Two essays on share repurchases, diversification discount and analyst cash flow forecasts

Abstract

This thesis consists of two essays. The first essay examines the effect of share repurchase on the diversification discount of multi-segment firms. The second essay investigates how firms’ decisions of share repurchases are influenced by analysts’ cash flow forecasts (CFF).

In the first essay, I investigate the relation between the market reaction to share repurchase announcements and multi-segment firms’ diversification discount. Prior studies have shown that information asymmetry causes a large diversification discount (measured as the negative value of firm excess value). Meanwhile, previous literature suggests that share repurchase announcement is a credible and efficient way in mitigating information asymmetry, with market reaction to share repurchase announcements being more positive for those firms subject to severe information asymmetry. These evidence leads to my conjecture that share repurchase can effectively decrease the diversification discount of multi-segment firms. This conjecture is supported by my empirical results. In addition, the cross-sectional analyses show that the positive correlation is less pronounced for firms with lower credibility of share repurchase announcements. In the additional analysis using a matched sample, I find that diversification discount decreases significantly for firms with share repurchase announcements in post-announcement periods while there is no decrease for the match sample of non-repurchase firms. Further analyses show that my conclusions are mainly driven by diversification discounts (i.e., negative firm excess value) instead of diversification premium (i.e., positive excess firm value) and that as a response to higher diversification discount, firms are less likely to announce share repurchases and more likely to refocus their business lines.

The second essay examines how analysts’ cash flow forecasts (CFF) affect firms’ decisions of open market share repurchases. I find that the likelihood of share repurchases decreases in the presence of CFF. This negative relation is more pronounced for firms with worse information environment, weaker corporate governance, and more severe financial constraint. In addition, within the sample firms with CFF, the negative correlation exists between the likelihood of stock repurchases and the prevalence of CFF, measured by the ratio of the number of analysts issuing CFF among the number of analysts following the same firm and the ratio of CFF frequency relative to the frequency of earnings forecasts. Moreover, using a matched sample, I document a lower likelihood of stock repurchases after the initiation of CFF. Furthermore, I predict and find that the stock repurchase announcements are more credible for firms covered by CFF, as evidenced by higher actual stock repurchase ratio and better firm performance in the following periods. Lastly, I show that the substitutive effect of CFF on stock repurchase announcement is more pronounced when CFF are optimistic.