Download Reasons for share repurchases in South Africa: Theory versus practice

Reasons for share repurchases in South
Africa: Theory versus practice
R Chivaka
Department of Accounting, University of Cape Town
A Siddle
Development Bank of Southern Africa
L Bayne, C Cairney and J Shev
Department of Accounting, University of Cape Town
Received: March 2008
Revised: March 2009
Accepted: June 2009
SAJAR
Vol 23 No. 1
2009
pp.1 to 30
Share repurchases (share buy-backs) have become an increasing global phenomenon, with South
Africa (SA) following the international trends since 1999. While there has been a significant
amount of international research concerning share repurchases, the same is not true of SA. In
addition, there is little research that compares the theoretical reasons given for share repurchases
and practice. The objectives to be addressed in this research are thus twofold; first to ascertain
the reasons disclosed by company directors for repurchases in order to create visibility of the SA
practice, and second to identify the similarities and differences between the reasons for share
repurchases in SA and the theoretical reasons, and those emerging from academic literature (in
finance theory), in order to contribute to the bridging of the gap between theory and practice. In
order to address these objectives, this research uses an archival analysis method to gather data
from companies listed on the Johannesburg Securities Exchange Ltd (JSE). Reasons for specific
share repurchases given by companies listed on the JSE are then analysed and compared against
theoretical reasons using the pattern of behaviour approach. The paper contributes to knowledge
by creating visibility of the reasons that influence share repurchases in the SA context. In
addition, this research contributes to the closing of the gap between theory and practice by
highlighting some of the potential tensions that exist between management and stakeholders in
the process of share repurchases. Such tensions, which arise from differences in expectations,
have the effect of precluding management from explicitly citing some of the reasons given in
finance theory when motivating for share repurchases.
KEY WORDS
Share repurchases, South Africa, Share buy-backs, Archival research strategy
Contact
[email protected]
R Chivaka, A Siddle, L Bayne, C Cairney & J Shev
1
INTRODUCTION
Recent years have seen share repurchases becoming an increasingly important agenda
item in many executive boardrooms across the globe. Not only are share repurchases
becoming a very popular (Rau, 2002) equity management tool (Otchere & Ross, 2002),
they are also seen as an integral part of successful corporate financial strategy (Mitchell
& Robinson, 1999; Hatakeda & Isagawa, 2004). Consequently, share repurchases are
now regarded as one of the most important strategic decisions that financial managers
have to make (Jong, van Dijk & Veld, 2003). Starting in the United States of America
(USA) (Stonham, 2002; Baker, Powell & Veit, 2003; Hatakeda & Isagawa, 2004), share
repurchases exploded onto the corporate scene in Canada (Jong et al., 2003), the United
Kingdom (UK) (Stonham, 2002; Rau, 2002), Australia (Mitchell & Robinson, 1999;
Otchere & Ross, 2002), Germany (Stonham, 2002), and Japan (Hatakeda & Isagawa,
2004). In the USA for example, from 1985 to 1999, corporations announced plans to
repurchase about US$750 billion of shares (Grullon & Ikenberry, 2000). Between 1999
and 2000, for the first time in history, industrial corporations in the USA spent more
money on share repurchases than they did on dividends (Grullon & Michaely, 2004).
Canada has also experienced a significant increase in share repurchases and comes
second, after the USA, in terms of share buy-back activity (Jong et al., 2003). UK
repurchases constituted 80% of European Union share buy-backs between 1993 and
1997, peaking to a staggering US$100 billion in 1999. While Australia’s initial uptake
of share repurchases started at a pedestrian rate when the relevant legislation was put in
place in 1989, the country experienced a significant increase in share buy-backs over
the years (Mitchell & Robinson, 1999; Otchere & Ross, 2002). Since share repurchase
were allowed in the 1997 change in the commercial law in Japan, share repurchases
have become a very popular financial strategy (Hatakeda & Isagawa, 2004).
Consistent with the interest in share repurchases, academic research has been
undertaken to investigate a number of issues surrounding share repurchases. Examples
of the issues investigated include reasons for share repurchases in the USA (Grullon &
Ikenberry, 2000; Baker et al., 2003), share price behaviour induced by share
repurchases announcements in Japan (Hatakeda & Isagawa, 2004), dividend and share
buy-back decisions in the context of management payout decisions in Canada (Jong et
al., 2003), financial benefits that share repurchases confer on corporates and
shareholders in the UK (Stonham, 2002), the impact of a drastic change in the
regulatory environment on share repurchases activity in the UK (Rau, 2002),
motivations for share repurchases (Mitchell & Robinson, 1999) and the signalling effect
of share repurchases announcements (Otchere & Ross, 2002) in Australia. However,
while South Africa (SA) has followed the international trend and allowed share
repurchases since 1999, following amendments to the Companies Act No. 61, 1973,
there has not been much published work on SA share repurchases. A search of the local
journals revealed that not much research around share repurchases has been done to
date. Gordon (2001) and Bhana (2007) are journal articles that have done research
related to share repurchases. Both Gordon (2001) and Bhana (2007) were more
interested in the market reaction to an announcement of share repurchases. However,
while the academic journals have barely touched on this issue, we have seen a flurry of
interest in share repurchases in the business journals and press. Of note is the brief
publication by Le Roux (2006), which reported that companies in South Africa
preferred share repurchases to special dividends due to tax benefits associated with
share buybacks.
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SA Journal of Accounting Research Vol. 23 : No. 1 : 2009
The leading finance textbooks in the country have hardly touched on the issue of share
repurchases, with Firer, Ross, Westerfield & Jordan (2004) giving a very general
theoretical argument of dividends versus share buy-backs, and the effects on the
accounting measures of a share repurchase. The only mention of SA’s share repurchase
experience is that they became allowed in 1999, with two types of buy-backs being
recognised by the Companies Act, and that in 2000, 79 transactions with a total value of
R12.8 billion took place. The only example mentioned in the book refers to SASOL,
which repurchased 10.8 million shares on the open market for R640 million in 2002.
While Correia, Flynn, Uliana & Wormald (2007), briefly discuss reasons for share
repurchases, they concentrate more on the mechanics of share repurchases.
Given the interest and significance that share repurchases have gained in other
countries, it is of interest to focus on the SA situation. As such, the questions that arise
from the above, which this research empirically investigates and answers, are as
follows:
ƒ
What are the reasons disclosed by company directors for share repurchases in SA?
ƒ
How do these reasons compare to established theoretical reasons (as shown in
finance theory) and empirical evidence from other countries?
Given the topicality of share repurchases and the above research questions, the
objectives of the research are therefore twofold;
ƒ
First, to ascertain the reasons disclosed by company directors for repurchases in
SA; and
ƒ
Second, to bridge the gap between theory and practice by comparing empirical
results from SA and the theoretical reasons given in finance theory.
The rest of the paper is laid out as follows: Section 2 discusses the literature on share
repurchases, drawing insights from empirical evidence from other countries. The
section concludes by giving a synoptic view of the regulatory framework governing
share buy-backs in SA and highlighting the gap that this research attempts to bridge. In
section 3, the research methodology followed in collecting and analysing data is
discussed. This is followed by section 4 which presents the results of the reasons for
share repurchases from a SA perspective. Section 5 gives details of the comparative
analysis of SA’s empirical results against the theoretical reasons given in the academic
literature. A summary of the main results and insights emerging from this research is
contained in section 6, while section 7 concludes the study and highlights areas for
further research.
LITERATURE REVIEW
This section deals with literature on share repurchases by drawing insights from
academic books, journal articles and theses that report on share repurchases in countries
such as the USA, UK, Canada and Australia. In addition, the available SA literature on
share repurchases is also reviewed, and the key regulatory aspects are highlighted. For
the purpose of brevity, the section is divided into two parts as follows: The first part
(2.1) focuses on reasons for share repurchases as stated in academic literature (these are
R Chivaka, A Siddle, L Bayne, C Cairney & J Shev
3
the theoretical reasons). Insights drawn from the empirical experience of other countries
are also brought into the discussion. The second part (2.2) discusses the SA regulatory
environment which permits share repurchases, and highlights the gap that exists in the
academic literature, which this research attempts to bridge.
Reasons for share repurchases
The question as to why share repurchases are increasingly becoming common is asked
in the context of various alternative mechanisms that companies could use to give back
money to their shareholders, such as cash dividends, special cash dividends, and return
of share capital. A number of reasons have been considered by academics as
underpinning the choice of share repurchases over the other alternative mechanisms.
The reasons for share buy-backs, discussed below, are amongst those most commonly
cited, hence this list does not purport to be exhaustive. The reasons have been grouped
into five broad categories, which reflect, in general terms, the potential motives behind
repurchases, as shown in Table 1.
Purpose/impact of share repurchase
Table 1: Main theoretical reasons for share repurchases
4
Theoretical Reasons Categories
An element of
Enhancement of
dividend policy
share value
Change of shareholding &
control
Administrative
reasons
Compensation
related reasons
9
Distribution
of surplus
assets
9
Repurchase
a “good
investment”
9
Attracting external
investors /
Transferability
9
Enabling a
company to
trade in its
own shares
9
Management
compensation
9
Dividend
substitution
for tax
purposes
9
Signalling
hypothesis
9
Exit for existing
shareholders
9
Repurchase
of
redeemable
shares
9
Employee
share
schemes
9
Capital
structure
adjustments
9
Buying out dissident
shareholders
9
Elimination
of odd-lots
9
To support
the market
for the
company’s
shares
9
Repurchase to avoid a
takeover
9
Other
9
Management buyouts &
going private
9
To avoid/reduce dilution
in shareholding
ƒ
acquisition
programmes
ƒ
share plans
SA Journal of Accounting Research Vol. 23 : No. 1 : 2009
Repurchases as an element of dividend policy
This category of share repurchases is concerned with repurchases which are carried out
as a component of the company’s payout decisions (Jong et al., 2003). Two ways in
which a company may pay out cash to its shareholders are by way of a dividend or by a
share repurchase. This raises the question: In what way(s) is returning cash to
shareholders via a share buy-back preferable to returning cash via a traditional
dividend?
Distribution of surplus assets
Repurchasing shares is a method of returning surplus cash to shareholders that the
company is unable to invest in projects that will generate a return greater than its cost of
capital (Ferran, 1999). If a company lacks internal investing opportunities and has cash
surplus to its ordinary requirements, then the excess cash can be employed to shrink the
equity base through the repurchase of shares (Brudney & Bratton, 1993; Blackman,
Jooste & Everingham, 2002). Shareholders will then be at liberty to invest the proceeds
as they deem fit. Returning excess cash to shareholders via share repurchases is seen as
a way of addressing concerns over whether managers work to increase shareholder
wealth by always making decisions that increase the value of the firm (Grullon &
Ikenberry, 2000). With the separation of ownership and control of enterprises, there is a
potential risk that managers may pursue their own interests at the expense of
shareholder value creation. In practice, the board of directors has to approve the payout
decisions and is able to disallow opportunistic payout choices. Douglas (2007) therefore
predicts that a relationship exists between the payout method and corporate governance
variables. This view is supported by the finding of Hu and Kumar (2004) that the
combination of dividends and share repurchases reflects the level of managerial
entrenchment. This gives rise to the concern that managers might allocate capital into
unprofitable activities, pursuing growth and size rather than profitability and value. The
costs that arise from this conflict between growth and value maximisation are known in
finance theory as “agency costs”, or more precisely, as the “agency costs of free cash
flow” (Grullon & Ikenberry, 2000; Grullon & Michaely, 2004). It has been argued that
one way to at least mitigate such free cash flow problems is to return cash to
shareholders in the form of increased dividends (Grullon & Ikenberry, 2000), and share
repurchases can achieve the same effect. The free cash flow hypothesis maintains that
by paying out free cash, share repurchases represent good news and add value by
curbing management’s tendency to waste it on low return investments (Gup & Nam,
2001). Consequently, a share repurchase is seen as a good management decision,
provided it does not jeopardise the firm’s ability to fund promising investment
opportunities that might arise in the future (Grullon & Ikenberry, 2000).
Related to the free cash flow hypothesis is the capital market allocation hypothesis. It
asserts that even without agency problems, shareholders are better off with a share
repurchase programme than depending entirely on corporate managers to invest the free
cash because they (shareholders) can allocate funds more effectively than corporate
managers, due to their broader view of economy-wide opportunities (Grullon &
Ikenberry, 2000). Since a corporation can pay dividends under the same circumstances,
i.e. where a company has surplus cash, a question that arises is; why is the power to pay
dividends not enough for the fulfilment of these dividend-type functions? It has been
suggested that a repurchase allows those shareholders who prefer a cash flow to sell
some of their shares, while allowing those who prefer a low payout investment:
R Chivaka, A Siddle, L Bayne, C Cairney & J Shev
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“…to stand pat; therefore shareholders will be better satisfied. But this argument
neglects the fact that it is quite unnecessary for any particular corporation to be all
things to all types of shareholders. Investors who want high yielding stocks can and do
invest in companies with high dividend payout ratios, and investors who want low
yielding stocks do the opposite” (Clark, 1986:627).
However, the question then arises as to why there should be any concern about either
choice, given the fact that if a company wants to make distributions, this can be
achieved by paying dividends or repurchasing shares (Clark, 1986). The reason for
concern is that repurchases have a greater potential for creating unequal treatment of
shareholders of the same class. If a company pays too much for its shares in a
repurchase, the remaining shareholders will be disadvantaged; if it pays too little, the
selling shareholders will be disadvantaged. When dividends are paid, however, every
shareholder receives the same amount per share (Clark, 1986). It is also possible that
repurchases serve as a substitute for dividends in that they provide an alternative means
of distributing large, non-recurring cash flows as opposed to recurring earnings which
are generally expected to be paid out regularly in the form of dividends over time
(Grullon & Ikenberry, 2000). It is worth noting the fact that, while this might be the
case, companies still have at their disposal an equally effective method in the form of a
special cash dividend.
Dividend substitution for tax purposes
In most countries in which share buy-backs are permitted, cash dividends are taxed
differently to share buy-backs in the shareholders’ hands, with a distinction usually
being drawn for tax purposes between income and capital gains. Thus, tax efficiencies
may exist in returning cash via one mechanism rather than the other. The tax efficiency
is country specific and dependent on circumstances. In the USA, before share
repurchases became popular in the 1980’s, cash dividends were the principal means of
returning excess capital to shareholders (Grullon & Ikenberry, 2000). It has been
suggested that in the USA, the increase in repurchase activity is a reflection, in part, of a
broad tax-motivated substitution of repurchases for dividends (Grullon & Ikenberry,
2000). This view is shared by Le Roux (2006) who concluded that when making the
decision about distributing excess cash via special dividend or share repurchases, South
African companies preferred share repurchases as they are seen as more tax efficient. In
an exhaustive study Lie and Lie (1999) found that tax considerations play a significant
role in the USA in the choice between a repurchase and a dividend, and that pressure
from institutional investors to take advantage of tax benefits is a factor in this choice.
The reason for this is that in the USA, repurchases generally constitute a more tax
efficient form of cash distribution than dividends. The marginal tax rate on dividends,
which are taxed as ordinary income, exceeds that on realised capital gains. This means
that the full amount of dividend income is taxed as ordinary income, whereas only the
portion of the proceeds from a share sale that constitutes a realised capital gain is taxed.
Also dividends are taxable when distributed, whereas taxes on capital gains are deferred
until the shares are sold (Bartov, Krinsky & Lee, 1998). In Australia, while the tax
efficiency of a share repurchase rather than dividend is dependent on the tax position
and nature of the investor (institutional or share trader), a general preference for capital
gains, relative to dividends on the basis of tax efficiency is noted in the literature
(Mitchell & Robinson, 1999). The tax efficiency of the repurchase is further enhanced
where payments are made out of share premium.
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In the SA context, share repurchases are fairly closely regulated by the Companies Act
No. 61, 1973, as amended (the Act), with section 85(1) being the principal enabling
provision for share repurchases. In addition, further regulation is provided by the
Listing Requirements of the JSE Ltd (JSE), in the case of listed shares. The need for
regulation arises from the fact that repurchases affect creditors and the relative rights of
shareholders (Correia et al., 2007). The main thrust of the regulations is thus to protect
creditors and shareholders from improper trading in a company’s shares by managers.
Therefore, the liquidity and solvency of a company after a repurchase needs to be
considered. Section 85 stipulates a number of restrictions that are aimed at protecting
the interests of shareholders. For example, some of the key prerequisites for any share
repurchase are that; (i) the company’s articles of association must authorise a
repurchase, (ii) approval from shareholders by way of a special resolution must be
obtained, (iii) a repurchase is prohibited if it would result in the company having no
shares in issue other than redeemable or convertible shares, (iv) a company may not
make payment to repurchase any share if there are reasonable grounds for believing that
the company is, or would after the payment be, unable to pay its debts in the ordinary
course of business, or if the consolidated assets of the company fairly valued would be
less than the consolidated liabilities, and (v) shares acquired directly by the issuing
company must be cancelled as issued shares and restored to the status of authorised
shares. Section 85(2) of the Act provides that the approval by special resolution may be
general or specific. A general approval is valid until the next annual general meeting,
but may be varied or revoked by special resolution at any prior general meeting
(Companies Act, 1973: s85(3); JSE, 2003: paragraph 5.67)). A specific approval relates
to a particular repurchase. Paragraph 5.67 of the Listing Requirements read with
section 85(3) of the Act provides for three categories of repurchases:
ƒ
A repurchase pursuant to specific approval (“specific repurchase”) incorporating a
pro rata offer;
ƒ
A specific repurchase incorporating a specific offer; and
ƒ
A repurchase pursuant to general approval (“general repurchase”).
In terms of the Listing Requirements, the disclosure requirements are more extensive
for specific repurchases than for general repurchases. The Listing Requirements provide
for the publication of certain information relating to specific repurchases, including
information relating to: (i) the reasons for repurchases, (ii) the method of repurchase,
(iii) the number of shares involved, the price to be paid, (iv) the effect of the repurchase,
(v) the source of funds to be utilised, and (vi) a statement from an independent
professional expert indicating whether or not any premium paid is fair and reasonable to
shareholders of the company if such premium exceeds 10% of the weighted average of
the market value of the shares for the five business days immediately preceding the date
on which the transaction was agreed.
However, for general repurchases, Paragraph 11.26 of the Listing Requirements
provides that a company pursuing general approval to repurchase its own shares must
send shareholders a notice of the annual general meeting, including a statement of the
board of directors’ intention regarding the utilisation of the authority sought. In
addition, paragraph 11.27 of the Listing Requirements requires that an announcement
be made when a company repurchases 3% in aggregate of the total number of any class
of shares in issue at the time that the general authority was granted by the shareholders.
R Chivaka, A Siddle, L Bayne, C Cairney & J Shev
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Similarly, an announcement should be made for each 3% in aggregate acquired
thereafter. This announcement must be made by no later than 08h30 on the second
business day following the day on which the threshold is reached, and must include: (i)
the date of repurchase, (ii) the highest and lowest prices paid, (iii) the number and value
of securities repurchased, and (iv) a statement as to the source of funds utilised.
The SA Income Tax Act No. 58 of 1962, as amended (Income Tax Act) also forms part
of the regulatory framework for share repurchases. The tax treatment of share buybacks in SA is dependent on the nature of the consideration paid by the company to the
shareholder. Section 64B of the Income Tax Act, imposes a liability on a company for
Secondary Tax on Companies (STC)1 on any consideration paid to the extent that it
constitutes a dividend, as defined. Generally, the consideration paid will constitute a
dividend to the extent that the share buy-back reduces the distributable reserves of the
company. Paragraph (f) of the dividend definition specifically excludes share buy-backs
to the extent that the consideration represents a reduction of the share premium of the
company. However, in terms of paragraph (iii) of the first proviso to the dividend
definition, any return of share capital or share premium to shareholders that arose from
a previous capitalisation of distributable reserves would be subject to STC. The
underlying principle envisaged by this proviso is that reserves retain their character
despite being capitalised.
Any amount that constitutes a dividend and which is subsequently subject to STC in the
company’s hands, will be exempt from income tax in the shareholder’s hands in terms
of section 10(1)(k)(i) of the Income Tax Act. The dividend portion of any consideration
paid by a company to buy back its shares from a sharedealer is specifically excluded
from this exemption. The amount distributed to shareholders may result in either
income tax or capital gains tax in the shareholder’s hands, to the extent that a share buyback does not constitute a dividend. The acquisition by a subsidiary company of shares
in its holding company does not constitute a dividend, and will consequently not attract
STC. However, such an acquisition will be subject to marketable securities tax, which
is charged at a minimal rate. In February 2007, paragraph (cA) of the dividend
definition was introduced to counter a particular avoidance scheme. In the event of the
reduction of the capital of a company pursuant to that company acquiring its own shares
by means of a distribution from any other company, paragraph (cA) of the dividend
definition provides that the amount of any reduction of the profits of that company that
was available for distribution to shareholders is deemed to be a dividend. This would be
applicable where a subsidiary acquires shares of its holding company and then
distributes these shares to the holding company. As a company cannot hold its own
shares, the holding company would have to cancel the issued shares and restore them to
authorised share capital. Any resulting reduction of distributable reserves would be
deemed to be a dividend. Section 70(3A) of the Income Tax Act requires that a
company obtains the approval of the Commissioner of the South African Revenue
Services (SARS) before the company makes any payment to a shareholder for the
repurchase of shares, where the consideration paid constitutes a dividend.
The regulatory provisions in SA, in principle, aim to involve the shareholders closely in
the repurchase process. The disclosure requirements relating to specific repurchases are
1
As per the Minister of Finance’s budget speech in February 2008, STC will be abolished in the future.
It will be replaced by a tax on dividends in the individual’s hands. This could influence the tax
considerations relating to share buy-backs.
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SA Journal of Accounting Research Vol. 23 : No. 1 : 2009
fairly stringent, the intention being to enable shareholders to make informed
decisions. The disclosure requirements relating to general repurchases are far less
onerous, but the scope of such share repurchases is also limited. It is in the context of
this SA regulatory environment that this research investigated reasons for share
repurchases, and compared them to the empirical evidence from other countries, as well
as to the established theoretical reasons.
Repurchases aimed at increasing share value
This category includes share repurchases which, in one way or another, and whether
expressed or implied, are aimed at increasing the value of the shares of the
company. These reasons include repurchases being seen as a good investment, those
aimed at supporting the market of the company’s shares, signalling that a company’s
shares are undervalued by the market, and capital structure adjustments.
Repurchase as a “good investment”
A repurchase may be made ostensibly to take advantage of a perceived undervaluation
to make a “good investment” for the benefit of shareholders. This has been dismissed as
a “form of doubletalk” because, “after the repurchase, the funds used for it will no
longer be in the corporation, or invested in its real business operations” (Clark,
1986:630). If the managers are right about the market’s undervaluation, the repurchase
serves only to:
“...shift wealth from the shareholders who sell to those who don’t. Perhaps managers
see this as a division between investors who lack faith in them and those who have it
and consequently think the repurchase is a fine method of punishing the doubters and
rewarding the faithful. But it hardly seems appropriate for managers to be doing this.
Shareholders who have more faith in the company’s future are perfectly able to buy
additional shares … without management’s help,” (Clark, 1986:630).
This view is supported by Fried (2005: ), who argues that managers can exploit inside
information that shows that the stock is underpriced to repurchase stock indirectly for
themselves and other remaining shareholders at a bargain price. He asserts that there is
considerable evidence that proves that managers use inside information to time share
repurchases so as to systematically transfer value from public shareholders to
themselves.
Repurchases to support the market for the company’s shares
A company may wish to repurchase its shares in order to bolster or stabilise the market
price (Ferran, 1999). Such conduct does, however, give rise to concerns about market
manipulation, which is considered a most serious consequence of recognising the right
of companies to purchase their own shares. The best case scenario is where a company
makes a market intervention because it believes its shares to be “undervalued”
(Blackman et al., 2002; Bhana 2007). Related to repurchasing, for the sake of
supporting the market for the company’s shares, is the question of signalling.
R Chivaka, A Siddle, L Bayne, C Cairney & J Shev
9
Signalling hypothesis
The “signalling hypothesis” holds that managers use repurchases as a means of
signalling to the market that they believe that their company’s shares are underpriced
(Baker et al., 2003). The point here is that due to information asymmetry, prevailing
share prices may not reflect true value as a result of investors’ knowledge being limited
to only publicly available information (Baker et al., 2003). As such, share repurchases
act as a vehicle to signal new and positive information about a company’s future
earnings prospects (Otchere & Ross, 2002).
The signalling hypothesis appears to have attracted widespread support in the USA as
the principal reason for share repurchases and the principal cause for increases in share
prices following repurchases. The weight of opinion amongst USA writers appears to be
that managers who believe their companies to be undervalued can increase the longterm value of the shares by repurchasing. The empirical evidence supporting the view
that the market responds positively to the announcement of a share repurchase is well
documented in the finance literature, with abnormal returns being observed around the
announcement of an open market repurchase program in the US on average about two
to three percent (Maxwell & Stephens, 2003).
Empirical evidence also includes reasons supplied directly by managers of firms
engaging in share repurchases in the US in 1998-1999. Based on 194 responses from
managers of firms engaging in open-market repurchases, the results show that the most
highly cited reasons for repurchasing shares of common stock are consistent with the
signalling hypothesis, specifically the undervaluation version of this hypothesis. (Baker,
et al., 2002)
Similarly, in Australia, signalling that the company’s shares are currently under-priced
is one of the two main motivations given by managers for on-market buy-backs. The
other is an attempt to improve the financial performance (earnings per share) and/or
position (net asset value) (Mitchell & Robinson, 1999).
Gordon’s (2001) study of 18 South African companies registered on the JSE Securities
Exchanges concluded that share repurchase announcements did indeed solicit a positive
response from the market. Bhana (2007) in an examination of the South African
market’s response to share repurchases finds evidence to support the hypothesis that
share repurchase announcements lead to increased share prices. This is due to the
inference that share repurchase announcements are credible managerial signals that the
company’s shares are undervalued or that there are other reasons suggesting that the
long-term prospects of the company are better than as is reflected by the existing share
price.
Capital structure adjustments
A company might repurchase its shares in order to adjust its debt-to-equity ratio
(Blackman et al., 2002; Grullon & Ikenberry, 2000). Such a course of action would be
based on the assumption that the company can reduce its overall cost of capital through
the use of debt in the capital structure (Brudney & Bratton, 1993). A company whose
capital structure is relatively heavily weighted with equity can lower its cost of capital
by incurring debt and using the proceeds to repurchase shares (Brudney & Bratton,
1993; Blackman et al., 2002). Several studies in the USA have found that repurchasing
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SA Journal of Accounting Research Vol. 23 : No. 1 : 2009
firms do in fact experience a decline in the cost of capital (Grullon & Michaely,
2004). Repurchases may be used to produce large-scale changes in capital structure
(Brigham & Daves, 2004) or to fine-tune their leverage over time (Grullon & Ikenberry,
2000).
Repurchases relating to changes in shareholding and control
This broad category is concerned with repurchases carried out with a view to changing,
or preventing a change in, the shareholding (with or without an accompanying change
in control) of the company. This is achieved by one of three approaches, namely (i)
introducing new shareholders, (ii) removing existing shareholders, and/or (iii) changing
the proportion in which shares are held.
Attracting external investors
If a company’s shares are not actively traded, it is not an attractive investment prospect
to external investors because of the risk of being permanently locked into that
investment. This risk is lessened if the company is able to act as an alternative
purchaser, in which case, smaller companies may find it easier to raise share capital
from external sources than would otherwise be the case (Ferran, 1999). This reason is
more commonly cited in relation to private companies, but circumstances may exist
where it is relevant to smaller listed companies.
Exit for existing shareholders
Being able to sell the shares back to the company also offers a way of unlocking the
investment made by a shareholder who no longer wishes to be involved in the company
(Ferran, 1999). This may be particularly useful when the other shareholders do not wish
to acquire the withdrawing shareholder’s shares themselves or there is no willing
outside purchaser. Again, this reason is more commonly cited in relation to private
companies, but it may be relevant to listed companies as well. Such a repurchase
possibility provides a substitute for an active stock market (Blackman et al.,
2002). Weston and Siu (2003) found that amongst smaller companies, where the
transferability of shares is limited by an illiquid market, facilitating the exit of an
existing shareholder was frequently the motivator behind the share repurchase.
Buying out dissident shareholders
Repurchase provides a means by which a company can rid itself of a dissident
shareholder (Blackman et al., 2002). This may lead to abuse (Ferran, 1999), and thus
result in the remaining shareholders being disadvantaged in cases where management
may be tempted to pay a considerable premium to persuade the dissident shareholder to
leave (Blackman et al., 2002).
Repurchases to avoid a takeover
A number of objectives might be achieved by repurchasing shares in a takeover
situation. The repurchase may result in an increase in the proportion of shares owned by
management. It may also increase the price of shares beyond that which is attractive to
the bidder, as the shareholders with the lowest reservation prices would be the first to
sell their shares (Weston & Sui, 2003). Weston and Sui explain the findings of earlier
R Chivaka, A Siddle, L Bayne, C Cairney & J Shev
11
research (of Ikenberry, Lakiunshok & Vermaelen (1995)) that found increases in prices
and returns to shareholders. Following share repurchase activity over an extended
period of time during the 1980’s, they observed that share repurchases served as a way
of eliminating shareholders with low reservation prices. As such, the increased
probability of takeovers that could have taken place during the high rates of merger and
acquisition (M&A) activity in the 1980’s would have increased prices and returns to
shareholders over time.
In addition, by embarking on a repurchase, the target company could divest itself of the
liquid assets which would make it attractive to the bidder, or increase its debt/equity
ratio to an unattractive level. Finally, the company might resort to “greenmail”,
whereby it agrees to pay the bidder a substantial premium for its shares in order to
induce it to turn its attention elsewhere (Blackman et al., 2002).
Management buyouts and going private
Management buyouts and the process of “going private” can be facilitated by means of
repurchases. The instigators of such transactions would seek to have the company
repurchase shares and thereby reduce, at the company’s expense, the number of shares
in issue which they would have to acquire in order to gain control of the company. In
the process, the liquidity of the outstanding shares might be reduced, thereby depressing
the price of those shares and placing pressure on the remaining shareholders to sell
(Blackman et al., 2002).
To avoid or reduce dilution in shareholding
Two specific circumstances are considered in the literature which could give rise to a
significant dilutive effect on shareholder value and control. A company engaging in a
takeover or merger might repurchase shares and then reissue them as consideration for a
takeover or merger without increasing the number of shares in issue. The objective
would be to prevent dilution of the equity of non-selling shareholders which would
otherwise occur if fresh shares were to be issued (Blackman et al., 2002). Share
repurchasing is also said to be prompted by the company’s obligation to issue shares
under employee share option plans. The ostensible purpose is again to avoid dilution of
shareholders’ equity (Blackman et al., 2002). Whether this objective is achieved is open
to question. Whilst the number of shares in issue remains the same, the shareholders
will still bear the cost of the employees’ options: the option holders pay less for their
shares than the company pays when repurchasing, and therefore the repurchase will
involve a net distribution of assets.
Repurchases carried out for administrative reasons
Repurchase of redeemable shares & eliminating odd-lots
If redeemable shares are trading at a discount to their redemption price, a company may
repurchase those shares at a price lower than the redemption price and thereby save
money (Ferran, 1999). Another reason that has been suggested for repurchasing
redeemable shares departs from a contrary viewpoint – it may reduce the temptation for
a company to redeem under a formal reduction scheme when the existence of such
shares becomes onerous for the company because of a change in interest rates; the
repurchasing of the shares may be viewed as preferable to a reduction scheme as it may
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SA Journal of Accounting Research Vol. 23 : No. 1 : 2009
be viewed as less coercive (Blackman et al., 2002). However, while the repurchase of
shares under this reason appears to simply reflect the administrative processes regarding
shares that were initially issued with the proviso that they would be bought back, in
reality managers are actually making a decision to increase shareholder value. This is
particularly true where considerations are made about repurchasing shares when their
redemption price is higher than the purchase price, and where interest rates are factored
into the decision. In addition, a company may repurchase shares in order to eliminate
small shareholdings (odd-lots) which can be expensive to administer.
Compensation related reasons
Repurchases may be carried out in order to facilitate or implement share-based
compensation schemes. These would include employee share schemes and management
compensation as discussed below.
Employee share schemes
It has been claimed that an advantage of allowing repurchases is that they can facilitate
the operation of an employee share scheme by assuring employees of a purchaser for
their shares when they leave the company (Ferran, 1999). Whether this is a serious issue
is open to question (Blackman et al., 2002), as employee share schemes are generally
operated through trusts which could purchase shares upon the departure of an employee.
Management compensation
Companies often use share options and share appreciation rights as part of the
compensation plans for key employees. Unlike share repurchases, which have no effect
on the value of these options, dividend payments reduce their value (Bartov et al.,
1998). Consequently, the fact that managers own share options may be an inducement
for them to distribute cash through open-market repurchase programs rather than
through dividends (Bartov et al., 1998). There is support in the literature for the theory
that repurchases may be carried out in response to share-based compensation schemes,
particularly where executives have large numbers of options outstanding and when
employees have large numbers of options currently exercisable (Baker et al., 2003;
Weston & Siu, 2003).
The reasons for share repurchases given and discussed above are in the context of the
regulatory environments in the countries in which the studies were done. It is therefore
necessary to briefly explore the SA regulatory framework that governs share
repurchases as a background to the empirical study.
Conclusion
Motivations for share repurchases, according to the literature reviewed, fall into five
main categories, namely an element of dividend policy, enhancement of shareholder
value, change in shareholding and control, compensation related and administrative
reasons. While research into reasons for share repurchases have been done in other
countries that have permitted such transactions, the SA situation has not been
investigated. Also, research investigating how the theoretical reasons compare to the SA
empirical results is lacking. This certainly creates a gap that needs to be filled via
empirical studies that not only investigate the reasons that motivate SA executives to
R Chivaka, A Siddle, L Bayne, C Cairney & J Shev
13
repurchase shares, but that also highlights a gap that might exist between theory and
practice. This research is aimed at addressing both issues by ascertaining the reasons
disclosed by company directors for repurchases in SA, and comparing the results with
reasons given in the academic literature.
RESEARCH METHOD
In order to answer the research questions, and address the research objectives, an
archival research strategy was used for this study. Archival research makes use of
administrative records and documents as the principal source of data (Saunders,
Thornhill & Lewis, 2007). This research strategy is appropriate since the JSE Listing
Requirements (para 11.23 and announcements under paragraphs 11.24 and 11.25) state
that listed companies in SA need to communicate the reasons for specific repurchases in
a circular to shareholders. Thus, the data required for this study was already
documented. Circulars regarding general repurchases were not scrutinised for reasons
because companies do not give reasons for such share buy-backs. It was thus not
considered a worthwhile exercise to go through these circulars as they would not yield
insights as to the motivations for share repurchases. The McGregor’s BFA database was
scrutinised for specific repurchase circulars issued by listed companies. The time period
covered was from 1999, when repurchases were legalised in SA, to the end of
December 2004. Where the reason for the repurchase was not discernable, the particular
repurchase was excluded from the study. A total of 55 repurchases (by 47 companies)
carried out over the period under review were examined. Four companies engaged in
more than one repurchase during the period under review. 19 companies gave more than
one reason for a repurchase. The reasons were arranged into 29 categories in order of
frequency (see Table 2). Some license was taken in placing repurchases in a particular
category, due to the reasons in some cases having been imprecisely or apparently
incompletely stated in the circulars. The similarities and differences between SA
practice and the established theory were compared using the pattern of behaviour
analysis approach (Yin, 1989; Eisenhardt, 1989) which enabled patterns to be identified.
RESEARCH RESULTS
This section presents the results of the study undertaken to establish the reasons given
by SA corporates for share repurchases. Table 2 below gives a summary of the reported
reasons for share buy-backs in SA. It is interesting to note that the most frequently
stated reasons are (i) administrative (sweeping up odd-lots of shares - 14%) and (ii)
enhancing shareholder value (to increase earnings per share - 13% and net asset value
per share - 10%). It is also noted that the frequency with which the majority of the
reasons under categories such as dividend policy and executive compensation appear in
the circulars is very low.
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SA Journal of Accounting Research Vol. 23 : No. 1 : 2009
Table 2: Reasons supplied by South African listed companies for specific share
repurchases conducted 1999 – 2004, in order of frequency
No.
Reason
SA1
Sweeping up odd-lots of shares
14%
SA2
Enhance the company's earnings per share
13%
SA3
Enhance the company's net asset value per share
10%
SA4
Create, maximise or enhance value for shareholders
6%
SA5
Distribute/deploy current cash resources effectively/More efficient utilisation of cash
5%
SA6
Enable or facilitate exit of disinvesting shareholder
5%
SA7
Increase return on shareholders' equity
4%
SA8
Shares held by share incentive trust surplus to requirements
4%
SA9
Disposal of shares held by share incentive trust to comply with JSE requirements
3%
SA10
Facilitate, or in anticipation of, winding up
2%
SA11
Facilitate introduction of BEE (Black Economic Empowerment) participant
2%
SA12
Remove uncertainty regarding shareholder's continued participation in company
2%
SA13
Termination of strategic alliance
2%
SA14
Settlement of claim against shareholder
2%
SA15
Capitalise on opportunity presented by shareholder's disposal of interest
1%
SA16
Reduce cost of capital
1%
SA17
Reduce discount at which shares are trading
1%
SA18
Comply with undertaking to underpin value of shares
1%
SA19
Take advantage of low share price
1%
SA20
Stabilise share price
1%
SA21
Resolve a dispute between company and shareholder
1%
SA22
Unlock value for departing shareholders
1%
SA23
Repurchase in best interest of company and shareholders
1%
SA24
Eliminate N shares
1%
SA25
Shares trading at a discount
1%
SA26
Termination of share incentive scheme due to value of shares being lower than purchase price
1%
SA27
Eliminate cross-holding
1%
SA28
Facilitate a clearer focus on the company's growth strategy
1%
SA29
Other / no reason given
TOTAL
% of total
reasons
(rounded)
10%
100%
In order to get a clear picture of the main reasons for share repurchases in SA, the
results presented in Table 2 were further summarised into the five broad categories (see
Table 3) identified in the literature review, to facilitate the identification of the major
broad objectives of share repurchases. Overall, enhancing shareholder value, change of
shareholding and control, and administrative reasons appear to be the three most
important motivators for share repurchases in SA.
R Chivaka, A Siddle, L Bayne, C Cairney & J Shev
15
Table 3: A summary of the 29 SA reasons into the categories established in the
literature review
% of total
reasons
SA Main Reasons Categories
An element
Enhancement
of dividend
of share
policy
value
5%
40%
Change of
shareholding
& control
Administrative
reasons
Compensation
related reasons
Other
15%
20%
8%
10%
COMPARISON OF SA REASONS TO THEORY
General overview
The reasons presented above are compared with the reasons given in literature. In order
to facilitate this comparison, the detailed summary of the SA results is superimposed on
the theoretical results identified in the literature review under the five categories
established in the literature review as summarised in Table 4. The first objective of this
comparison is to identify the similarities and differences between established theory and
SA practice. Analysis of the similarities and differences identified is then done in order
to generate insights that assist in bridging the gap between theory and practice. Further
cross-category analysis is undertaken in order to identify any trends or inconsistencies
that may exist.
Note that “9” represents the presence of a reason, either under theory or practice, while
“x” represents a situation where a reason is not represented in theory or practise (as the
case may be). From Table 4 it is clear that many of the reasons for share repurchases, as
presented by the finance theory, clearly manifest as part of the SA practice regarding
the motivation for share buy-backs. It is also equally evident that there are numerous
SA reasons that do not find direct correlation to the theory. The differences and
similarities are discussed in detail under section 5.2 below.
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SA Journal of Accounting Research Vol. 23 : No. 1 : 2009
Table 4: A comparison of the stated reasons for specific repurchases in South
Africa for the period 1999 – 2004, to the established finance theory
Category
As an element
of dividend
policy
Theoretical reasons
9 Distribution of surplus assets
Enhancement of
Shareholder
Value
9
Dividend substitution for tax
purposes
Repurchase a “good investment”
9
Signalling Hypothesis
x
9
Capital structure adjustments
9
SA16: Reduce cost of capital
9
To support the market for the
company’s shares
9
9
9
SA17: Reduce discount at which shares are trading
SA20: Stabilise share price
SA25: Shares trading at a discount
x
9
SA2: Enhance the company's earnings per share
x
9
SA3: Enhance the company's net asset value per
share
x
9
SA4: Create, maximise, enhance value for
shareholders
x
9
SA7: Increase return on shareholders' equity
x
9
SA23: Repurchase in best interest of company &
shareholders
x
9
SA28: Facilitate a clearer focus on the company's
growth strategy
Change
of
shareholding &
control
9
9
9
Comparable SA reasons
9 SA5: Distribute/deploy current cash resources
effectively/ more efficient utilisation of cash
x
9
Attracting external investors /
Transferability
x
Exit for existing shareholders
9
9
9
9
9
9
Buying out dissident shareholders
9
9
Repurchase to avoid a takeover
x
9
Management buyouts & going
private
x
9
To avoid/reduce dilution in
shareholding:
ƒ
acquisition programmes
ƒ
share plans
SA19: Take advantage of low share price
SA6: Enable or facilitate exit of disinvesting
shareholder
SA12: Remove uncertainty regarding shareholder's
continued participation in company
SA18: Comply with undertaking to underpin value of
shares
SA22: Unlock value for departing shareholders
SA15: Capitalise on opportunity presented by
shareholder's disposal of interest
SA21: Resolve a dispute between company and
shareholder
x
x
x
9
SA11: Facilitate introduction of BEE (Black
Economic Empowerment) participant
x
9
SA13: Termination of strategic alliance
R Chivaka, A Siddle, L Bayne, C Cairney & J Shev
17
Category
Administrative
reasons
Compensation
related reasons
9
Theoretical reasons
Elimination of odd-lots
Comparable SA reasons
9 SA1: Sweeping up odd-lots of shares
9
Repurchase of redeemable shares
x
x
9
SA10: Facilitate, or in anticipation of, winding up
x
9
SA24: Repurchase of N shares
x
9
SA27: Eliminate cross holding
9
9
SA14: Settlement of claim against shareholder
SA8: Shares held by share incentive trust surplus to
requirements
SA9: Disposal of shares held by share incentive
trust to comply with JSE requirements
SA26: Termination of share incentive scheme due to
value of shares being lower than purchase price
x
9
Employee share schemes
9
9
9
Management compensation
x
Detailed analysis
As an element of dividend policy
Distributing surplus cash resources was the only indication provided by SA directors
that share repurchases are considered as part of a company’s dividend policy. However,
as discussed previously in the literature review, although returning cash to shareholders
in the absence of suitable investment projects follows a sound financial principle, a
special dividend could be used for exactly the same purpose. This reason does not
explain why a share repurchase was the preferred mechanism to return cash to
shareholders, nor why a share repurchase was included in the firm’s dividend policy in
this regard.
Conversely, tax efficiencies, which are one of the most prominent reasons for preferring
share repurchases as a mechanism to return cash to shareholders in the USA was not
acknowledged as a reason for share buy-backs in SA. There are two possible
explanations for this omission: (i) that this reason may have limited relevance in the SA
context, as tax efficiencies are dependent on the regulatory environment, which differs
between countries and jurisdictions, and (ii) that the share repurchase reasons provided
in SA have been sourced from public circulars and as such directors may not desire to
make a public statement in this regard.
Firstly, it is possible that the opportunities for tax planning are more limited in SA.
Cash returned via a share buy-back is generally deemed to be a dividend for tax
purposes under SA legislation and would consequently be subject to STC, in a similar
manner to a dividend. However, potential exists for a company to avoid STC in SA if
the company repurchases its shares by utilising its share premium account or if the share
buy-back is structured so that the subsidiary company repurchases the holding
company’s shares (Correia et al., 2007). Generally speaking, where these two
exceptions do not apply, share buy-backs could not be carried out for reasons of tax
efficiencies.
However, it should be noted that, SA companies are required to obtain the approval of
the SARS Commissioner prior to making any payment for a share buy-back if the
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SA Journal of Accounting Research Vol. 23 : No. 1 : 2009
consideration constitutes a dividend. Consequently, in situations where tax efficiency
may exist, the company’s directors are unlikely to have stated tax efficiencies as a
reason for the share buy-back. In addition, potential tax efficiencies arise for
shareholders where capital gains and dividends are taxed at different rates (Correia et
al., 2007). Several of the SA repurchases included in this study occurred prior to the
introduction of capital gains tax on 1 October 2001, and would therefore not have
considered capital gains tax as a reason for the share buy-backs.
In conclusion, SA directors recognise the factual reason established in the theory that
share repurchases are used to distribute surplus cash resources. However, there is no
evidence of these directors reporting the more contentious reason relating to tax
efficiencies, which features prominently in the theory. The similarities and differences
in the reasons relating to the enhancement of shareholder value are discussed next.
Enhancement of shareholder value
It is evident from Table 3 that the sentiment that is communicated most strongly by
directors is that the share repurchase will result in an enhancement of value for
shareholders. It has already been noted that finance theory identifies both legitimate
causal links between share repurchases and shareholder value, as well as mechanisms
whereby the link to shareholder value is more tenuous, or even non-existent. The
variety of reasons put forward by SA company directors not only encompasses almost
all of the reasons envisaged by the theory, but also goes beyond these. In some
instances directors merely state the intention to enhance shareholder wealth, without
providing any indication of how or why this is to be achieved. Since the enhancement of
shareholder wealth would be a matter of some importance to shareholders, a more
weighty consideration of this category is warranted.
Firstly, it must be emphasised that the causal relationship, identified by finance theory,
between a share repurchase and an increase in shareholder value is determined by the
relationship between the price at which shares are repurchased and the intrinsic value of
those shares. A transfer of wealth from shareholders that sell to those that do not occurs
where shares are repurchased at amounts that are lower than their intrinsic values. On
no occasion is “repurchasing shares at less than the value of the shares” stated by the
SA directors as the mechanism by which they anticipate that a share repurchase will
increase shareholder value for the remaining shareholders. This is understandable
because such a statement may result in the number of shareholders willing to sell their
shares decreasing significantly, which would reduce the likelihood that the company
would be able to repurchase the planned quantity of shares at the intended price.
However, while no direct statement is made in this regard it may be that a number of the
more vague sentiments expressed by directors are intended to convey this message,
without dissuading those shareholders that otherwise would have sold their shares. The
reason that a repurchase is to “take advantage of low share prices” may certainly be the
most overt reflection of the intention to repurchase shares below their intrinsic value for
the benefit of the remaining shareholders.
Secondly, finance theory considers the potential for a share repurchase to increase the
market price for the company’s shares, although uncertainty exists as to the permanence
of this improvement in price. Signalling was the dominant reason cited in the literature
for share buy-backs in both the USA (Maxwell & Stephens, 2003; Baker et al., 2003),
and Australia, (Mitchell & Robinson, 1999). 36% of respondents to a survey carried out
R Chivaka, A Siddle, L Bayne, C Cairney & J Shev
19
by Mitchell & Robinson (1999) revealed signalling an under-pricing of the company’s
shares as the most frequently cited reason for share buy-backs. Evidence of signalling in
the context of South Africa was first presented by Gordon (2001) and Bhana (2007).
While in our study the SA reasons do not explicitly cite signalling, the circumstances
referred to in reasons SA17, SA20 and SA25 (Table 2) may be similar to signalling.
However, the SA reasons may be referring to a specific situation, such as where the
problem with pricing has arisen from the company’s shares being thinly traded, rather
than the intention to signal a more general under-pricing of the those shares. When
considering the type of share repurchases included in this study – specific share
repurchases - it would be surprising if the companies’ directors did not intend for the
share repurchases to have some sort of signalling effect to the market. Fixed-tender
price repurchases in the USA are the rough counterpart of SA specific share
repurchases. Of the three kinds of share repurchases that exist in the USA, Comment
and Jarrell (1991) note that the fixed tender method was the most effective of the three
as regards signalling an under-pricing of the shares to the market. It would therefore be
reasonable to expect that in SA one of the reasons underlying a specific repurchase is
likely to be, in at least some instances, a signal of under-pricing. This is especially so
where there are no obvious grounds for a share repurchase to be specific rather than
general. An example of reasonable grounds for the choice of a specific share
repurchase, in preference to a general repurchase, would be where a specific
shareholder (or group thereof) is to be bought out or for sweeping up odd-lots of shares.
It is unlikely that managers would make a public announcement that the intention
behind a share repurchase was to signal an under-pricing of the share, and that the
objective of the share repurchase was to bring about an increase in the share price. Such
an announcement would be counter-productive, as the share repurchase may
consequently be viewed with some scepticism by the market. USA research indicates
that the market responds more strongly to share repurchases in circumstances that are
not indicative of market manipulation (Comment & Jarrell, 1991).
Finally, more than 25% of the reasons stated by SA directors for a share repurchase
include the enhancement of financial accounting measures, with specific reference to
earning per share (EPS), net asset value (NAV) per share, and return on equity (ROE).
This is surprising, as this is not reflective of finance theory. These financial measures
are discussed below, with the enhancement of EPS and NAV per share being discussed
together as these two accounting measures are closely related. The effect on ROE is the
net result of the change in these measures.
The share repurchase would influence EPS and NAV per share as follows:
ƒ
The effect on EPS of a share buy-back is usually to increase EPS due to the
reduction of the number of shares in issue.
ƒ
However, the effect of the share repurchase on the company’s NAV per share
could be either positive or negative, depending on whether the price of the
repurchase was above or below the NAV per share. When a repurchase occurs,
both the net assets and number of shares is reduced. If the repurchase price is
below the NAV per share, then indeed the NAV per share will be enhanced.
However, the opposite is true if the price paid is above the NAV per share.
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SA Journal of Accounting Research Vol. 23 : No. 1 : 2009
It is interesting to note that the frequency of this reason is very similar to that of the
results of a survey undertaken in Australia in 1999 (Mitchell & Robinson, 1999). In that
survey, the motivation “to achieve an increase in EPS and/or NAV” was the second
most frequently cited reason for carrying out a share buy-back, and accounted for 24%
of the total number of reasons given. The frequency of the reason to improve EPS
(13%), and improve NAV per share (10%) in SA totals 23% which is very similar to the
combined result of the Australian study. While the Australian survey was carried out
some years ago, it should be noted that share repurchases in Australia were permitted
ten years before these were permitted in SA. Thus, a ten year history of share
repurchases would have existed at the time of the Australian study, while the SA study
records the first five years of SA’s history of share repurchases. Yet, the percentages are
similar, perhaps indicating the expectation that roughly 25% of share repurchases will,
at least partially, continue to be conducted in SA for the reason of enhancing these
accounting measures.
While a positive effect may be experienced in EPS (and potentially NAV per share),
this does not directly translate into a positive change on the value for the remaining
shareholders. The impact on shareholder wealth is determined by the amount at which
the share is repurchased, relative to the intrinsic value of the share. The potential of a
share repurchase to cause a transfer of wealth between shareholders that sell, and those
that do not, has already been discussed earlier in this study. The direction of the transfer
of wealth is dependent on whether the shares are purchased at a premium or discount to
the intrinsic value (not necessarily market price, as this may be understated) of the
company’s share.
Finance theory does not however present an increase in EPS or an increase in NAV per
share as a reason for a company to repurchase its own shares. The effect on the
accounting measures is noted by the finance theory – but these are presented as the
effect of a share repurchase, not a motivation for a share repurchase. The question must
then be raised as to why in both SA and Australia, the improvement in these two
accounting measures accounted for about 25% of the reasons for share repurchases.
Mitchell and Robinson (1999) comment that an improvement in EPS by a share buyback has the potential to boost perceived profitability, at least in the short term
(emphasis added). The message communicated by directors to their shareholders could
be interpreted as an increase in share value for the remaining shareholders after the
repurchase, due to the increase in EPS. It is important for shareholders to recognise that
while there may be an increase in EPS, this does not automatically result in an increase
in value for the remaining shareholders, and due consideration must be given to the
justification of the purchase consideration.
In summary, the majority of the reasons cited by SA directors relate to the enhancement
of shareholder value. Some of the theoretical reasons are supported by practice in SA.
These reasons include repurchase as a “good investment”, capital structure adjustments,
and supporting the market for the company’s shares. The signalling hypothesis, which
was the most dominant reason cited in some countries, is not mentioned in SA practice.
Stating this as the reason for a share buy-back may be viewed as being controversial
due to the potential for market manipulation. Several reasons relating to the
enhancement of financial accounting measures are given by directors for share buybacks in SA and have no matching counterpart in finance theory. However, these are
included in the theory as effects of, rather than reasons for, share repurchases.
R Chivaka, A Siddle, L Bayne, C Cairney & J Shev
21
Change of shareholding and control
The strongest relationship between SA practice and finance theory in this category
exists in relation to exit for existing shareholders as a reason for share buy-backs. The
theoretical reason for buying out dissident shareholders is also supported by SA
practice. However, the reasons such as attracting external investors, transferability,
repurchase to avoid takeover, management buyouts, going private, and the avoidance of
dilution in shareholding found in literature have no counterparts in SA practice. This is
understandable and may be explained by both SA’s desire to attract foreign investment
and M&A activity in SA. Allowing share buy-backs in order to improve the
attractiveness of the SA market to foreign investors may have been a motivation behind
the SA government’s decision to allow share repurchases. However, it should be noted
that attracting external investors is a reason for the permissibility of share repurchases,
not a reason for a company to carry out a share repurchase. Trade in the shares of
smaller companies may indeed be low, and it is possible that in order to attract foreign
investment, the ability of a company to repurchase those shares may be an attraction to
a foreign investor.
SA’s M&A activity tends to follow global trends. M&A activity decreased substantially
from 2001 to 2002 both globally (by approximately 28%) and in SA (by approximately
50%) (Ernst & Young, 2006). Although domestic transactions in SA increased during
this period, the decline in offshore transactions more than offset this increase. M&A
activity continued to decline in 2003 and improved marginally in 2004 (Ernst & Young,
2006). The decline in M&A activity during the period reviewed may justify why
directors did not disclose this as a reason.
The SA reason of terminating strategic alliances is not directly associated with any of
the theoretical reasons. This reason may be relevant where a company acquired the
shares of another company in anticipation of benefiting from synergies created by the
acquisition. Where the expected synergies fail to materialise, the shares would be
repurchased by the second company.
A reason for share repurchases given in SA practice, but which is absent from finance
theory is the facilitation of the introduction of a Black Economic Empowerment (BEE)
partner. The issue of equity to a BEE partner usually occurs at a discount to the market
value of the share in order to be attractive to the BEE partner. A very small percentage
of the reasons for effecting a share repurchase (2%) relate to BEE. This could be
interpreted to mean that companies do not view dilution in shareholder control and
value to be an issue. This is unlikely, firstly given the significant discounts at which
BEE transactions occur, for example 30% in the case of Angloplat (Wray, 2007).
Secondly, given the minimum holding of 25% in order to achieve BEE compliance as
per the recently updated Codes of Good Practice (Department of Trade and Industry,
2007), the dilution in shareholder control is significant. An increase in shares of at least
25% (in total, not necessarily in one issue), coupled with a significant discount to
market prices, would be likely to have a dilutive effect on shareholder control and
value, particularly that of controlling shareholders.
A more likely explanation for the low frequency of BEE transactions as a reason for
share buy-backs relates to the time of the study. The study covers the period 1999 –
2004 and the legislative framework for Broad Based Black Economic Empowerment
(BBBEE) Act was only promulgated in 2004. In addition, although the initial version of
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SA Journal of Accounting Research Vol. 23 : No. 1 : 2009
the BBBEE Codes of Good Practice and generic scorecard were introduced shortly
thereafter, these were only finalised and gazetted on 9 February 2007. Thus, at the time
of this study, the criteria for determining what constituted equity ownership and control
for the purposes of BEE compliance was certainly new to the market, and companies
would have been unwilling to enter into significant equity transactions, without clarity
as to the requirements of the codes (Financial Mail, 2007). In instances where
companies had granted share options, those share options would only be exercisable at
some future point, certainly not within the time of the study (e.g. ABSA’s share options
were issued in 2004, and exercisable from 2006 – 2008, inclusive).
It is anticipated that given the trend in the USA, the repurchase of shares for the purpose
of reducing the dilutive effect of equity issues pursuant to BBBEE equity issues has the
potential to become one of the more prominent reasons for share repurchases in SA.
From an administrative perspective there are advantages to repurchasing the shares that
are to be transferred to a BBBEE partner through a subsidiary company. Not only will
such a purchase avoid the payment of STC, but the need to re-issue the shares, or
authorise and issue new share capital, will be avoided.
While there are reasons that show strong correlation in relation to the change of
shareholding and control, there are also a number of differences between the theory and
practice in SA. Nevertheless, all of these differences appear to be relatively factual
reasons, which raise no contention. The differences and similarities in the
administrative reasons are discussed next.
Administrative reasons
The most frequently cited reason for specific repurchases in SA was for the sweeping
up of odd-lots. In the past, odd-lots were expensive and inconvenient for companies to
administer. Prior to repurchases being permitted in SA, a company could only deal with
odd-lots by matching would-be sellers to would-be purchasers. However, with shares
being fully dematerialised and electronically traded on the JSE by 2002, the sale of oddlots would no longer pose an administrative problem as the JSE provides a mechanism
for the purchase and sale of odd-lots at the ruling market price (Correia et al., 2007).
Consequently, there is no longer a need for companies to match buyers and sellers, and
share repurchases are not expected to be carried out for this reason in the future.
The other administrative reasons in SA practice, namely to facilitate winding up,
eliminate N shares, eliminate cross-holding, and settlement of claim against
shareholder, have no direct equivalents in the theory, and vice versa. It is not clear why
these reasons seem to be specific to SA and as such, it can only be concluded that they
are a function of the country’s operating environment. Although the sweeping up of
odd-lots of shares was the most frequently cited reason in SA, and it is also evident in
finance theory, alternative mechanisms for eliminating odd-lots are now available.
Consequently, this may be eliminated from practice and in turn have an impact on
finance theory in the future.
Compensation related reasons
Share repurchases occur both in theory and in SA practice for the purpose of employee
share schemes. The regulatory environment in SA is one of the causes of repurchases
being carried out for compensation purposes. The JSE Listings Requirements (JSE,
R Chivaka, A Siddle, L Bayne, C Cairney & J Shev
23
2003) provide that a share trust must dispose of any shares for which binding
unconditional agreements do not exist between participants and the trustees for
participants to acquire these shares from the share trust. This circumstance might occur
when a share trust acquires shares for onward transfer to employees, but there is
insufficient demand for such shares.
A noteworthy omission arises from the relationship between share repurchases and
management compensation. It is unlikely that a company’s management would wish to
draw public attention to any personal interest that they may have in a share repurchase
decision. This is the only compensation related difference between the theory and SA
practice. In section 6 below, we now discuss the key research insights and present the
main contributions of this paper.
RESEARCH INSIGHTS AND CONTRIBUTION OF PAPER
Based on the comparison of the SA reasons to finance theory, it is clear that a strong
relationship exists between theory and practice. From Table 3, it is evident that the
reasons aimed at creating shareholder value constitute the majority (40%) of the reasons
cited as influencing share repurchases. This finding is in line with what would be
expected as managers are expected to create, or at least be seen to be creating,
shareholder value. It is also notable that 27% of the reasons supporting the
enhancement of shareholder value relate to improving EPS (13%), NAV per share
(10%) and ROE (4%). Reasons relating to a change of shareholding and control, and
administrative reasons are also relatively prominent in SA practice, being reported by
directors in 15% and 20% of cases, respectively.
Although a strong relationship exists between the theoretical reasons and practice in
SA, what is interesting is that there is a significant difference in some of the key reasons
under the enhancement of shareholder value. A further analysis of the phenomenon
reveals that for all factual (non-contentious) reasons, theory is in line with practice.
However, for all the potentially contentious issues, it is observed that a significant
difference exists between the theoretical reasons and the SA practice. Contention
appears to arise where the reasons for share buy-backs potentially affect the interests of
multiple stakeholders, resulting in a possible misalignment between the various
stakeholders’ interests. For example, the two most prominent reasons for share
repurchases found in the finance literature, being (i) the signalling mechanism of an
under-valuation of the company’s equity and (ii) the potential tax efficiency of a share
repurchase, are conspicuously absent from the reasons stated in the circulars by SA
directors.
The signalling of the under-pricing of a company’s shares may result in a misalignment
of the interests of the selling and remaining shareholders, as directors state such a
reason in anticipation of an increase in shareholder value for the remaining
shareholders. Thus, value would be transferred from the selling shareholders to the
remaining shareholders. Where the directors of a company are also shareholders of the
company, this would have the further implication of a misalignment between the
interests of the directors and shareholders. Agency theory suggests that managers are
imperfect agents (Easterbrook, 1984) and as such, the relationship between management
and shareholders may be fraught with conflicting interests (Jensen, 1986). This is
particularly important in a situation where both the agent (managers) and principal
(shareholders) are utility maximisers, thus creating an environment in which the agent
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SA Journal of Accounting Research Vol. 23 : No. 1 : 2009
may not always act in the best interests of the principal (Jensen & Meckling, 1976).
Where management has a significant number of share options outstanding, or where
management intends selling shares (hence an agent interested in utility maximisation),
the impact of the share repurchase on the share price, and consequently the value
derived by managers may be relevant. It is unlikely that a company’s management
would draw public attention to the interest they may personally have in the share
repurchase decision.
Tax efficiency may not be stated by SA directors as a reason for a share repurchase due
to the misalignment of the interests of SARS and the shareholders or directors of the
company. A company or shareholder generally has the desire to pay as little tax as
possible within the constraints of tax law, whereas SARS wishes to collect as much tax
as possible within these limitations. By publicly stating the reason for a share
repurchase as tax efficiency, companies may prompt SARS to investigate the treatment
of repurchases by both the company and the respective shareholders for tax purposes.
Another contentious reason for share repurchases, where SA practice fails to support
finance theory, is around management compensation. The repurchase of shares for
management compensation purposes may result in a misalignment between directors’
and shareholders’ interests. Agency theory, as discussed above in relation to the
signalling of an under-valuation of shares, explains why the directors may be loathe to
report management compensation as a reason for share buy-backs. This point is
particularly important given the increasing public interest in executive compensation.
Compensation policy is one of the influential factors in an organisation’s success as it
impacts on the behaviour of executives, but also on the kind of executives an
organisation can attract (Jensen & Murphy, 1990). Due to the significance of
compensation policies and the concomitant public interest, pressure on directors to
create more visibility of management compensation packages has increased. While this
greater transparency serves to protect shareholder interests, it may have the unintended
consequence of making management more reluctant to be seen to be rewarding
themselves with highly visible substantial financial gains (Jensen & Murphy, 1990).
There are some differences between finance theory and practice in SA, which are not
considered to be contentious. For example, share buy-backs may be carried out to
attract external investors or to improve the transferability of shares of small companies.
Repurchases for the purposes of avoiding a takeover, management buyouts and going
private do not seem to be considered to be contentious. A number of differences exist
between the administrative reasons given in SA practice and finance theory. However,
the administrative reasons given in both theory and practice seem to be in the same
spirit and these differences are expected.
A further area of particular interest relates to the enhancement of shareholder value.
Directors in SA state the enhancement of EPS, NAV per share and ROE as reasons for
share repurchases. However, the theory fails to include these as reasons for repurchases
and rather cites them as effects of repurchases. EPS, NAV and ROE are all accounting
measures. SA directors are offering these measures as reasons relevant to the decision to
repurchase shares rather than simply for information purposes. Shareholders perceive
share repurchases for the purpose of enhancing EPS, NAV per share and ROE as being
in their best interests. However, these measures may obscure the transfer of value from
the selling shareholders to the remaining shareholders (some of whom may be directors)
and potentially misalign the interests of these shareholders.
R Chivaka, A Siddle, L Bayne, C Cairney & J Shev
25
The contribution of this paper is twofold; (i) it creates visibility of the reasons that
motivate SA corporates to repurchase their shares and (ii) it highlights the potential
conflicts that exist between the interests of shareholders and management that
potentially impact on management’s disclosure of motives for share repurchases. Thus
the paper contributes to knowledge by creating visibility of the reasons that influence
share repurchases in the SA context. By being the first detailed study of share
repurchases in SA, this research provides knowledge of the local situation in the country
with regard to share repurchases. In addition, by conducting a comparative analysis, this
research gives a picture of how the local practices measure up against practices in other
countries as well as finance theory. This research therefore contributes to the bridging
of the gap between theory and practice by highlighting some of the potential tensions
that exist between management and stakeholders in SA which have the effect of
precluding management from actually citing the reasons given in theory. Also, the
research reveals that the facilitation of the introduction of a BEE partner appears to be
sufficiently unique to represent a truly “South African” reason to engage in share
repurchases and contributes to the finance theory on share buy-backs. While
repurchasing shares for BEE partnership purposes was not frequently reported as a
reason for repurchases under the period of review, due to the changes in the regulatory
environment relating to BEE transactions, this is likely to be a prominent reason in the
future.
CONCLUSION AND AREAS FOR FURTHER RESEARCH
Conclusion
The primary objectives of this paper were to create visibility of the main reasons
underpinning share repurchases in SA, and to contribute to the narrowing of the gap
between theory and practice. In order to address these objectives, the research applied
an archival analysis approach to gather relevant share repurchase data. The results of the
empirical analysis of SA data reveal a strong relationship between finance theory and
practice. The results show the reasons that feature prominently in practice such as the
enhancement of shareholder value, changes in shareholding and control and
administrative issues being frequently reported to shareholders for repurchase decisions
by SA directors. The conclusion that can be made here is that, for all factual (noncontentious) reasons, the theoretical reasons are in line with practice. The results of this
research also revealed that significant differences exist between some of the key reasons
relating to the enhancement of shareholder value, compensation related reasons and
repurchases as an element of dividend policy, as presented in finance theory and SA
practice. The conclusion that can be made here is that, for all the potentially contentious
issues, where there is possible misalignment between management interests and
stakeholder interests, a significant difference exists between the theoretical reasons and
the SA practice, although the underlying reasons (which are not overtly stated) may
well be in line with theory.
Also, a significant proportion of the SA reasons categorised under the enhancement of
shareholder value relate to accounting measures such as EPS, NAV per share and ROE.
This is a major departure from finance theory, highlighting an area where the SA
practice seems to be driven by management’s desire to focus on reasons that are
perceived by shareholders as capable of boosting profitability. Finally, the changing
economic, financial and regulatory conditions in SA are likely to influence the reasons
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SA Journal of Accounting Research Vol. 23 : No. 1 : 2009
given for share repurchases over time. For example, the individual reason most
frequently stated for share repurchases in SA was the sweeping up of odd-lots of shares,
which is an administrative reason. However, due to the dematerialisation of shares and
the handling of odd-lots by the JSE, this is not likely to be a reason for share
repurchases given in future.
Areas for further research
Share repurchases in SA have not been researched extensively and potential exists for
further research in this area. Possible future research could undertake in-depth
investigation into tax efficiency, signalling, management compensation and accounting
measures given as reasons for share repurchases. Tax efficiency was not stated as a
reason for returning cash via a share repurchase. Three potential reasons identified in
this regard require further research, covering issues such as; (i) the extent to which
share repurchases are carried out through subsidiaries or from share premium (i.e. this
would indicate the potential extent of share repurchases carried out for reasons of tax
efficiency), (ii) the use of a different research method, offering directors confidentiality,
could be used in order to identify the prominence of tax efficiency in the minds of the
directors in the absence of any publicity constraints, and (iii) the effect of the
introduction of CGT on the level of share repurchases.
Future research could also delve into the signalling of under-pricing of a company’s
shares since this was not stated as a reason for share repurchases by directors in SA. In
this regard, research may be performed to determine; (i) the extent to which share
repurchases are carried out for the purpose of signalling in SA, and (ii) how effective
signalling is in achieving shareholder value creation. With respect to management
compensation, an investigation could be conducted into the effect of share repurchases,
and the correlation between share repurchases and the volumes of share options
exercised/exercisable. Using the agency theory as a framework for example, further
research could investigate why SA directors provide improvement in accounting
measures as a reason for a share buy-back. Finally, future research could also explore:
issues around the theoretical reasons not stated by directors in SA to determine whether
these reasons are relevant to SA and any motivations for these omissions; detailed study
of the circulars for general repurchases to glean any reasons motivating such share buy
backs; a comparative study with a similar market such as Australia; an in-depth study
on the beneficiaries of share repurchases, taking into consideration the effects on both
shareholders who exit and the remaining shareholders; a study into the effects of SA
share repurchases on the cost of capital; and the reasons for the purchase of treasury
shares, in order to obtain an understanding of the tendency of subsidiary companies to
purchase shares in their holding companies.
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