Precautionary versus Signalling Motive of Share Repurchases: Evidence from Policy Uncertainty and the COVID‐19 Crisis
| Published date | 01 October 2023 |
| Author | Zhong Chen,Zicheng Lei,Chunling Xia |
| Date | 01 October 2023 |
| DOI | http://doi.org/10.1111/1467-8551.12668 |
British Journal of Management, Vol. 34, 1750–1773 (2023)
DOI: 10.1111/1467-8551.12668
Precautionary versus Signalling Motive of
Share Repurchases: Evidence from Policy
Uncertainty and the COVID-19 Crisis
Zhong Chen,1Zicheng Lei1and Chunling Xia2
1King’s Business School, King’s College London, London, WC2B 4BG, UK 2School of Business and
Management, Queen Mary University of London, London, E1 4NS, UK
Corresponding author email: zicheng.lei@kcl.ac.uk
Using policy-related uncertainty as a shock to rms’ internal and external nancing fric-
tions, we nd signicantly lowerrepurchase likelihoods, short-term market reactions, and
post-announcement completion rates of open market share repurchases during periods of
high policy uncertainty.Firms are more likely to switch from a high- to a low-commitment
repurchase technique when policy uncertainty is high. In contrast, for rms that are sig-
nicantly undervalued ex ante, higher policy uncertainty leads to more repurchaseactivi-
ties. In addition, we show that the COVID-19crisis is associated with a lower repurchase
likelihood for nancially constrained rms or those with high cash ow volatility, while
undervalued rms repurchased more shares during the pandemic period. Our results are
robust after controlling for potential sources of endogeneity and conducting a battery
of robustness tests. Collectively, our evidence suggests that the relationship between un-
certainty and share repurchases is conditional on institutional contexts. Firms’ level of
nancial exibility,their demand for signalling, and the credibility and magnitude of re-
purchase signals all signicantly affect their precautionary and signalling motives.
Introduction
In the contemporary economy, regulatory institu-
tions and policymakers make policy-related deci-
sions that frequently change the business environ-
ment in which rms operate. Such changes can
signicantly alter corporate behaviours. However,
few studies to date have examined how economy-
wide factors affect an important corporate de-
cision: share repurchases (e.g., Walkup, 2016).1
More importantly, it is unclear how rms react to
elevated policy uncertainty when their needs for
signalling and hoarding cash reserves are both am-
plied. This paper attempts to ll this gap by em-
1Share repurchases are the dominant form of corporate
payout (Skinner, 2008), and industrial public US rms
spent more than $550 billion on share repurchases prior
to the credit crisis of 2007–2008 (Farre-Mensa, Michaely
and Schmalz, 2014).
pirically investigating the impact of policy-related
uncertainty on share repurchases in the United
States.
The predicted effects of policy uncertainty on
share repurchases are unclear ex ante. On the
one hand, policy uncertainty increases external -
nancing costs and provides a shock to the sup-
ply of credit (Brogaard and Detzel, 2015; Pas-
tor and Veronesi, 2013). In addition, cash ow
volatility is also intensied when policy is uncer-
tain (Nguyen and Phan, 2017). Such elevatedinter-
nal and external nancing frictions lead to signi-
cant deteriorations in cash ows, and rms might
have stronger precautionary motives to hold more
cash for operating activities, which are essential
for rms’ long-term prospects (Duong et al., 2020;
Jens and Page, 2021). Because share repurchases
exhibit a more exible way than dividends to dis-
tribute excess cash to shareholders and managers
are not obliged to undertake share repurchases
© 2022 The Authors.British Journal of Management published by John Wiley & Sons Ltd on behalf of BritishAcademy
of Management.
This is an open access article under the terms of the Creative Commons Attribution-NonCommercial-NoDerivs Li-
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commercial and no modications or adaptations are made.
Precautionary versus Signalling Motive of Share Repurchases 1751
(Jagannathan, Stephens and Weisbach, 2000), this
precautionary motive hypothesis implies that rms
may decide to retain a larger portion of their earn-
ings by reducing share repurchases amid uncer-
tainty.
On the other hand, policy uncertainty amplies
information asymmetry about rm values, mak-
ing it more difcult for investors to collect corpo-
rate information(Nagar, Schoenfeld and Wellman,
2019). Therefore, rms are more likely to be mis-
valued during periods of high policy uncertainty,
and they could react to such a deteriorated in-
formation environmentby sending positive signals
about their underlying protability and nancial
strength to the market through share repurchases
(Anolick et al., 2021; Dittmar, 2000; Ikenberry,
Lakonishok and Vermaelen, 1995). The credibil-
ity of the positive signals could be enhanced in the
event of uncertainty, and rms could use share re-
purchases as a tool to reduce information asym-
metry in response to increased policy uncertainty.
Therefore,this signalling motive hypothesis predicts
that rms increase share repurchases during peri-
ods of high policy uncertainty.
While policy uncertainty is unobservable and
could be difcult to quantify, we use the Baker,
Bloom and Davis (2016; henceforth, BBD) index
to measure policy uncertainty. The BBD index is
constructed as a weighted average of four com-
ponents: the frequency of newspaper articles con-
taining keywords relatedto policy uncertainty, the
level of uncertainty related to future changes in the
federal tax code, and the dispersion in economic
forecasts of both government spending and the
Consumer Price Index. The BBD index is statis-
tically signicantly correlated with events that are
expected to generate policy-related uncertainty.2
Policy uncertainty provides an ideal setting in
which to study the relationship between uncer-
tainty and share repurchases. Unlike rm-specic
uncertainty, policy uncertainty acts as a shock
to all rms in the economy and is difcult for
rms and investors to hedge or diversify away
(Duong et al., 2020). The policy uncertainty in-
dex designed by Baker, Bloom and Davis (2016) is
broader, captures the long-run, time-variant policy
uncertainty, and reects a wider range of policy-
2The index spikes during events that are associated with
high policy uncertainty, such as the two Gulf wars, the
9/11 attack, the 2011 debt-ceiling dispute, and political
battles over scal policy.
relevant environments than event-driven uncer-
tainty, which ignores the uncertainty outside the
timeframe recorded by the specic events (Attig
et al., 2021; Brogaardand Detzel, 2015). It includes
different types of uncertainty that are directly tied
to policies, such as uncertainty related to tax, gov-
ernment spending, and both scal and monetary
policies. Overall, the policy uncertainty index pro-
vides a comprehensive picture of the magnitude of
the rst-order effect of uncertainty on share repur-
chases.
Specically, we focus on the universe of non-
nancial, non-utility rms covered by the Compu-
stat database from 1985 to 2021. Consistent with
the precautionary motive hypothesis, we rst nd
evidence of a negative effect of policy uncertainty
on share repurchases that is economically sizable
and statistically signicant. In particular, a one
standard deviation increase in policy uncertainty
is associated with a 5.0% lower repurchase ratio,
and with a 1.3% decrease in repurchase likelihood.
These results are economically sizable because the
decrease is 25.0% of the average repurchase ratio
(18.6% of the unconditional probability) in our
sample. We further nd that the overall index’s ex-
planatory power arises mainlyfrom its news-based
component, while the other three components are
not signicantly related to share repurchase activ-
ities. The baseline results remain unaltered after
conducting a battery of robustness tests. In ad-
dition, through a series of cross-sectional hetero-
geneity analyses, we further demonstrate that pol-
icy uncertainty affects r ms’ repurchase decisions
through its impact on internal and external nanc-
ing frictions.
Our results are also robust to controllingfor po-
tential sources of endogeneity. Policy uncertainty
and share repurchases can be jointly correlated
with unobservable factors, such as investment op-
portunities, which raises an endogeneity concern
and potentially biases the coefcient estimates.
Followingthe prior literature (e.g., Gulen and Ion,
2016; Nguyen and Phan, 2017), we use the parti-
san polarization measure (POLAR), which tracks
legislators’ideological positions over time as an in-
strument for policy uncertainty. Using the tted
value of policy uncertainty, we still nd that higher
policy uncertainty is associated with a lowerrepur-
chase ratio and likelihood. Another potential issue
is that the policy uncertainty index might capture
the effects of non-policy-related factors, such as
economic uncertainty,and these factors may affect
© 2022 The Authors.British Journal of Management publishedby John Wiley & Sons Ltd on behalf of British
Academy of Management.
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