlukevich, and Vedrashko (2012) show that this drift is more pronounced when insidersbuy the company stock prior to the repurchase announcement. 6
  • features with Huang and Thakor (2011), who develop and test the explanation for sharerepurchases as a mechanism to remove pessimistic shareholders. Our model has its roots in the theoretical signaling literature. For example, Vermae-len (1981) and Ofer and Thakor (1987) show that stock repurchases can signal positiveinformation to investors, whereas Myers and Majluf (1984) illustrate why stock issuancesconvey negative news. Constantinides and Grundy (1989) describe the signaling equi-librium, in which the …rm issues a security and uses proceeds to partially …nance stockrepurchases. Dynamic signaling is also explored in a number of recent papers.5 As inMyers and Majluf (1984), …rms’actions in our model convey information to the market,and managers maximize long-term value. We assume that the manager has superior information regarding …rm value. Some ofthe earlier articles argue that equity timing can also originate from di¤erences in beliefsbetween managers and investors. For example, Jenter (2005) …nds that managers’ per-ceptions of fundamental value systematically diverge from market valuations, while Yang(2011) demonstrates that di¤erences of opinion can have implications for capital struc-ture.6 Additionally, …rms may appear to time their equity issuances because of changing…nancing or investment opportunities, even if the information is symmetric.7 Finally,waves of stock repurchases and issuances can also be a result of …rms taking advantage ofaggregate market mispricing or reacting with their investment decisions to the change in 5 For example, Hennessy, Livdan, and Miranda (2010) build a dynamic equity signaling model, fea-turing new equity issues and repurchases, in which the …rm can completely avoid equity mispricing. Intheir model, signaling is achieved through higher leverage and, consequently, higher bankruptcy costs.Morellec and Shurho¤ (2011) show that in the presence of adverse selection early exercise of investmentoptions can serve as a positive signal and allow the …rm to issue securities at a fair price. 6 In Yang’ model, there is no asymmetric information, but the manager and outside investors “agree to sdisagree”on …rm value. Since outside shareholders set the stock price, and the manager makes all of the…nancing decisions, market timing in his framework can lead to …rm value loss and has rich implicationsfor capital structure. 7 Bolton, Chen, and Wang (2012) build a dynamic model with time-varying external costs of …nancingand show that …rms can exploit the opportunity to issue equity at a lower cost. Similarly, Li, Livdan,and Zhang (2009) model timing of equity …nancing decisions within a neoclassical q-theory frameworkand draw conclusions about expected stock returns. 7
  • the business environment. An example of this is the work of Dittmar and Dittmar (2008),who relate aggregate issuance and repurchase activity to the business cycle.2 MODEL2.1 SetupTo guide and motivate our empirical analysis, we build a simple model based on the ra-tional expectations framework of Grossman (1976). The economy is populated with aproportion of …rms that are controlled by informed managers who are able to time themarket (“timing …rms” and a proportion 1 ), of other …rms that sell and repurchaseequity for reasons that are unrelated to misvaluation. For example, …rms can repurchasestock to distribute excess cash, manage earnings, adjust leverage, or counteract the di-lution from employee stock options (Grullon and Michaely (2002), Skinner (2008), andBabenko (2009)). Similarly, new equity issuance can be motivated by the need to …nancenew investment.8 We assume that investors, who observe the stock price and managers’actions, are unable to distinguish between the two types of …rms, and thus the equilibriumprice does not fully adjust to the news about repurchases and equity issuances. The model has three dates: 0, 1, and 2. Each timing …rm is endowed with a risk-neutral manager who receives private information at date 0. Based on this information,she can trade on the …rm’ behalf at date 1 with the objective of maximizing trading spro…t. Following most of the literature (e.g., Morellec and Shuerho¤ (2011)), we assumethat the manager does not tender her own shares during a repurchase and also does notparticipate in a seasoned equity o¤ering. 8 For example, DeAngelo, DeAngelo, and Stulz (2010) …nd that, without SEO o¤er proceeds, 63% ofissuers would run out of cash the year after the SEO. Additionally, Hertzel, Huson, and Parrino (2012)…nd that timing of SEOs can be determined by market perception of potential overinvestment problem,as opposed to equity mispricing. 8
  • At date 0, the …rm is owned by shareholders, some of which may decide to liquidatetheir holdings at date 1 (we call this group “short-term shareholders” Additionally, a ).group of new shareholders can decide to buy the company stock at date 1 (“incomingshareholders” The remaining shareholders are passive and hold the stock until date 2 ).(“long-term shareholders”). We assume that the long-term (fundamental) value of the …rm is drawn from thenormal distribution 2 P2 N (P0 ; p ): (1)The manager has a noisy signal v about the long-term …rm value 2 v = P2 + "; where " N (0; " ); (2)and can use this information to buy or sell stock for the …rm. The manager is strategic(i.e., she takes into account the e¤ect of her trade on the stock price) and maximizes theexpected pro…t from trading F shares, conditional on her signal max E [(P2 P1 (F )) F jv] : (3) F All shareholders and potential investors can observe the market-clearing price and the…rm’ decision to repurchase or issue equity.9 We conjecture that the equilibrium price is slinear in the …rm’ order size F s P1 = P0 + F; (4)and solve for parameter later in the equilibrium. Positive trades by the …rm indicate 9 In practice, investors may not always be able to observe the …rm’ issuance and repurchase decisions. sFor example, the information on stock buybacks used to be limited to announcements of future intentionsto repurchase stock and is now reported with a signi…cant delay in 10-K and 10-Q forms. Whetherinvestors observe repurchases and equity issuances is not crucial in our model since investors can inferthe same information from the market price. 9
  • stock buybacks, F > 0, whereas negative trades capture stock issuances. Finally, we assume that all shareholders are risk-neutral and maximize their expectedpro…ts net of adjustment costs. Speci…cally, the objective functions of the short-term andincoming shareholders are given by, s max Xs (E (P2 jF ) P1 ) (Xs Qs )2 ; (5) Xs 2 i max Xi (E (P2 jF ) P1 ) (Xi Qi )2 : (6) Xi 2where Qi > 0 and Qs < 0.10 The important assumption modeled here implicitly is thatthe demand for shares is …nite in equilibrium and is a decreasing function of price.11Downward-sloping demand functions can be justi…ed by the heterogeneously held share-holders’beliefs (see, e.g., Huang and Thakor (2011)), the structuring of investor tradesthrough the limit order book (Biais, Hillion, and Spatt (1995)), or the …rm’ stock having sno close traded substitutes (Wurgler and Zhuravskaya (2002)). Additionally, Greenwood(2005) and Shleifer (1986) provide compelling empirical evidence of downward-slopingdemand functions. The following proposition describes the equilibrium.Proposition 1 If < 1=2, the rational expectations equilibrium exists. The equilibriumprice is given by P1 = P0 + F; (7) 10 For example, absent information reasons to trade, short-term shareholders may desire to sell thestock for liquidity reasons, whereas incoming shareholders might buy the stock in order to diversify theirholdings. 11 An alternative way to capture the same intuition is by considering investors with mean-variancepreferences, as in Grossman (1976). We adopt the former approach mainly for tractability purposes. Theresults of the alternatively speci…ed model, in which investors maximize CARA utility, are available fromthe authors upon request. 10
  • where 1 s i = : (8) 1 2 s + i The intuition for (7) is as follows. If the …rm places a positive order for stock, theequilibrium price increases since investors infer that with some probability the order iscoming from an informed manager and thus signals positive information. The sensitivityof price to the …rm’ order ‡ is positive whenever equilibrium exists, and it increases s owwith the proportion of timing …rms in the economy. Note that sensitivity is positive evenif shareholders cannot infer any information from the price or from the …rm’ trades (e.g., swhen ! 0) simply because the market must clear; however sensitivity becomes largeras investors learn. We now analyze the implications of market timing for the wealth of di¤erent groupsof shareholders.Proposition 2 Short-term and incoming shareholders are worse o¤ when a …rm engagesin market timing. The proposition holds irrespective of whether we measure the welfare ofshareholders by wealth or by utility functions, as in (5) and (6). Intuitively, the manager is informed and acts in the interest of long-term shareholders.Long-term shareholders therefore bene…t at the expense of other investors, who can onlyimperfectly infer the managerial signal. The next proposition establishes our central resulton the e¤ect of market timing with share repurchases and equity sales.Proposition 3 Short-term shareholders are worse o¤ from market timing with equityissuances. The incoming shareholders are worse o¤ from market timing with repurchases.The proposition holds irrespective of whether we measure the welfare of shareholders bywealth or by utility functions, as in (5) and (6). 11
  • In general, there might be two e¤ects on shareholders of trading by an informed …rm: aquantity e¤ect and a price e¤ect. The quantity e¤ect appears if some shareholders changetheir demand for stock as a result of the …rm’ timing actions. For example, demand can sbe a¤ected because of the market’ need to clear additional trades by the …rm or because sagents infer information from the …rm’ decisions. The price e¤ect arises whenever the s…rm’ timing actions change the equilibrium stock price and shareholders buy or sell stock sat this new price. Consider, for example, short-term shareholders who are negatively a¤ected by thetiming of equity sales. When the …rm issues equity, short-term shareholders can sell fewerof their own shares and this decreases their expected pro…t since the stock is overpriced.Additionally, because an equity sale by the …rm conveys negative information to themarket, short-term shareholders end up selling shares at a lower price. In contrast, thee¤ect of repurchase timing on short-term shareholders can be ambiguous since the priceand quantity e¤ects go in opposite directions. We …nally note that the intuition for shareholder wealth implications is preserved evenif the …rm’ repurchase and issuance decisions are unobservable, although wealth transfers sare smaller in this case. This could be seen by considering a limiting case in Proposition1 when the number of timing …rms goes to zero, ! 0. Before we proceed to the next result, it is convenient to separate all …rm investorsinto two groups. Speci…cally, we de…ne “current shareholders” as long- and short-termshareholders, and “future shareholders” as long-term and incoming shareholders. Thefollowing corollary describes the wealth implications for these two groups of shareholders.Corollary 1 The expected wealth of current shareholders increases with share repurchasetiming. The expected wealth of future shareholders increases with equity issuance timing. This result follows immediately from Proposition 3 once we recognize that the gains 12
  • and losses of all …rm investors sum to zero. For example, if the short-term shareholdersexperience a loss, it must be that the long-term and incoming shareholders are collectivelybetter o¤. Therefore, we conclude that managers will time the equity market with repur-chases only insofar as doing so increases the welfare of the …rm’ existing shareholders. sSimilarly, managers will time new equity issuances if their objective is to maximize thevalue of future shareholders.3 Empirical AnalysisWe next proceed to the development and testing of the main empirical implications ofthe model. First, we introduce a new measure of market timing to empirically assessthe success of market timing strategies. Second, we infer from the data whether …rmmanagers tend to maximize the value of current or future shareholders. The model showsthat the manager working purely in the interests of long-term shareholders has incentivesto use both equity issuances and repurchases. Timing of stock buybacks makes currentshareholders relatively better o¤, whereas timing of equity sales bene…ts future sharehold-ers. We therefore attempt to determine managers’true objectives by looking at whetherthey time the market primarily on the repurchase or the share issuance side. Finally, weexamine whether CEO pay is in‡uenced by the success and nature of past market timingstrategies.3.1 DataOur sample includes the universe of Compustat …rms with non-missing balance sheet datafor the period 1992-2010.12 Following Stephens and Weisbach (1998), we proxy for sharerepurchases by the monthly decreases in split-adjusted shares outstanding reported by 12 The …rst year of the sample is determined by the availability of the executive compensation data thatwe use in our tests. 13
  • CRSP. This method implicitly assumes that the …rm has not repurchased any shares ifthe number of shares increased or remained the same during the month. We take the lastday of the month as the repurchase date and calculate the stock return over a horizonof either one or three years from that date. The fraction of shares repurchased in eachmonth is the number of shares repurchased during the month divided by the number ofshares outstanding at the end of the previous month. A potential issue with this measure is that it tends to underestimate the amount oftrue share repurchases (see, e.g., Jagannathan, Stephens, and Weisbach (2000)). Forexample, if a company buys back stock and issues equity during the same month, we canrecord a zero repurchase. This becomes particularly important for small …rms since theytend to issue more equity though broad-based equity compensation programs (Bergmanand Jenter (2008)) and also do more SEOs. We therefore also employ a commonly usedalternative approach to calculate the actual repurchases by using the Compustat data onthe total dollar value spent on repurchases. These data are only available at the quarterlyand annual frequencies and can contain some information unrelated to repurchases ofcommon stock (see, e.g., Kahle (2002) and Banyi, Dyl, and Kahle (2008)). Nevertheless,the advantage of Compustat repurchase data is that they should not be systematicallyunderstated for small …rms and provide the least biased estimate of true repurchases(Banyi, Dyl, and Kahle (2008)). To calculate the number of shares repurchased eachquarter using Compustat data, we follow Jagannathan, Stephens, and Weisbach (2000)and divide the total dollar amount spent on repurchases during a quarter by the averagemonthly stock price. The sample of SEOs is from the Securities Data Company (SDC) new issues database.We look only at primary issues of common stock. Although the SDC database providesthe exact stock issuance date, we use the last day of the calendar month as the issuancedate in calculating the one-year and three-year stock returns after an SEO. This procedure 14
  • ensures that post-SEO stock returns are directly comparable to post-repurchase returns. We also compute the new equity issuances using the changes in the number of sharesoutstanding. Similar to the calculation of our repurchase measure, we track the increasesin the total number of shares each month. The advantage of this measure is that itcaptures, in addition to SEOs, other ways in which …rms sell shares, such as privateplacements, mergers and acquisitions, convertible debt and warrant exercises, direct pur-chase plans, rights, and employee stock option exercises. According to Fama and French(2005), the issuance of stock through SEOs constitutes only a small fraction of the totalissuance activity, and is smaller in magnitude than the issuance of stock due to merg-ers …nancing or employee stock-based compensation plans.13 Additionally, Shleifer andVishny (2003) present a model showing how rational managers can use stock as a means ofpayment in mergers and acquisitions to take advantage of stock mispricing, and Loughranand Vijh (1997) …nd evidence of negative long-run abnormal returns for bidders makingstock acquisitions. In contrast, the advantage of looking only at the SEO data is thatmarket timing of SEOs should be more pronounced than for other equity issuances sincethe manager is likely to have more control over these events. Finally, we use the compensation data on …rms’CEOs from the Standard and Poor’ sExecucomp database. Since executive compensation variables tend to be highly skewed,we de…ne the total CEO pay as the logarithm of the total annual CEO compensationadjusted for in‡ation.3.2 Market Timing MeasuresOur measures of market timing aim to capture the additional risk-adjusted return earnedby a …rm’ long-term shareholders because of equity market timing. For each month, we s 13 For example, Fama and French (2005) report that approximately 86% percent of all …rms issued someform of equity over the period 1993 to 2002. This number contrasts sharply with the low frequency ofSEOs over the same period. 15
  • calculate the proportion of equity repurchased during a month, i, and then multiply itby either one- or three-year post-repurchase risk-adjusted returns, ri . We then sum theresulting measures over the 12 months of the year to obtain the total, X 12 Repurchase timing = i ri : (9) i=1For example, if a manager buys back 5% of the …rm’ outstanding shares in May, and sshares appreciate by 10% from June to May of the following year, the measure of repur-chase timing will be equal to 0.5%. Sales timing is de…ned in a similar manner, with thedi¤erence that we track the proportion of equity sold each month, si . X 12 Sales timing = si ri : (10) i=1 Note that timing measures can be positive or negative, with larger positive valuesindicating more successful timing by the …rm. For …rms that neither issue nor repurchaseany stock during the year, the timing measures are set to zero. Although the construction of our market timing measures may seem intuitive, theirinterpretation requires a deeper discussion. Intuitively, the additional return earned bylong-term shareholders because of market timing is given by the di¤erence between therealized stock return and the return that would be seen had the …rm not issued or re-purchased any stock. By its very nature, the latter return is unobservable, but it can beinferred from the realized return and the cash going out (into) the …rm in stock repurchase(issuance). Speci…cally, consider a manager who repurchases a fraction of its stock at today’ s 0price P1 expecting the stock to appreciate to P2 in the future. Even if the manager’ sexpectation were correct, the future price will change as a result of the repurchase itself.We denote this actual price with P2 . If the real policy of the …rm is independent of 16
  • repurchases and issuances,14 then the non-arbitrage relation between prices implies 0 (1 )P2 = P2 P1 : (11)Empirically, we observe the actual price, but not what the price would be had the manager 0not repurchased any shares. Therefore, we infer P2 using expression (11) and obtain theadditional return from repurchase as 0 P2 P2 P2 P1 Repurchase timing = = : (12) P1 P1A similar argument can be made for the calculation of market timing with SEOs or equitysales. Finally, note that stock returns in the market timing measures need to be adjusted forrisk. One way to see how the risk adjustment works is to consider, for example, the stockrepurchase by the company as an investment into company’ own shares. The return on sthe investment, adjusted for risk, is then shared among all …rm’ investors. To make the sadjustment, we use the Fama and French 100 portfolios formed on size and book-to-marketdeciles. Each month, we match …rms in our sample to the comparable size and book-to-market portfolios based on the break points available on Kenneth French’ web site and scalculate the di¤erence in buy-and-hold returns for our …rms and these portfolios.15 14 This assumption implies, in particular, that the investment policy of the …rm is independent of its…nancing decisions. Consistent with this assumption, Brav et al. (2005) …nd in their interviews with…rms’ CFOs that payout decisions are considered of second-order importance relative to the operatingdecisions of the …rm. 15 This method is preferred over risk adjustment using the market model since using cumulative abnor-mal returns over a long period may yield positively biased test statistics (Barber and Lyon (1997)). 17
  • 3.3 Summary Statistics on Equity Market Timing MeasuresPanel A of Table 1 presents the average additional returns earned by long-term share-holders when the company sells or repurchases a fraction of its stock. Positive entries inthe table correspond to successful market timing e¤orts. It appears from the table that…rms time the market with both stock repurchases and equity sales. For example, themean return from SEO timing with a one-year horizon is positive 0:45% (t-stat = 2:28)and the corresponding number for a three-year horizon is 3:23% (t-stat = 8:38). SinceSEOs represent only a small proportion of newly issued equity and most of the …rm-yearobservations do not have an SEO event, we also repeat the estimation using the measurebased on all equity sales (increases in the number of outstanding shares). This measureproduces similar results, with robust evidence of successful market timing of equity saleswith one- and three-year horizons. Speci…cally, the additional return earned by long-term shareholders because of successful timing of equity sales is 0:49% per year and isstatistically di¤erent from zero (t-stat = 26:28). Similarly, the evidence on share repurchases in Table 1 suggests that managers, onaverage, time the market by buying back shares, although the magnitude of this e¤ectappears to be much smaller in economic terms. We …nd no evidence of successful timingusing the three-year horizon and the CRSP-based repurchase measure. Note, however,that it is possible that some …rms time the market and earn substantial returns, whereasothers engage in share repurchases for reasons that are unrelated to undervaluation. Additionally, Table 1 o¤ers summary statistics on the overall market timing ability of…rm managers and the imbalance in market timing strategies. For example, the sum oftiming with repurchases and SEOs captures the ability of the …rm’ manager to time the sequity decision when the stock is either over- or underpriced. In contrast, the di¤erencebetween the two variables captures the imbalance in timing by a particular …rm, with pos-itive values indicating a propensity to time more successfully by buying back shares. We 18
  • observe that while over the one-year period there is no clear pattern, over the three-yearperiod …rms appear to time equity issuance more successfully than they do repurchases. We also display the average risk-adjusted returns after repurchases, SEOs, and equitysales, along with fractions of repurchased or issued stock. For example, …rms in our samplebuy back, on average, 3.15% of their outstanding shares and experience 1.37% in abnormalreturns the year after the repurchase.16 SEOs tend to be much larger in magnitude, with…rms issuing, on average, 20.17% of stock and earning -3.18% in abnormal returns thefollowing year. Next, we investigate whether market timing characteristics of …rms are persistent orchange quickly over time. For example, if a …rm successfully times a stock repurchase, isit also more likely to be a successful market timer in the future (e.g., because the managerhas a particular objective or the ability to correctly identify stock mispricing)? To answerthis question, we …rst split our total sample period into three-year periods, separated by aone-year break between periods.17 For each three-year window, we sum the annual timingmeasures. It is important to aggregate the timing measures over a period of time becauseonce a company issues or repurchases stock during a particular year, it is less likely todo so again the next year. For example, frequent repurchases require large cash reservesand SEOs trigger substantial underwriting costs. We then regress the timing measureover a three-year window on the same measure in the previous period and report theautocorrelation and the associated p-values in Table 2. The results suggest that indeed…rms that were successful timers in the past tend to remain successful in the future. Thisis true for all market timing measures, with the exception of SEO timing, which is likelydriven by extremely low frequency of SEOs. For example, the autocorrelation between 16 The abnormal returns after the repurchases are smaller in our sample than in previous studies (e.g.,Ikenberry, Lakonishok, and Vermaelen (1995)) because we look at actual repurchases rather than atannouncements of intent to buy back the stock. 17 A one-year break guarantees that we do not use the overlapping returns in our tests. Our resultsbecome statistically and economically stronger if we use the back-to-back three-year periods. 19
  • the CRSP-based repurchase timing measures is 3.2% and is statistically di¤erent fromzero.3.4 Firm Size and Equity Market TimingAdditional insights into how …rms time sales and purchases of their equity can be obtainedby looking separately at the samples of small and large …rms. It is conceivable that amanager’ objective function depends on …rm size. For example, it can be more important sto leave “a good taste in investors’mouths” if a …rm is small and plans to grow in thefuture by attracting new investors. Additionally, managers in small …rms may believe thattheir future compensation contracts will be shaped by future shareholders. Alternatively,it is possible that small …rms are more informationally opaque to investors and thatmanagers of such …rms …nd it easier to time the market with both stock repurchases andequity sales. Table 3 indicates that smaller …rms are more successful in timing equity issuance. Inparticular, …rms with market capitalization below $100 million earn an additional returnof 4:52% (t-stat = 5:00) because of SEO timing, as compared to 0:87% (t-stat = 3:38)for …rms with capitalization over $1 billion. The results are similar if we look at totalequity issuance, but are opposite for market timing with share repurchases. For example,the returns due to repurchase timing for large and small …rms are, respectively, 0:10%and 0:09%, with the means being statistically di¤erent between the two groups. In sum, we …nd that large …rms are more successful repurchase timers and small …rmsare more successful equity issuance timers. These results are in line with the …ndings ofWaruswitharana and Whited (2011), who document that large …rms have more volatileshare repurchases and less volatile share issuances than small …rms. Together with thepredictions of the theoretical model, our evidence suggests that managers of large …rms aremore concerned with maximizing the welfare of existing shareholders, and that managers 20
  • of small …rms look to create value for future shareholders. Our measures of market timing are designed to capture whether …rms repurchase(issue) more shares when they expect high (low) stock returns, but do not indicate whethertiming is primarily due to post-event returns, program size, or the correlation structure.For example, one might wonder whether our result that small …rms time the market withSEOs can be attributed to smaller …rms having a larger volume of SEOs or a larger issuesize (e.g., because of greater …nancing needs). To explore these issues in more detail,in Table 4 we present the separate components of our timing measures in subsamples ofdata sorted by …rm size. Large …rms conduct smaller seasoned equity o¤erings, with theaverage proportion of equity issued 12.6%, as compared to 36.1% for small …rms. However,the larger SEO timing for …rms with small market capitalization is also strongly drivenby the return pattern. For example, small …rms experience, on average, abnormal returnsof -19.9% in the year after the issue, whereas large …rms post positive returns of 4.0%.Our interpretation is that SEO timing is more pronounced for small …rms because ofboth return and issue size patterns (see Table 4). For repurchase timing, the main e¤ectsappear to come from the stock return pattern since the average fraction of repurchasesshares is similar across subsamples.3.5 CEO CompensationWe next analyze the relation between the success and nature of market timing strategiesand executive compensation. In their survey of …rms’ CFOs, Brav et al. (2005) foundthat most …rms keep track of whether their …rm “beats the market” over the long term.Additionally, the people who implement the repurchase policy admit to being rewarded…nancially for successfully timing the market. This …eld evidence suggests that there maybe a link between market timing success and CEO pay. Another view, however, is that CEOs are already aligned with the long-term share- 21
  • holders and personally bene…t from market timing of any kind; hence they should not berewarded further. Alternatively, shareholders may desire to impose a particular timingstrategy on their CEOs. For example, if current shareholders have some in‡uence onthe executive pay-setting process, we should expect CEOs to be rewarded for timing themarket with their share repurchase decisions, but not with SEOs. Since we rely on Execucomp data, we can only analyze the relation between pay andmarket timing for large …rms and cannot verify whether results generalize to the wholeuniverse of …rms. Our dependent variable in Table 5 is equal to the natural logarithmof one plus total CEO compensation adjusted for in‡ation in the year following the mea-surement of market timing. In all speci…cations, we control for past and contemporaneousstock returns to ensure that higher compensation is not driven simply by higher returns.We also include important …rm characteristics, such as size, market-to-book ratio, lever-age, R&D spending, and payout ratio, since they have been linked by prior research toexecutive pay. Additionally, we include the year and …rm …xed e¤ects to absorb sources ofvariation in market timing measures that may be undesirable because of their correlationwith the amount of asymmetric information. For example, if executives in …rms with highstock return volatility command a pay premium because these …rms are di¢ cult to man-age, and executives in these …rms always time the market more successfully, this e¤ectwill be absorbed by the …rm …xed e¤ects. Overall, we …nd that timing repurchases positively and signi…cantly a¤ects CEO com-pensation. For example, a one standard deviation increase in timing of repurchases overthree-year horizon results in a 2:59% increase in CEO compensation or approximately$119; 105 (t-stat = 3.03). In contrast, the e¤ect of timing equity sales is signi…cantlynegative. Interestingly, timing repurchases net of SEOs has the largest impact on com-pensation (columns 9 and 10), implying that managers who engage in timing repurchasesand avoid timing new equity sales, earn the highest compensation. 22
  • In Table 6, we investigate whether all components of annual CEO compensation re-spond to the successful market timing of share repurchases. For example, one mightexpect a board of directors to be less likely to adjust the salary component of CEO com-pensation since salaries tend to be sticky. Indeed, we …nd in Table 6 that the fact thata CEO times the market primarily with repurchases rather than SEOs has no signi…cante¤ect on salary. In contrast, annual CEO bonuses strongly respond to successful markettiming of repurchases and negatively to timing of SEOs. For example, the coe¢ cient ontiming repurchases minus timing SEOs is 0:89 (t-stat=4:20). Since bonuses represent themost ‡exible part of CEO compensation, this result lends additional support to the hy-pothesis that compensation responds to managerial timing actions. The e¤ect of markettiming on the new equity-based grants (stock options and restricted stock) is generally inthe same direction as that on bonuses.3.6 Alternative Explanations and RobustnessIn this section, we analyze alternative explanations for our results, consider statisticalissues, and o¤er robustness checks. We …rst examine an alternative explanation that hasroots in the investment literature. Speci…cally, it is known that sales of equity often pre-cede new capital investment and can be used to …nance the exercise of real options (see,e.g., DeAngelo, DeAngelo, and Stulz (2010)). In turn, the exercise of real options may de-crease the systematic risk of the …rm and result in lower expected returns. This could bebecause options are exercised in anticipation of the low cost of capital (Cochrane (1991)).Alternatively, as Carlson, Fisher, and Giammarino (2006, 2010) argue, the exercise trans-forms riskier options into less risky assets in place and therefore reduces risk and expectedreturns. Therefore, if we fail to adjust properly for the change in expected returns, wemay mistakenly attribute the evidence of post-issuance abnormal returns to mispricing.This concern is further exacerbated by the fact that smaller …rms are more likely to issue 23
  • equity to …nance their investment. Thus we need to check whether the pattern that small…rms time the market more with SEOs can be attributed to investment. Although the risk-adjustment technique that we employ does not match …rms oninvestment rates, we anticipate that the bias associated with risk adjustment due toexercise of real options is likely small. First, the connection between investment andreturns may be pronounced for equity issuance, but it is more di¢ cult to build a similarrisk-based explanation for stock repurchases. Second, as Lyandres, Sun, and Zhang (2008)explain, new investment is often …nanced by such methods, as IPOs, SEOs, straight debt,and convertible debt. Of those, only SEOs are present in our sample, and they are moreinfrequent than other …nancing methods. For example, we …nd very similar (unreported)results when we exclude SEOs from the equity sales data. To see whether our results for equity sales and SEOs are driven by di¤erent realinvestment dynamics in these …rms, we sort all …rms in our sample by their investmentrates, de…ned as capital expenditures in the year of the SEO divided by the beginning-of-year book assets. For each investment tercile, we further sort the …rms into three groupsby …rm size. Table 7 shows our results. The pattern that timing with SEOs is muchmore pronounced for small …rms is evident across all groups of investment rates. Wealso observe that the overall e¤ectiveness of timing e¤orts does not vary consistently withinvestment rates, suggesting that our results are unlikely to be driven by expected returndynamics due to investment. Another issue that we address is applicable to all ex-post measures of market timingand was …rst raised by Mitchell and Sta¤ord (2000). They argue that corporate events,such as seasoned equity o¤erings and stock repurchases, are not independent and tendto cluster over time and by industry. The authors further con…rm in their tests that thepost-event returns are positively cross-correlated in the data and suggest a method tocorrect the standard errors. After accounting for the positive cross-correlations of event- 24
  • …rm abnormal returns, Mitchell and Sta¤ord (2000) do not …nd any robust evidence ofabnormal performance for …rms conducting SEOs and share repurchases. A commonly used approach to address the statistical issue of positive cross-correlationis by using the calendar-time portfolio analysis. However, it appears infeasible in oursetting since we are interested not in the abnormal post-event returns but in the timingmeasures. Additionally, we would like to capture the cross-sectional di¤erences in markettiming strategies and link them to executive compensation, while calendar-time portfolioanalysis can only give us the averages. Therefore, we follow the methodology by Mitchelland Sta¤ord (2000) in estimating the cross-correlations for di¤erent measures of markettiming and appropriately correcting the standard errors. As Kothari and Warner (2007)point out, however, the inference with this method is not without caveats since preciseestimates of cross-correlations are di¢ cult to come by. Overall, we …nd that the cross-correlations tend to be lower for our market timingmeasures than for post-event abnormal returns, suggesting that the bias in standarderrors should be less pronounced for our measures.18 We further calculate the t-statisticsfor each measure of timing taking the cross-correlation into account and …nd that ourconclusions for timing with SEOs and equity sales remain una¤ected by this alternativeprocedure, but timing with repurchases becomes insigni…cant owing to relatively largecross-correlation estimates. In Table 8 we report the corrected t-statistics for di¤erentmarket timing measures in subsamples sorted by …rm size. The means in each subsampleare the same as in Table 3. After correcting for cross-correlation, we observe signi…canttiming with SEOs and equity sales in medium, and particularly small …rms, whereas thereis no timing in large …rms. We also check the robustness of our results to using earlier data. The starting date 18 For example, Mitchell and Sta¤ord (2000) …nd that the cross-correlation for returns after repurchasesis 0.017, while it is only 0.009 for our repurchase timing measure. Similarly, we …nd that the SEO timingmeasures are negatively cross-correlated in our sample. 25
  • for the main sample matches the availability of Execucomp data. However, meaningfulmeasures of repurchase timing can be constructed starting in 1982.19 Therefore, in Table9 we present the summary statistics for this earlier period. Overall, we still observe that…rms do time equity issuance and SEOs successfully in this sample, whereas timing withstock repurchases becomes more pronounced and is signi…cant even using the three-yearhorizon. Additionally, if we sort …rms by market capitalization (unreported), we observethe same pattern as in Table 3. Another possible concern speci…c to repurchase timing measure is that not all of therepurchases are done using open market programs. In particular, repurchases that areexecuted via tender o¤ers and Dutch auctions can involve a premium over the marketprice, which is not accounted for in our measure. Thus it is possible that we will tendto overestimate the returns created for the long-term shareholders by stock repurchasetiming. To address this issue, we rely on the observation by Comment and Jarrel (1991),who show that tender o¤ers and Dutch auctions typically have much larger program sizethan open market stock repurchases. Therefore, in Table 9 we also give the results forrepurchases of less than 10% of …rm’ outstanding stock and observe that the magnitude sand statistical signi…cance of market timing remain similar.4 ConclusionIn this paper, we infer managers’preferences for maximizing current or future shareholdervalue by examining their …rms’market timing strategies. Two modeling assumptions dis-tinguish our approach from the extant literature. First, we look at managers who time themarket with both equity sales and share repurchases, so that we can meaningfully exploit 19 After 1982, when the safe harbor provisions under the Securities and Exchange Act were adopted,…rms could repurchase stock without facing the legal uncertainty (Jagannathan, Stephens, and Weisbach(2000)). 26
  • the imbalance in timing. Second, we allow the manager’ incentives to be imperfectly saligned with those of an average …rm shareholder. Our model predicts that the wealth ofcurrent shareholders is maximized when a manager engages in market timing with sharerepurchases. In contrast, managers who tend to time the market with equity issuancesmaximize the value of future shareholders. We test the model by introducing a new measure of market timing that quanti…es theadditional returns due to equity market timing. Our evidence indicates that small …rmsprimarily time the market with SEOs and other equity sales, whereas large …rms engagein market timing with stock repurchases. Overall, these results suggest that the objectivefunctions of …rm managers are likely di¤erent in small and large …rms. We hope thisapproach will …nd its way into future analyses concerned with managers’incentives. Our results on CEO compensation suggest that executives in large …rms tend to berewarded for market timing strategies that bene…t existing shareholders. It would there-fore be interesting to explore whether di¤erent managerial pay structures (e.g., di¤erentcompensation horizons) a¤ect managerial incentives to time the market and whether thereare pronounced di¤erences in compensation structures for executives of large and small…rms. We leave these questions to future research. 27
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  • AppendixProof of Proposition 1. Applying the projection theorem for a normal distribution, we obtain the conditionalmean and variance of the long-term price given a managerial signal 2 2 " p E(P2 jv) = 2 P + 2 0 2 2 v; (13) p + " p + " 2 2 p " V ar(P2 jv) = 2 2 : (14) p + "Substituting conjecture for the market-clearing price P1 from (4) into the manager’ prob- slem (3), and taking the …rst-order condition with respect to F , we obtain 2 E(P2 jv) P0 p v P0 F = = 2 2 : (15) 2 p + " 2The second-order condition is satis…ed whenever (proportion of …rms that repurchaseor sell stock for information reasons) is less than 1 . Whenever > 1=2, the equilibrium 2does not exist. The conditional mean of the long-term price is E(P2 jF ) = E(P2 jF; informed) + (1 ) E(P2 jF; uninformed) (16) = P0 + 2 F:The individual demand functions by short-term and incoming shareholders are given,respectively, by E (P2 jF ) P1 (1 2 ) F Xs = Qs + = Qs ; (17) s s E (P2 jF ) P1 (1 2 ) F Xi = Qi + = Qi : (18) i iThe equilibrium price is de…ned by the market clearing condition, which is Xs + Xi + F = 0: (19) Since in absence of arbitrage P0 = E (P1 ), we also must have Qs = Qi , i.e., in absenceof information the net demand for stock is zero. Substituting the demand functions into(19) and also using conjecture for the equilibrium price (4), we obtain the equilibriumprice as given in the main text. QED. 34
  • Proof of Proposition 2. We can write the change in expected wealth of short-term shareholders as a result ofmarket timing by the …rm as h i f P2 P1 E ( W s ) = E Xs e e Qs P e2 P0 : (20)Note the second term in the expression above has a zero mean. Substituting the optimaldemand functions from (17) and (18) into (20), we have 20 1 3 e E P2 jF e P1 E ( Ws ) = E 4@Qs + e A P2 e P1 5 : (21) sUsing the conditional expectation of the long-term price (16) and the equilibrium price(7), we can further simplify this expression to (1 2 ) F e e E ( Ws ) = E Qs P2 P1 : (22) sUsing the expression for the optimal demand for stock by the …rm (15) and the marketclearing price, we obtain (1 2 ) h i E ( Ws ) = e e E F P2 P 0 Fe (23) s (1 2 ) h i h i = E F e P2 + E F 2 : e e sFinally, after simplifying the expression and using 2 4 e p e v P0 p 1 E F2 = V ar 2 2 = 2 2 2, (24) p + " 2 p + " 4 2 4 e e p e v e p and E F P2 = Cov 2 2 ; P2 = , (25) p + " 2 2 p + 2 2 "we obtain the change in expected wealth of shareholders 4 (1 2 ) p E ( Ws ) = 2 2 < 0: (26) 4 s p + "Thus, short-term shareholders are unambiguously worse o¤ as a result of market timing.Note also that if we considered the change in utility of short-term shareholders from (5),this result would only be reinforced. This is because in the absence of market timing, theoptimal demand for stock is Xs = Qs and hence adjustment costs are zero. The proof forincoming shareholders is identical if index s is changed everywhere to i. QED. 35
  • Proof of Proposition 3. We start by showing that incoming shareholders are negatively a¤ected by the markettiming of repurchases. The di¤erence in their pro…ts due to the timing of repurchases is E( Wi jRep) = E[Xi (P2 P1 ) Xinorep (P2 P1 norep ) jRep]; (27) | {z } | {z } gain/loss with rep. timing gain/loss without rep. timingwhere the expectation is taken with respect to uncertainty in the managerial signal, ".Note that when there is no timing by the manager, the demand for stock by incomingshareholders is Xinorep = Qi ; and the price at date 1 is equal to the unconditional mean, norepP1 = P0 . Using these facts and rewriting the expression above gives E( Wi jRep) = (Xi Qi ) E [P2 P1 jRep] + Qi (P0 P1 ): (28) | {z } | {z } quantity e¤ect price e¤ectThe …rst part in (28) captures how shareholders are a¤ected because of the change in theirdemand for stock as result of market timing, whereas the second part shows the e¤ect ofprices. Let us …rst analyze the quantity e¤ect. Using the optimal demand function from (18)and the conditional expectation of long-term price from (16), we obtain E (P2 jF ) P1 (2 1) F Xi Qi = = : (29) i iIt is easy to see that the last expression is negative since F > 0 for repurchases, < 1=2,and > 0. Additionally, E[P2 P1 jRep] = E[P2 (P0 + F )jF > 0]: (30)Using the expression for the optimal demand for stock by the …rm from (15), we obtain 2 p (v P0 ) E[P2 P1 jRep] = E[P2 P0 2 2 jv > P0 ] (31) 2 p + " 2 +2 2 p " = E [v P0 jv > P0 ] > 0: 2( 2 + 2 ) p "Thus we can see that incoming shareholders are negatively a¤ected by market timingthrough the quantity e¤ect (Xi Qi ) E [P2 P1 jRep] < 0: (32) Also note that whenever there is repurchase timing by the …rm, F > 0, the price atdate 1 always exceeds the unconditional mean, P1 > P0 . Additionally, for the incoming 36
  • shareholders Qi > 0, implying that the price e¤ect is negative. Thus, we have E( Wi jRep) < 0. As before, if we consider the change in utility of incoming shareholders instead ofchange in wealth, the conclusions would remain the same. This is because in absenceof repurchases and SEOs, the optimal demand for stock by incoming shareholders isXi = Qi , and thus they do not incur any adjustment costs. The proof for the short-termshareholders in the case of market timing of equity sales follows essentially the same steps.QED. 37
  • Table 1. Summary Statistics. The numbers in the table are the additional returns (in %) earned by the shareholders due to market timing e¤orts by the …rm. Timing SEOs is equal to the post-SEO risk-adjusted return in %, calculated over a horizon of one or three years and multiplied by the proportion of newly issued equity (as identi…ed in the SDC New Issues database). Timing sales is equal to the risk-adjusted return in %, calculated over a horizon of one or three years after an increase in shares outstanding (as identi…ed in the CRSP monthly database), and multiplied by the fraction of equity issued. Timing repurchases is equal to the post-repurchase risk-adjusted return in %, calculated over a horizon of one or three years after a decrease in shares outstanding (as identi…ed in the CRSP monthly database), and multiplied by the fraction of equity repurchased. Timing repurchases Compustat is equal to the post-repurchase risk-adjusted stock return in %, calculated over a horizon of one or three years and multiplied by the fraction of equity repurchased (as identi…ed from the Compustat quarterly database). The last column in the table gives t-test statistics for the di¤erence of the mean from zero. Variable Obs. Mean St. dev. 10th Median 90th T-test Timing SEOs (1-year) 3,615 0.452 11.935 -8.707 0.744 11.078 2.28 Timing SEOs (3-year) 2,577 3.229 19.572 -13.343 3.021 24.031 8.3838 Timing sales (1-year) 68,553 0.491 4.892 -1.904 0.034 3.859 26.28 Timing sales (3-year) 49,793 1.312 9.004 -3.074 0.121 8.185 32.52 Timing repurchases (1-year) 36,092 0.028 1.863 -1.355 -0.005 1.266 2.81 Timing repurchases (3-year) 28,674 -0.050 2.994 -2.272 -0.018 1.784 -2.82 Timing repurchases Compustat (1-year) 28,612 0.045 1.761 -1.380 -0.007 1.345 4.30 Timing repurchases Compustat (3-year) 21,102 0.051 3.871 -2.964 -0.046 2.639 1.92 Timing SEOs and repurchases (1-year) 38,717 0.068 4.037 -1.681 -0.004 2.019 3.31 Timing SEOs and repurchases (3-year) 30,561 0.226 6.410 -2.635 -0.013 3.175 6.15 Timing repurchases minus SEOs (1-year) 38,717 -0.017 4.099 -2.026 -0.007 1.659 -0.73 Timing repurchases minus SEOs (3-year) 30,561 -0.319 6.475 -3.530 -0.026 2.234 -8.61
  • Variable Obs. Mean St. dev. 10th Median 90th T-test Fraction of issued equity in SEO 3,615 20.174 17.826 5.020 15.561 40.228 N/A Fraction of issued equity 68,553 7.216 12.513 0.141 1.688 23.194 N/A Fraction of repurchased equity 36,092 3.154 4.240 0.041 1.439 8.885 N/A Fraction of repurchased equity (quarterly data) 28,612 3.219 3.965 0.074 1.727 8.639 N/A Risk-adjusted returns after repurchase (1 year) 36,092 1.374 47.047 -48.469 -3.698 51.013 5.55 Risk-adjusted returns after repurchase (3 year) 28,674 -0.784 72.087 -74.728 -9.925 75.860 -1.84 Risk-adjusted returns after SEO (1 year) 3,615 -3.138 47.487 -55.315 -7.968 48.325 -3.97 Risk-adjusted returns after SEO (3 year) 2,577 -15.046 87.483 -104.66 -28.339 80.979 -8.73 Risk-adjusted returns after equity issuance (1 year) 68,553 -1.290 48.184 -52.930 -6.289 51.221 -7.01 Risk-adjusted returns after equity issuance (3 year) 49,793 -3.893 103.81 -105.33 -20.601 106.29 -8.3739
  • Table 2. Serial Autocorrelation of Timing Measures. The numbers in the table are the serial autocorrelation coe¢ cients for the di¤erent markettiming measures. We …rst split the total sample period into …ve three-year periods, separatedby a one-year break between periods. We then sum the di¤erent timing measures over eachthree-year window and regress the next three-year measure on the previous three-year measure.The variables are described in the header of Table 1. P-values for the di¤erence of the autocor-relation from zero are displayed in parentheses. Variable Autocorrelation Variable Autocorrelation Timing SEOs (1-year) -0.011 Timing repurchases (1-year) 0.032 (0.149) (0.001) Timing sales (1-year) 0.016 Timing repurchases Compustat 0.059 (0.048) (1-year) (0.001) 40
  • Table 3. Market Timing and Firm Size. The numbers in the table are the additional returns (in %) earned by the shareholders due to market timing e¤orts by the …rm. The variables are described in the header of Table 1. Columns 2 and 3 present statistics for …rms with market capitalizations of less than $100 million; columns 4 and 5 for …rms with market capitalization above $100 million but below $1 billion; and columns 6 and 7 for …rms over $1 billion. T-statistics for the di¤erence of the mean from zero are shown in parentheses. The last column provides a two-sample t-test for the di¤erence in means between small and large …rms. Obs. size<$100m Obs. $100m<size<$1B Obs. size>$1B T-test for di¤erence Timing SEOs (1-year) 383 4.515 2,069 0.432 1,160 -0.865 5.73 (5.00) (1.63) (-3.38) Timing SEOs (3-year) 235 10.618 1,509 3.138 831 1.288 4.83 (5.61) (5.76) (3.43) Timing sales (1-year) 22,527 1.020 28,209 0.359 17,592 0.015 21.50 (26.88) (12.56) (0.53) Timing sales (3-year) 15,013 1.908 21,026 1.354 13,669 0.563 13.1441 (22.68) (21.38) (9.66) Timing repurchases (1-year) 11,299 -0.089 13,703 0.066 11,019 0.100 -7.59 (-4.22) (4.19) (7.51) Timing repurchases (3-year) 8,683 -0.030 11,004 -0.102 8,949 -0.005 -0.55 (-0.73) (-3.75) (-0.22) Timing repurchases Compustat (1-year) 7,516 -0.056 10,751 0.042 10,287 0.122 -6.34 (-2.33) (2.51) (8.50) Timing repurchases Compustat (3-year) 5,174 -0.021 7,827 -0.001 8,080 0.149 -2.20 (-0.31) (-0.01) (4.31)
  • Table 4. Post-event Stock Returns and Program Size in Subsamples Sorted by Firm Size. The table gives the average one-year risk-adjusted returns after the event (SEO, equity sale, or repurchase) and the average program size in each subsample. Columns 2 and 3 present statistics for …rms with market capitalizations of less than $100 million; columns 4 and 5 for …rms with market capitalization above $100 million but below $1 billion; and columns 6 and 7 for …rms over $1 billion. T-statistics for the di¤erence of the mean from zero are shown in parentheses. Obs. size<$100m Obs. $100m<size<$1B Obs. size>$1B Fraction of equity issued in SEO 383 36.06% 2,069 21.51% 1,160 12.55% Risk-adjusted returns after SEO (1-year) 383 -19.92 2,069 -3.98 1,160 3.99 (-7.45) (-3.80) (3.09) Fraction of equity issued 22,527 7.87% 28,209 7.53% 17,592 5.84% Risk-adjusted returns after equity issuance (1-year) 22,527 -7.33 28,209 0.89 17,592 3.00 (-19.25) (3.22) (11.25) Fraction of equity repurchased 11,299 3.54% 13,703 3.07% 11,019 2.85% Risk-adjusted returns after repurchase (1-year) 11,299 -3.47 13,703 3.13 11,019 4.16 (-6.53) (7.78) (12.84)42 Fraction of equity repurchased Compustat 7,516 3.28% 10,751 3.08% 10,287 3.31% Risk-adjusted returns after repurchase Compustat 7,516 -3.05 10,751 1.99 10,287 3.03 (1-year) (-4.53) (4.47) (9.34)
  • Table 5. Total CEO Compensation and Equity Market Timing. The dependent variable is the logarithm of one plus the total annual CEO compensationadjusted for in‡ ation. Firm size is the logarithm of the book assets; book leverage is the sumof long-term and short-term liabilities divided by the book value of assets; contemporaneous(past) stock returns are the returns during (one year prior to) the year in which compensationis measured; and payout ratio is the sum of share repurchases and dividends paid on commonstock during the year, normalized by the book assets. Other variables are described in theheader of Table 1. The estimation includes year and …rm-…xed e¤ects and the standard errorsare clustered at the …rm level. Variable (1) (2) (3) (4) (5) (6) Timing repurchases (1-year) 1.492 (3.03) Timing repurchases (3-year) 1.747 (4.87) Timing SEOs (1-year) -0.771 (-2.26) Timing SEOs (3-year) -0.334 (-2.28) Timing sales (1-year) -0.669 (-3.53) Timing sales (3-year) - 0.870 (-7.83) R&D/assets 0.072 0.070 0.070 0.068 0.058 0.053 (0.43) (0.42) (0.42) (0.41) (0.34) (0.32) Firm size 0.228 0.228 0.228 0.229 0.233 0.229 (10.07) (10.08) (10.08) (10.14) (10.35) (10.34) Book leverage -0.139 -0.136 -0.138 -0.138 -0.138 -0.126 (-1.14) (-1.14) (-1.14) (-1.14) (-1.14) (-1.12) Tobin’ Q/1000 s 0.180 0.176 0.180 0.179 0.184 0.173 (2.07) (2.05) (2.06) (2.06) (2.05) (2.02) Past stock return 0.192 0.187 0.197 0.198 0.189 0.179 (14.73) (14.33) (15.32) (15.44) (14.68) (14.50) Contemporaneous stock 0.171 0.172 0.176 0.178 0.166 0.170 return (12.44) (12.66) (13.03) (13.10) (12.42) (12.75) Payout ratio 9.705 9.772 9.637 9.625 9.789 9.433 (3.73) (3.76) (3.71) (3.70) (3.76) (3.62) Adjusted-R2 0.715 0.716 0.715 0.715 0.716 0.717 Observations 27,402 27,402 27,402 27,402 27,402 27,402 43
  • Variable (7) (8) (9) (10)Timing SEOs and repurchases (1-year) -0.213 (-0.76)Timing SEOs and repurchases (3-year) 0.039 (0.28)Timing repurchases minus SEOs (1-year) 0.961 (3.34)Timing repurchases minus SEOs (3-year) 0.587 (4.15)R&D/assets 0.068 0.068 0.072 0.068 (0.41) (0.41) (0.44) (0.41)Firm size 0.229 0.229 0.228 0.228 (10.12) (10.11) (10.14) (10.16)Book leverage -0.139 -0.139 -0.138 -0.136 (-1.14) (-1.14) (-1.14) (-1.14)Tobin’ Q s 0.180 0.180 0.180 0.177 (2.06) (2.06) (2.07) (2.06)Past stock return 0.200 0.199 0.191 0.193 (15.57) (15.57) (14.73) (14.95)Contemporaneous stock return 0.179 0.179 0.170 0.175 (13.17) (13.16) (12.55) (12.88)Payout ratio 9.645 9.663 9.662 9.640 (3.71) (3.72) (3.72) (3.71)Adjusted-R2 0.715 0.715 0.716 0.716Observations 27,402 27,402 27,402 27,402 44
  • Table 6. Components of CEO Compensation and Equity Market Timing. The dependent variable in columns 1 and 2 is the logarithm of one plus the CEO salaryadjusted for in‡ ation. The dependent variable in columns 3 and 4 is the logarithm of one plusthe CEO bonuses received during the year adjusted. The dependent variable in columns 5 and6 is the logarithm of one plus the Black-Scholes value of stock option grants and the value ofrestricted stock grants, adjusted for in‡ation. Firm size is the logarithm of the book assets; bookleverage is the sum of long-term and short-term liabilities divided by the book value of assets;contemporaneous (past) stock returns are the returns during (one year prior to) the year in whichcompensation is measured; and payout ratio is the sum of share repurchases and dividends paidon common stock during the year, normalized by the book assets. Other variables are describedin the header of Table 1. The estimation includes year and …rm-…xed e¤ects and the standarderrors are clustered at the …rm level. (1) (2) (3) (4) (5) (6) Variable Salary Salary Bonus Bonus Equity Option Grants Grants Timing repurchases minus 0.035 0.892 0.808 SEOs (1-year) (0.77) (4.20) (1.87) Timing repurchases minus 0.041 0.464 0.543 SEOs (3-year) (1.53) (3.16) (2.53) R&D/assets 0.095 0.095 -0.129 -0.133 0.103 0.100 (3.21) (3.20) (-1.27) (-1.30) (0.45) (0.43) Firm size 0.082 0.082 0.089 0.089 0.266 0.266 (10.52) (10.52) (3.66) (3.67) (7.98) (7.98) Book leverage -0.011 -0.011 -0.082 -0.081 -0.187 -0.186 (-1.04) (-1.03) (-1.25) (-1.24) (-1.15) (-1.15) Tobin’ Q/1000 s 0.042 0.042 0.261 0.258 -0.105 -0.108 (1.83) (1.81) (2.30) (2.25) (-0.54) (-0.56) Past stock return 0.021 0.021 0.180 0.183 0.193 0.194 (6.99) (7.02) (15.72) (16.13) (10.17) (10.23) Contemporaneous stock 0.011 0.011 0.279 0.283 0.127 0.130 return (3.60) (3.66) (19.75) (20.14) (6.38) (6.62) Payout ratio 2.690 2.687 1.682 1.621 18.03 18.01 (3.34) (3.34) (0.59) (0.57) (3.80) (3.80) Adjusted-R2 0.878 0.878 0.613 0.613 0.549 0.549 Observations 27,628 27,628 27,628 27,628 27,432 27,432 45
  • Table 7. Returns Due to Market Timing and Investment Rates. The numbers in the table are the additional returns (in %) earned by the shareholders dueto market timing e¤orts by the …rm. The low (high) investment rate group includes …rms thathave investment (capital expenditures divided by the book assets) during the issuance year inthe lowest (highest) tercile. Other variables are described in the header of Table 1. T-statisticsfor the di¤erence of mean from zero are shown in parentheses. The last column provides atwo-sample t-test for the di¤erence in means between the group with high investment rate andthe low investment rate. Low investment rate Obs. size<$100m Obs. $100m<size<$1B Obs. size>$1B T-test Timing SEOs 128 6.237 838 0.287 493 -0.689 4.08 (1-year) (3.73) (0.65) (-2.26) Timing SEOs 59 9.227 553 3.386 341 0.668 1.97 (3-year) (2.15) (3.78) (1.97) Timing sales 7,581 1.143 8,453 0.491 4,768 0.048 12.38 (1-year) (16.37) (8.85) (0.88) Timing sales 4,895 2.177 6,187 1.810 3,738 0.510 8.78 (3-year) (14.20) (14.89) (4.56) Medium investment rate Timing SEOs 94 3.96 531 0.301 281 -1.120 2.75 (1-year) (2.23) (0.60) (-1.99) Timing SEOs 54 14.863 402 1.584 184 1.405 3.74 (3-year) (4.25) (1.45) (1.64) Timing sales 6,907 1.033 8,955 0.354 6,005 0.003 12.76 (1-year) (15.36) (7.18) (0.07) Timing sales 4,555 1.916 6,613 1.307 4,573 0.631 7.19 (3-year) (12.85) (12.02) (6.39) High investment rate Timing SEOs 117 5.661 653 0.821 367 -1.012 4.24 (1-year) (3.81) (1.79) (-1.96) Timing SEOs 80 11.253 508 4.433 289 1.600 3.83 (3-year) (3.58) (4.71) (2.78) Timing sales 5,822 1.217 8,824 0.352 6,220 0.009 13.36 (1-year) (15.69) (6.79) (0.20) Timing sales 3,731 2.093 6,483 1.202 4,773 0.595 8.50 (3-year) (11.66) (10.14) (6.14) 46
  • Table 8. Market Timing and Firm Size: Adjusting for Cross-Correlation. The numbers in the table are the additional returns (in %) earned by the shareholders dueto market timing e¤orts by the …rm. The variables are described in the header of Table 1. Thestandard errors are calculated using the procedure in Mitchell and Sta¤ord (2000), where we…rst estimate the cross-correlations between the timing measures in each subsample. T-statisticsfor the di¤erence of mean from zero are based on standard errors adjusted for cross-correlationand shown in parentheses. Obs. size<$100m Obs. $100m<size<$1B Obs. size>$1B Timing SEOs (1-year) 383 4.515 2,069 0.432 1,160 -0.865 (3.02) (1.63) (-0.83) Timing SEOs (3-year) 235 10.618 1,509 3.138 831 1.288 (5.61) (1.95) (0.94) Timing sales (1-year) 22,527 1.020 28,209 0.359 17,592 0.015 (3.57) (1.81) (0.08) Timing sales (3-year) 15,013 1.908 21,026 1.354 13,669 0.563 (5.38) (2.49) (0.85) Timing repurchases 11,299 -0.089 13,703 0.066 11,019 0.100 (1-year) (-0.49) (0.45) (1.10) Timing repurchases 8,683 -0.030 11,004 -0.102 8,949 -0.005 (3-year) (-0.10) (-0.48) (-0.23) 47
  • Table 9. Robustness: 1982-2010 Sample and Excluding Tender O¤ers. The numbers in the table are the additional returns (in %) earned by the shareholders due to market timing e¤orts by the …rm. Timing SEOs is equal to the post-SEO risk-adjusted return in %, calculated over a horizon of one or three years and multiplied by the proportion of newly issued equity (as identi…ed in the SDC New Issues database). Timing sales is equal to the risk-adjusted return in %, calculated over a horizon of one or three years after an increase in shares outstanding (as identi…ed in the CRSP monthly database), and multiplied by the fraction of equity issued. Timing repurchases is equal to the post-repurchase risk-adjusted return in %, calculated over a horizon of one or three years after a decrease in shares outstanding (as identi…ed in the CRSP monthly database), and multiplied by the fraction of equity repurchased. Timing repurchases quarterly data is equal to the post-repurchase risk-adjusted stock return in %, calculated over a horizon of one or three years and multiplied by the fraction of equity repurchased (as identi…ed from the Compustat quarterly database). The last column in the table gives t-test statistics is for the di¤erence of mean from zero. 1982-2010 Sample Variable Obs. Mean St. dev. 10th Median 90th T-test Timing SEOs (1-year) 5,518 0.381 11.274 -9.288 0.608 10.536 2.51 Timing SEOs (3-year) 4,156 2.464 18.781 -14.242 2.687 21.521 8.4648 Timing sales (1-year) 98,628 0.392 4.776 -1.871 0.026 3.499 25.77 Timing sales (3-year) 76,567 0.978 8.783 -3.141 0.088 7.171 30.86 Timing repurchases (1-year) 50,557 0.053 2.028 -1.348 -0.004 1.314 5.87 Timing repurchases (3-year) 39,453 0.133 4.874 -3.068 -0.022 2.732 5.42 Firms Repurchasing less than 10% of Equity: 1992-2010 Timing repurchases (1-year) 35,274 0.023 1.421 -1.144 -0.004 1.082 3.04 Timing repurchases (3-year) 25,440 -0.009 3.262 -2.600 -0.026 2.162 -0.44