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2023 Feb/23
Motivation and Long-term Performance of Acquisition and Resale of Treasury Shares
Research Papers 23-06
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- Research Topic Capital Markets
- Page 75
- Summary
- Acquisition and disposal of treasury stocks were permitted through revisions to the Securities and Exchange Act in the 1990s, and the listed companies have been actively utilizing treasury stocks. According to the undervaluation hypothesis, the acquisition of treasury stocks is used as a means to inform the market when a company's stock price is undervalued compared to its real value. More than 90% of the acquisition purpose reported in public disclosure was stock price stabilization and shareholder returns.
Outside investors, however, cannot easily evaluate the intrinsic value of a company. There is a possibility that the acquisition of treasury stocks could be used as a false signal. Taking advantage of information asymmetry between insiders and investors, companies may opportunistically use disclosure of treasury stocks. The disclosures can be used for boosting short-term stock price or for the private benefit of corporate insiders.
In addition, regulations on the acquisition and disposal of treasury stocks in Korea differ from those in overseas markets. In most countries, treasury stocks are immediately retired after the acquisition, or disposal is regarded as equivalent to issuing new stocks. On the other hand, domestic regulations are relatively flexible, allowing companies to dispose of the acquired treasury stocks at its discretion. Not only by acquiring treasury stocks directly in the open market, companies can also acquire treasury stocks indirectly through trusts or treasury stock funds, which is a unique method difficult to find in other countries. The indirect acquisition has weaker regulatory constraints compared to direct acquisition in various aspects, such as a longer acquisition period, no compulsion to acquire the entire amount of trust contracts, and permission to dispose of treasury stocks during the trust contract period, making it difficult to assert shareholder return effects.
This paper comprehensively examines on the acquisition and disposal of treasury stocks by domestic listed companies. Using public disclosure data on the acquisition and disposal of treasury stocks from January 2015 to May 2022, empirical analyses are conducted on the real motivation and long-term effects of the acquisition and disposal of treasury stocks.
The results of the empirical analyses are summarized as follows. First, the disclosure itself does not provide sufficient information to determine whether a company is actually undervalued. Regardless of the type of disclosure, stock prices rose significantly after the announcement. On average, however, insiders sold their company stocks prior to the disclosure, and the share of insiders decreased. the trading pattern of insiders is contrary to the prediction of corporate undervaluation, making it impossible for outside investors to distinguish between genuine undervaluation signals and false ones.
Second, repurchase announcements are subject to insider opportunism in cases when insiders sell their shares before repurchase disclosures. The sale of insiders continues even after the announcements. This suggests that insiders do not personally believe that the firm is undervalued, and maintain their thoughts even after the announcement., resulting in the continued sales of shares. Therefore, if insiders sell their holdings even though the company has announced the acquisition of treasury stocks, it is highly likely to be a false signal.
Third, in case of indirect acquisition, it is difficult to regard it as reliable information even if the insider's share increases. Insiders do not sell their stocks after the announcement, whereas in the case of indirect acquisition, they sold a significant amount of their holdings after the share price rose sharply due to the announcement of the acquisition of treasury stocks. Insiders of a company that chooses indirect acquisition may use the flexibility of the indirect acquisition system to induce a rise in stock prices through public disclosure and to pursue private interests by selling individual shares.
Fourth, the disposal of treasury stock is freely used for various purposes such as employee performance compensation and financial structure improvement. In most cases, it has been shown to have a positive effect on stock prices. Depending on the insider's stake, some long-term performance is different, so it is judged that it can be used as a complementary method to judge the effect of disclosure.
According to the above analysis results, there is a possibility that the acquisition of treasury stocks by domestic listed companies is a false signal, unlike the company's disclosure purpose. The background of the disclosure of the acquisition of treasury stocks is questionable because insiders who influence decision-making show a different transaction behavior from the disclosure. If companies use their treasury stocks for opportunistic purposes, the credibility of the company and the market will inevitably be damaged.
Therefore, it is necessary to comprehensively review and prepare countermeasures against private profit-seeking behavior by insiders. In addition, it is necessary to actively consider improving the indirect acquisition of treasury stocks, a system difficult to find overseas. Indirect acquisitions are subject to more flexible regulations than direct acquisitions, making it difficult to determine the effectiveness of disclosures, and are highly likely to be used as false signals. More fundamentally, it is necessary to discuss the validity of the current legal interpretation of treasury stock. Although treasury stocks are not recognized as assets from an economic point of view, they take a contradictory attitude that does not clearly deny their asset properties legally. As a result, the disposal of treasury stocks occurs freely for various purposes, and there are cases where controlling shareholders abuse their treasury stocks for personal gain. It is necessary to supplement the treasury stock regulation system so that it can play a role as a shareholder return method through fundamental improvement and regulation revision.