Stock repurchases by Indian corporations : Effect on share prices

Abstract

Miller and Modigliani (M&M) (1961) have stated that in perfect capital markets as long as theinvestment policy does not change modifying the mix of retained earnings and payout does notaffect a firm’s value. The fundamental underlying the previous statement is: All information isalready priced into stocks and any new information regarding the payout should not affect the shareprice. However, the statement by M&M is based on the following sets of assumptions:i) Efficient Capital Markets.ii) No transaction costs.iii) Same tax rates on dividends and capital gains.iv) No costs of financial distress.The above assumptions would simply imply that buybacks are just a way to return excess cash to theshareholders. Shareholders would be indifferent to receiving cash in the form of dividends or sharebuybacks. However, the above assumptions do not hold in the real world. Numerous studies indicatethat buyback/dividend announcements have a significant impact on the share price of a firm.