The Market Reaction to Share Repurchase Announcements ------An Empirical Study of China Mainland and Hong Kong

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The Market Reaction to Share Repurchase Announcements

---An Empirical Study of China Mainland and Hong Kong

MSc International Financial Management Faculty of Economics and Business

MSc Business and Economics Faculty of Social Sciences

Xinran Wang

University of Groningen: S2093030 Uppsala University: 881211-P675

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2 Abstract

This thesis examines the market reactions to share repurchase announcements released by listed firms on the China mainland markets and the Hong Kong market using listed firm-level data on Shenzhen Stock Exchange, Shanghai Stock Exchange and Hong Kong Exchange for the period from 2008 to 2011. The empirical results show that stock prices react positively to firms’ share repurchase announcements both on the China mainland markets and the Hong Kong market. Furthermore, China mainland markets react more to share repurchase announcements than the Hong Kong market does. The main findings of this study also reveal the fact of signaling hypothesis that share repurchases are announced to signal a firm’s undervaluation or the management’ s confidence of future development.

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1. Introduction

Stock repurchase (or share buyback) refers to the reacquisition a company of its own stock. It originates from the United States and has become a common and important form of dividend payout method and capital operation. Firms implementing shares buyback can adjust their capital structure and equity structure, improve corporate governance, and enhance profitability and shareholder returns. On the other hand, the share repurchase may lead to a liquidity squeeze or a high debt-to-asset ratio if employing it in an inappropriate way. Moreover, some insiders may use it speculatively with the intent to expropriate the interests of minority stockholders. There are three main types of share repurchases: open market share repurchases, fixed price tender offers and Dutch auction tender offers. Although these three types of share repurchases vary from each other with different methods of how to achieve the buyback activities in practice, they all aim at buying back firms’ own shares from the market. Open market repurchases, among them, have been reported by many researchers as the most popular method for companies to repurchase shares (Bagwell & Shoven, 1991; Grullen & Michaely, 2002).

Firms in U.S. have widely employed repurchase programs since 1980’s (Ho et al. 1997), and nowadays, share repurchases in U.S. capital market have developed quite mature, allocating a great deal of wealth to shareholders. For example, Bartov et al (1998) show that $383 billion worth of open market repurchase announcements are made in a ten-year period from 1985 to 1994. These figures go up to approximately $550 billion in the following 3-year period of 1996-1998, as reported by Ikenberry et al. (2000). Coming into the 21st century, the share repurchases still grow rapidly in quantity. Lu, et al. (2011) report that the use of share repurchases has grown to $349 billion in 2005. During the first 4 months in 2010, 310 companies announce plans to repurchase as much as $ 173.3 billion worth of stock1.

Even though the share buyback develops relatively late in other places around the

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world, it also gains increasing popularity in recent years. Rau and Vermaelen (2002) indicate that there is only one share repurchase in the UK during 1985 with the value of 1.1 million pounds, while this amount jumps to 4,661.9 million pounds with 50 share repurchase programs in 1997. Von Eije and Megginson (2008) study the European markets as a whole with fifteen nations that were European Union members before May 2004, and they find that there are 1707 share repurchases in 1989. In 2005, however, the number of announced share repurchase programs increases to 3148. In the Asian area, Zhang (2002) examines stock buyback programs in Japan and observes the dramatic development increasing from only 2 repurchases in 1995 to 36 repurchases in 1997. According to Brokman & Chung (2001), 8 share repurchase programs are announced in Hong Kong in 1992, but in 1995 there are 100 repurchases announced.

China mainland, in contrast to these developed countries and areas mentioned above, starts its capital markets quite late. Meanwhile, due to its imperfect market mechanism, the share repurchases develop slowly in the past years. The initial share repurchase allowed by China authorities is implemented in 19922. However, after that it takes a quite long time of limitation for listed firms to accomplish share repurchase programs, especially from 1992 to 1995. During this period, only non-tradable shares are allowed to be repurchased3. To be specific, both the <Company Law of The People's Republic of China> (1993) and <Guidelines for Articles of Association of Chinese Listed Companies> (1992) show that a listed company can only repurchase shares when reducing capital or merging with other firms which hold its shares. It states until June 2005, that the China Securities Regulatory Commission (CSRC) issues the < Administration of Repurchase of Public Shares by Listed Companies Procedures (Trial Implementation)>, indicating that China relaxes the restrictions of repurchasing tradable shares. And since then, listed companies repurchasing shares is permitted both by policies and laws. Apparently, political factors result in a short and

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Big yuyuan, as a shareholder of little yuyuan, negotiated repurchase all the shares of little yuyuan.

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devious history of stock repurchases on the China mainland markets. Due to its unique political and economic environment, studies on share repurchases in China are quite complex and may differ from existing theories and previous findings done on developed markets (for example, Ikenberry, Lakonishok & Vermaelen, 2000; Kahle, 2002; Grullon & Michaely, 2004; Vermaelen, 2005). Therefore, to further study share repurchase practices in China can enrich the relevant literature on the China mainland markets and give important insights into share repurchase activities in developing countries.

This thesis introduces Hong Kong as a comparable market to explore the different empirical evidence between China mainland and developed market (Hong Kong). Whereas China has resumed its sovereignty over Hong Kong since July 1, 1997, nevertheless, because of the “One-country-two-system” policy, Hong Kong still keeps its own economic and political system and a high degree of autonomy. The capital market in Hong Kong has been being independent witha relatively well-developed regulatory system. Consequently, China mainland and Hong Kong have different institutional settings including financial regulations of their markets. In Hong Kong, with the enactment of <Corporations Legislation Amendment Act> (1991), companies were permitted participating in share buy-back activities (Zhang 2008). Under its financial regulation regime, companies must obtain approval from their shareholders to purchase their own shares4. And a company must report its share buyback programs to the Exchange for public disclosure. Evidently, Hong Kong has greater transparency in regulations and a more mature stock market than China mainland, and it is interesting and meaningful to investigate the difference performance of share repurchase activities on such two different markets.

There are a lot of studies that reveal motivations of share repurchases such as the information signaling hypothesis, the free cash flow hypothesis, the optimal capital structure hypothesis and the management incentive. The most popular motivation for

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stock repurchases is that managers announce stock repurchases for the purpose of credibly communicating that ﬁrm value exceeds the stock price (McNally, 1999). In other words, it is a means by which managers can convey, or signal, their beliefs that their firm's stock prices are too low and hence their own shares are an excellent investment option (Wansley, Lane & Sarkar, 1989). According to the signaling hypothesis, share repurchase announcements are good news for the stock market. Several studies have reported evidence consistent with this hypothesis. For example, Raad & Wu (1995) examine the data on the U.S. market, and they find that open market repurchase announcements are greeted by abnormal increases in stock prices with around 2.6% cumulative abnormal returns. Additionally, many studies covering European markets, Australian and Asian markets support this view (Seifert & Stehle, 2003; Quintana & Ulrich Hege, 2006; Thirumalvalavan & Sunitha, 2003；Zhang 2002). However, empirical studies on China mainland markets (Shanghai Exchange and Shenzhen Exchange) are rare. In the view of the unique capital markets in China, this thesis tries to investigate whether these findings are applicable to China mainland. Furthermore, since the institutional framework surrounding share repurchase announcements in China mainland differs from Hong Kong, markets in China mainland or Hong Kong may react differently to share repurchase announcements released by listed firms. Thus, basing on the considerations above, this paper aims to answer the following research questions:

1. Do the China mainland markets react positively to share repurchase announcements?

2. Does the Hong Kong market reacts positively to share repurchase announcements?

3. Do China mainland and Hong Kong markets differ in their reactions to share repurchase announcements?

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period from 2005 to 2011 to examine share repurchase announcement impacts both on the China mainland and Hong Kong markets. In addition, observation firms’ financial leverage, firm scale, profitability, cash operation and market level are controlled to investigate whether the market performance is different in China mainland and Hong Kong. Basing on previous studies on other markets and relevant hypotheses, this thesis proposes that both the China mainland and Hong Kong markets respond positively regarding share repurchase announcements, and the market reacts more in China mainland than in Hong Kong. Accordingly, for my empirical study, I expect the abnormal returns on China mainland and Hong Kong markets are positive. Furthermore, share repurchases on China mainland markets induce more abnormal returns surrounding the repurchase announcements than the Hong Kong market does due to the less efficient markets and the examined information leakage phenomenon in China mainland.

Compared previous research, especially studies on China, this thesis provides several complements to enrich the share repurchase literature. Firstly, it contains a long period (2005-2011) and a broad range (including both the Shanghai and Shenzhen Exchanges) of investigating sample on the China markets, providing the latest research of market reactions to share repurchase announcements. Only since recent years, the on-market repurchases begin to be popular in China mainland, therefore a study on a relatively long period can reveal and capture the changes on market responses to share

repurchase programs. Moreover, this study is the first to compare the difference in announcement effects between China mainland and Hong Kong. The share repurchase market in China mainland is so unique and complicated that a lot of share repurchase activities conducted for their specific reasons. Through comparing China mainland with more developed Hong Kong market, this thesis can provide useful information for improving share repurchase policies in China mainland and Hong Kong..

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announcements and studies discussing the relevant hypotheses to explain the motivations for companies conducting such programs, and this is followed by the proposition of the two hypotheses this paper mainly investigates. The sample selection is described in section 3. Then in section 4, I introduce the modeling framework of event study and an OLS model. Besides, the explanatory variables are described in the section 4 as well. Finally, the thesis reports the empirical results in section 5 and concludes in section 6.

2. Literature review and Hypotheses

There are a great proportion of previous studies on market reactions to repurchase announcements covering many countries and regions, since different capital markets and institutional settings can result in different empirical results. Additionally, researchers also pay their great attention on why firms embark on share repurchase programs, and several hypotheses and motivations5 have been raised to explain the underlying motivations behind share repurchase conducts, such as the signaling hypothesis and the optimal financial leverage hypothesis. Therefore, this section provides a review of the relevant literature regarding empirical studies on market reactions to share repurchase announcements, and regarding share repurchase motivations. In addition, a discussion about the efficient market hypothesis follows.

Meanwhile, I develop the hypotheses to be tested on the basis of the reviewed hypotheses, empirical evidence and my own arguments.

2.1 Motivations of share repurchases

Every economic phenomenon has its particular theories to support, including share repurchases. Since share repurchase activities emerge, many kinds of hypotheses have been proposed and tested by empirical studies. Wansley, Lane & Sarker (1989) describe the five most popular motivations for open market repurchases namely signaling, agency costs of free cash flows, tax motivated substitution for dividends,

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leverage/capital restructure and anti-takeover. Furthermore, they also summary 17 motivations for share repurchases, ranging from distributing excess cash to as a part of a defensive strategy to avoid takeover.6 This section reviews several most common cited hypotheses and in the end gives a brief discussion.

2.1.1 Tax motivated substitution for cash dividends

Share repurchases can act as a substitute to cash dividends. Companies implement share repurchase programs with the purpose that shareholders can benefit from tax advantages of repurchases. Specifically, if capital gains tax rates are lower than dividends tax rates, repurchasing firm’s own shares constitutes a better alternative to distributing cash to shareholders. Because capital gains tax rates are lower than personal income tax rates that will be imposed on dividends, the personal taxes of investors can be reduced. Moreover, if firms use debt to repurchase shares, the interest costs can be deducted before calculating income taxes, thereby increasing shareholders’ wealth.

On the one hand, numerous studies provide empirical findings to support tax motivated substitution for cash dividends. Bierman & West (1966) study the effect of share repurchases on firm value, and conclude that stock buyback can increase firm value, and the only motivation for repurchasing shares is “tax avoidance”. Grullon & Michaely (2002) examine the U.S. market and report that companies have been shifting to utilize share repurchases instead of dividends as a form of cash distribution to shareholders. They show that not only do most of firms that initiate cash payments do so through share repurchases, but also many firms that have been paying dividends have started to repurchase their stocks. Skinner (2008)’s study coincides with their

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findings. Von Eije & Megginson (2008) study the European markets and state that there is an increasing popularity among firms repurchasing shares rather than increasing dividends.

On the other hand, some researchers criticize the above. Elton & Gruber (1968) contend that Bierman & West (1966) have several fundamental errors in their analysis in that they do not take the effects of transaction costs and homogeneous stockholders into account. They stress that when considering transaction costs, the costs of share repurchases may exceed the costs of paying dividends thus the tax advantages of repurchasing shares may be offset by an increase in transaction costs for the stockholders in certain corporations. However, stockholder heterogeneity can decrease the transaction costs relating to share repurchases and increase the transaction costs associated with a cash dividend. Therefore, they conclude that the effect of share repurchases as a substitution for cash dividends on firm value is uncertain.

2.1.2 Leverage/Capital Restructure

A competing explanation of stock buyback is that firms can deliberately change their capital structure via share repurchases, which comes in the form of reducing the equity and increasing the debt. Since debt can bring tax shield effects to firms, firms with higher level of debt will receive greater taxation earnings. According to the Modigliani-Miller theorem with taxes, the value of a firm increases as firm’s debt increases. In reality, however, firms with more debt will be confronted with higher bankruptcy costs as well.

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offer share repurchase, since the repurchase moves the firm closer to its target capital structure. Chan, Ikenberry & Lee (2001) show evidence that firms may time repurchase announcements to meet with the exercise of stock options. This result also support the idea that firms may utilize share repurchases to reach small required changes in their capital structures.

The leverage/capital structure hypothesis is initially based on the idea of the “optimal capital structure”. However, whether there exists an “optimal capital structure” for a curtain firm is still a mystery for financial analysts. Even though share repurchases can change firms’ financial leverage, there is no comprehensive theory to support that the capital structure is “optimized”. Dann (1983) argues that since privately negotiated stock repurchases and tender offers have the same effects on firms’ leverage ratio under the leverage hypothesis, they should have equal announcement effects as well. His empirical results, however, reveal that when firms announce privately negotiated stock repurchases, their stock prices are not changed in the same degree as after tender offer announcements.

2.1.3 Signaling Hypothesis

Signaling is the most popular motivation that has been widely studied in academia and commonly tested in practice. It is based on the existence of information asymmetry between firm’s management and outside investors. Since the management who holds a lot of information inside of the company perceives an undervaluation of firm’s market value (the signaling undervaluation hypothesis) or expects a good future growth (the earnings signaling hypothesis), they may intend to announce repurchase programs as signals to the market that the prevailing stock prices are below the firm’s fundamental value.

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existing share prices may not reflect the firm’s inherent value. In this case, when announcing share repurchases, a company is signaling to the market that shares are priced below their intrinsic value. An alternative explanation of the signaling hypothesis demonstrates that when management expect that a firm’s earnings and cash flow will increase in the future, while this idea is not shared by the market, a share repurchase plan may be announced to convey management’s confidence about the company’s future performance to the market.

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repurchase announcement are negatively correlated with the open market repurchase returns, indicating that firms repurchase shares when their share prices are perceived as undervalued.

In addition, a lot of investigations also show evidence to support the signaling hypothesis. Wansley, Lane & Sarker (1989) conduct a questionnaire survey including 17 statements with motivations for repurchasing shares, and the results indicate that both repurchasers and nonrepurchasers7 agree with “management feels the firm’s share price is undervalued” as the most important motivation for repurchasing shares. Moreover, the repurchasers and nonrepurchasers rank “share repurchase as a method to express management’s confidence in the future level of earnings and stock price” as the second and the third important motivations, respectively. Baker, Powell & Veit (2003) survey 624 top financial executives to investigate their views about share repurchases in their companies from January 1998 to September 1999. They collect 194 responses and the results show that the most highly cited reasons for open market repurchases are consistent with the signaling hypothesis, specifically the version of the signaling undervaluation hypothesis.

2.1.4 Other motivations and a discussion

Various other studies also try to give motivations for share repurchases. For instance, Denis (1994) examines defensive changes in corporate payout policies and finds that firms repurchase shares as a defensive tool in response to hostile takeover attempts. Jensen (1986) proposes a free cash flow hypothesis that much excess free cash flow will increase agency costs between the management and shareholders, since managers may over-invest or invest in negative NPV projects in order to diversify investment risk or expand their controlling power. Share repurchases can be seen as an approach that firms distribute cash to shareholders thereby reducing agency costs. Bens et al (2003) indicate that share repurchases are used to increase earnings per share (EPS) figures. Maxwell & Stephens (2003) find evidence that the management uses

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repurchase programs to transfer wealth between firms’ bondholders and shareholders.

Overall, the motivations for firms repurchasing shares are various and may have multiple effects. The hypotheses discussed above are all developed along with different motivations, and each hypothesis has its real cases in practice. A company may consider more than one factor when it decides to implement share repurchase programs. For example, a company may repurchase shares with the purpose of signaling information while at the same time changing financial leverage. Moreover, firms should more focus on how to maximize firm’s value rather than the separated effect of share repurchase activities when making decisions. In general, any single hypothesis cannot explain the full effect of share repurchases, and each one is coordinated with instead of subordinated to others.

2.2 Previous empirical findings 2.2.1 U.S. market studies

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offers during period of 1984-1989, among which 72 observed firms use a Dutch-auction procedure to determine their repurchase prices. The empirical results show that fixed-price self-tender offers induce an average excess return of about 11%, while Dutch-auctions are associated with a lower average excess return of about 8%. Moreover, 1,197 open market repurchase programs announced between 1985 and 1988 are also tested, and empirical results show a only about 2% average excess stock return on announcements. Based on these findings, Comment & Jarrell (1991) conclude that fixed-price offers provide the strongest effects of stock price undervaluation supporting the signaling-based hypothesis. Raad & Wu (1995) study 204 firms that launch open market repurchase plans between 1982 and 1990 and report that repurchase announcements elicit an accumulative access positive return of 2.6%. Similarly, Stephens & Weisbach (1998) examine open market repurchase announcement effects from 1981 to 1990 and observe an average accumulative positive excess return of 2.69% on the announcements.

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21-year period from January 1981 to December 2001. They report that the pre-repurchase market excess returns from days -130 to -68 prior to the announcement is about -3.5%, and firms experience an average abnormal return of about -2.6% over the period [-67,-5]. The average abnormal return surrounding the announcement (3 days before and 3 days following the announcement) increases to 13.5%. Besides, they further divide the sample into fixed-price tender offers and Dutch-actions, and find that the market responds more to fixed-price offer announcements than to Dutch-action offers. This is consistent with Comment & Jarrel (1991)’s empirical study.

2.2.2 Studies on other capital markets

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In China mainland, most studies on share repurchase announcements are conducted through case studies in early years (Wang, 2002; Xu &Chi, 2003; Tan & Chen, 2007). In recent years, as the popularity of stock buyback is increasing, more and more firms are involved in share repurchases activities and accordingly many empirical studies on market reactions to share repurchases emerge. Liang (2006) examines 35 valid samples of listed firms between June 1, 2005 and July 31, 2006 to investigate the market responses to share repurchases announcements. She finds that both targeted repurchases and open market repurchases induce abnormal returns after the announcements. She further points out that targeted repurchases also result in abnormal returns before the announcements are released and attributes this phenomenon to the existence of information leakage on China mainland markets. Wang et al. (2006) study share repurchases programs disclosed on China mainland markets from November, 1994 to March, 2006. The empirical findings reveal that the accumulative excess return of announced firms is negative before the announcements, while it turns to be positive after the announcements. More specific, they indicate that firms’ share prices experience a decline during the period prior to their repurchases announcements, and in order to prevent further decrease, firms use share repurchase announcements as signals to convey positive information to the market. As a result, investors regard such announcements as good news and stock prices go up to a certain degree. Additionally, Wang et al. (2006) divide the samples into two groups, announcements on tradable shares and non-tradable shares, to compare the market reactions regarding different repurchase objects. They observe that the accumulative abnormal returns followed by non-tradable shares repurchase announcements are significantly lower than that of tradable repurchase announcements.

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the announcement day are positive and appear to increase in the following days after the announcements. This indicates that the market reacts positively to share repurchase announcements. Furthermore, they separate all observations based on different repurchasing purposes, and find that even though the market has positive reactions regarding all repurchase announcements with various purposes, firms aiming to complete the reform of non-tradable shares or to reduce state-owned shares have more positive market reactions than firms announcing repurchases to raise their stock prices or implement shares incentives. Sun (2008) employs an event study to examine market reactions to share repurchase announcements between April 18, 2005 and December 12, 2007. His findings are consistent with previous studies that firms’ share prices present positive accumulative abnormal returns during the announcement event periods. Nevertheless, accumulative abnormal returns before the announcements are significantly greater than that in the post announcement periods, which indicates that information leakage occurs on the China mainland markets. Sun (2008) also concludes that an information leakage phenomenon exists both in open market repurchases and non-tradable shares repurchases.

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the Hong Kong market still have announcement impacts. Conducting an empirical study to test such effects can further complement studies on stock buyback programs on the Hong Kong market.

2.2.4 Hypothesis development

As discussed above, a great deal of empirical studies, starting with Vemaelen (1981) and Dann (1981), show that stock prices react positively to the share repurchase announcements. In addition, the signaling hypothesis holds that when a firm’s stock price is undervalued by the market or the management expects a good future growth while the outside market hasn’t noticed the good prospect, the management would intend to announce repurchase programs to signal stock undervaluation or good growth prospect to the market.

Xu & Liu (2003) study the specific capital structure of China listed companies and argue that the information signaling hypothesis explains share repurchase activities of listed firms to a certain extent. Firth & Yeung (2005) examine share repurchases in Hong Kong and their empirical findings show that undervaluation primarily motives managers to repurchase shares, supporting the notion of signaling on Hong Kong market. Whereas it cannot be denied that other motivations combined with the signaling simultaneously influence firms’ decisions of stock buyback, this paper still sees signaling as the most possible motivation and builds hypotheses based on it.

Following a logic governed by the signaling, share repurchase programs can be seen as good news in stock market, and a market will act positively to firms’ repurchase announcements. Consequently, on the basis of both previous empirical evidence and the explanatory hypothesis, I propose that:

Hypothesis 1: stock prices react positively to firms’ share repurchase announcements

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2.3 Efficient Market Hypothesis

According to the efficient capital market hypothesis (EMH), if a market is efficient, the current market price should reflect all available information. Ikenberry et al. (1995) show that if markets act efficiently, current prices should respond immediately to the new information and adjust in an unbiased way. Thus the new equilibrium prices should be the best-unbiased estimate of the true value of an investment. The semi-strong form of EMH indicates that all publicly available information is reflected in shares’ current market prices. The stated public information not only consists of past prices but includes economic factors, financial statements disclosed by firms and firms’ announcements as well. It also implies that no one can profit from any of this public information. Therefore, when this condition goes for a firm’s share repurchase announcements, it indicates that the announcement released by a company cannot help investors to forecast its future share prices or secure high investment returns. Skjeltop (2004) examines the market reactions and timing of open market repurchases in the Norwegian market, and indicates that the market is likely to underreact to the signal conveyed by the announcements. He further concludes that if the market reacts efficiently and in an unbiased manner, it responds to the announcement signals by adjusting prices, and thus purchasing these firms’ shares would not profitable.

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Consequently, it can be concluded that on a less efficient market, the price of a stock reflects less available information about its true value, and thus investors make incorrect judgment of the stock value. Brockman & Chung (2001) report that the disclosure requirements in Hong Kong are very stringent. Any information regarding share repurchases must be reported to the public on the following business day. In the case of China mainland, however, capital markets develop with a relatively short history, and owing to the restriction of policies, share repurchase programs are not as prevailing as in Western markets. Moreover, previous studies show that there exists information leakage before repurchase announcements in China mainland. (Tan & Chen, 2007; Wang & Bi, 2007). Therefore, China mainland markets are perceived as less efficient compared to the Hong Kong market. Finally, basing on these evidence and considerations, I propose that China mainland markets will react more to share repurchase announcements than the Hong Kong market does.

Hypothesis 2: China mainland markets react more to share repurchase

announcements than the Hong Kong market does.

3. Sample and data

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Business8 website and the Wind database. Furthermore, all the financial figures and stock prices data are obtained from the Wind, RESSET and Datastream databases.

The sample on China mainland markets is formed by selecting announcements reported on the Shanghai Stock Exchange and the Shenzhen Stock Exchange stating that a company is intending to repurchase its own common stocks. During 2005 to 2011, there are 50 and 39 announcement events observed from the Shanghai Exchange and the Shenzhen Exchange, respectively. This thesis uses several criteria to further construct the sample. Firstly, I eliminate 10 announcements that are involved in merger and acquisition. Then 11 observations regarding the cancellation of stock option incentive plans are removed from the sample, and as well as 1 repurchase regarding debt restructuring, 1 repurchase involved in a legal dispute and 3 cases of related-party transactions. Moreover, 6 announcements of repurchasing H-shares9 and 3 announcements of repurchasing overseas B-shares are also eliminated from the sample. Finally, a total of 54 (Shanghai Exchange 37 and Shenzhen Exchange 17) share repurchase announcements meet the requirements and are included in the final sample on the China mainland markets.

There are far more share repurchase activities conducted in Hong Kong than activities in China mainland. In order to compare with the relatively small sample on the China mainland markets, this study focuses on “red chip”10 shares to narrow the sample at a more comparable scale with the sample of China mainland. The “red chip” companies are originally founded in China mainland, and they are mainly controlled by mainland entity shareholders. Furthermore, “red chip” companies launch an integral part of their business in China mainland, and thus gain most of revenues from the mainland. On

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www.business.sohu.com/ganggugg/ Sohu Business is the specified corporative website media with Hong

Kong Stock Exchange website

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H-shares refer to shares in Chinese companies primarily list on the main board of the Hong Kong Exchange and are denominated in H.K. dollars. H-shares are issued in China mainland under Chinese law.

A-shares refer to shares in China mainland companies that list on Shanghai Exchange or Shenzhen Exchange and are dominated in Chinese currency, the Renminbi.

B-shares refer to shares in China mainland companies that list on Shanghai Exchange or Shenzhen Exchange and are dominated in foreign currencies which are known as Reminbi special shares.

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this basis, “red chip” firms are similar with corporations listed on the China mainland markets as they compete in the same market, and are China mainland based companies. Choosing “red chip” companies as comparable observations with listed firms on China mainland markets can also avoid influencing factors such as culture differences and market movements. Nevertheless, “red chip” firms are listed on the Hong Kong Exchange. Their shares trade on the Hong Kong capital market and they comply with all legal requirements and financial regulations regarding share repurchases in Hong Kong. As discussed above, this study aims to examine the different market performance of share repurchase announcements between the China mainland markets and the Hong Kong market. Therefore, comparing “red chip” firms with listed firms on China mainland markets meet the requirements for this purpose.

Overall, this study defines the announcements disclosed by “red chip” corporations on the Hong Kong market as the comparable observations. There are 109 listed firms that are recognized as “red chip” companies, and this study observes 39 companies with 63 share repurchase announcements during the time span from 2005 to 2011. Using the same criteria for constructing sample of China mainland, I eliminate 2 repurchase announcements involved in acquisitions, and finally obtain 61 observations in Hong Kong.

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distributed during the whole observation period than the sample on China mainland markets in that the data of China mainland mainly concentrate in 2006, and there are much fewer observations in other years. To further illustrate, listed firms on China mainland markets conducting share repurchase to complete the reform of non-tradable shares result can partly explain this significant increase in 2006.

Table1 Number of announcements observations in China mainland and Hong Kong by year

Year Hong Kong China mainland

2005 7 11 SH(8) SZ(3) 2006 8 27 SH(23) SZ(4) 2007 5 1 SH(0) SZ(1) 2008 21 4 SH(0) SZ(4) 2009 3 2 SH(1) SZ(1) 2010 2 2 SH(1) SZ(1) 2011 15 7 SH(4) SZ(3) Total 61 54 SH(37) SZ(17) Note: SH refers to Shanghai Exchange; SZ refers to Shenzhen Exchange.

4. Research design and variable descriptions

This thesis first examines the market reactions to share repurchase announcements on the China mainland markets and the Hong Kong market, and then further investigates whether the announcement effects on China mainland markets are differ from the Hong Kong market.

4.1 Event study

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thesis, I employ the event study to examine the market responses to share repurchase announcements, and use cumulative abnormal return (CAR) to measure the market reaction.

4.1.1 Event period

The event day should be determined before defining the event period. In accordance with studies of Liang (2006) and Tan & Chen (2007), I set the day when a company’s board of directors announces to repurchase its shares as event day, and define it as T=0.

Care must be taken when determining the event day for sample companies from Hong Kong, since there is no disclosure of share repurchases required under the local ordinance. Not all companies announced their repurchase plans before they actually implement repurchases. Many of them only announce the yearly shareholder

meeting’s resolutions that giving the board of directors the right to implement share repurchases in the following one year, and this study argues that such announcements cannot be perceived as share repurchase announcements in that it is not a determined announcement that the firm is certain to repurchase shares on a certain day. On the other hand, Hong Kong market does require that listed firms must immediately

disclose their trade records when the repurchases are done. When observed companies announce the actual repurchases trade publicly, it is the first time that the market learns that these firms are doing repurchases. Thus the market receives the information which the announcing firms are signaling that their share prices are undervalued, and reacts to such information. Therefore, for listed companies in Hong Kong that do not have prior share repurchase announcements, I set the day when listed companies in Hong Kong first announce their trade records of share repurchase as the event day. Regarding the whole 61 share repurchases observed from “red chip” firms on Hong Kong market, there are only 3 companies’ board of directors announce their repurchase plans prior to the actual repurchases. Therefore, to achieve

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repurchases trades as the event day to the whole sample on Hong Kong market. Finally, Following Tan & Chen (2007)’s study, this thesis chooses a 20 days period as event window, in which T (-9) presents stock trading days before the announcement day while T (10) presents stock trading days following the announcement day.

4.1.2 The CAR approach

In general, there are three approaches to calculate the abnormal returns, namely mean-adjusted model, market model and market-adjusted model. In most situations, these three models generate similar returns (Weston, J.F., et al, 2003), therefore this thesis uses market-adjusted model to obtain the abnormal stock returns. Under the cumulative abnormal return (CAR) approach, abnormal returns are calculated each day relative to a benchmark and the aggregated over time. This procedure assumes that returns are not compounded, as well as daily rebalancing with sample firms receiving equal portfolio weights (Ikenberry et al, 1995). The individual share daily return is calculated using following formula:

Rit = (Pit-Pi (t-1))/ Pi (t-1)

Where:

Rit refers to the actual return of stock i on day t,

Pit refers to the closing price of stock i on day t,

Pi (t-1)refers to the closing price of stock i on day t-1

The market actual daily return is calculated using the following formula: Rmt = (Pmt-Pm (t-1))/ Pm (t-1)

Where:

Rmt refers to the actual market return on date t,

Pmt refers to the closing market indexon day t,

Pm (t-1)refers to the closing market index on day t-1

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Kong Exchange, respectively.

Therefore, the individual daily abnormal return is calculated as follows: ARit = Rit – Rmt

Where:

ARitrefers to the daily abnormal return of stock i on day t,

Average daily abnormal return of all stocks on the market on day t can be obtained using formula:

AR (t) = 1/n ∑ ARit

Accordingly, the cumulative abnormal reruns during the specific time period can be obtained as follows:

CAR i [t1, t2] =∑ ARit

Where:

CAR i [t1, t2] refers to the cumulative abnormal returns of individual stock during the

event window [t1, t2].

Finally, the cumulative abnormal returns of all stocks on the market during time period [t1, t2] are obtained as follows:

CAR [t1, t2] =∑ AR(t)

Where:

CAR [t1, t2] refers to the cumulative abnormal returns of all stocks on one market

during the event window [t1, t2].

4.1.3 Significance testing

I use the t-test to examine the significance level for the average daily abnormal returns (AR) and cumulative abnormal returns (CAR) during the event window [-9, 10]. This thesis states H0 (a) as:

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And H0 (b) as:

CAR [t1, t2] = 0

4.2 variable descriptions and the multiple regression model

This study employs a multiple regression model to investigate the difference of market performance regarding share repurchase announcements between China mainland markets and the Hong Kong market. The variables descriptions and model design are introduced as follows.

4.2.1 The dependent and independent variables

This thesis designates the accumulative abnormal returns covering 2 days before and 10 days after share repurchase announcements (R) as dependent variable. Many studies indicate that there exist market distortions on share repurchase announcements on China mainland markets (Yi & Zhang, 2005; Wang et al, 2006). In order to better reveal the conveying information about repurchases program, this thesis chooses cumulative abnormal returns in the event window [-2, 10] as the dependent variable.

This study employs a dummy variable (DM) as the independent variable to examine the different abnormal performance between China mainland markets and the Hong Kong market. If announcing companies are listed on China mainland markets (Shenzhen Exchange or Shanghai Exchange), DM equals 0, whereas if announcing companies are not listed on China mainland markets, DM equals 1. This thesis expects a significantly negative empirical result, which indicates that China mainland markets react more to share repurchase announcements than the Hong Kong market does.

4.2.2 Control variables

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The information asymmetry hypothesis holds that information asymmetry exists between the external market and companies. Firms can be undervalued when the outside market does not have enough information about these firms. Barth & Kasznik (1999) argue that the degree of information asymmetry is positively related to market responses to announcements. This can be explained in that announcing firms convey firms’ information to the external market, thereby reducing such information

asymmetry between companies and the outside investors. To examine this factor in empirical studies, both Ikenberry et al. (1995) and Ho et al. (1997) consider firm size as a proxy for information asymmetry. Specifically, corporations with smaller scale are harder to be noticed by the market, and thus have greater extent of information asymmetry with the outside shareholders. In the case of larger corporations, the market perceives more knowledge about them, and as a result, they convey limited information to the outside through repurchase announcements and thus have less degree of market responses. Li & McNally (2003) and Grullon & Michaely (2004) also observe significant, negative relations between firm size and the abnormal market performance. Following Ho et al. (1997)’s study, this thesis includes firm size (Size) as a control variable, measured by the natural logarithm of firms’ total assets one year before announcements.

(2) Sales growth

Healy & Palepu (1993) point out that when firms are undervalued, the management can communicate with the market through announcements. Due to the existence of information asymmetry, the market does not fully understand a firm’s original accounting information. Since share repurchase announcements are signals that the management is confident with its current and future profitability, if investors perceive the announcements are reliable, the market will change its understanding with this firm’s original information and regard a higher profitability as good news. From this perspective, firms with higher profitability have stronger market reactions to

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flow in the future, which indicates they have more investment projects with positive NPV and thus achieve higher profits. Barth & Kasznik (1999) further show that the sales growth rate can be used to measure a firm’s future investment opportunities and its profitability. Liang (2006) studies China mainland markets and finds that sales growth rate is positively related to abnormal market reactions to share repurchases. Following Barth & Kasznik (1999) and Liang (2006), this thesis defines the sales growth rate (SG) as a measurement of firms’ profitability.

(3) Operating cash flow ratio

Both dividend policies and share repurchases result in the outflow of firms’ internal resources, but dividends are relatively more stable. Jagannathan et al. (2000) argue that the increase of dividends is related to sustainable cash flow, while share repurchases are related to unstable cash flow. Since operating cash flow is more sustainable than non-operating cash flow, when firms have relatively high stable cash flow, they are more likely to pay out dividends. Instead, firms tend to implement share repurchase programs when their cash flow is unstable. Chi (2003) employs operating cash flow ratios to measure a company’s sustainable cash flow, and examines that there is a negative relationship between operating cash flow ratios and market reactions to share repurchase announcements. This thesis adds operating cash ratio (OC) as a control variable, and following Chi (2003)’s study, operating cash flow is calculated as firms’ operating cash flow one year prior to announcements divided by their current liabilities.

(4) Leverage

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(5) Market-to-book ratio

Barth & Kaszink (1999) and Grullon & Michaely (2004) designate the

market-to-book ratio as a proxy for whether firms are undervalued. They examine the relation between the ratios and the cumulative excess returns, and find that firms with higher market-to-book ratios have less abnormal market reactions. Furthermore, Chi (2003) also indicates that firms with lower market-to-book ratios in Taiwan are more likely to announce share repurchase programs. Accordingly, this study sets the market-to-book (MB) ratio as a control variable. Overall, all the regression variables and their descriptions are summarized in Table 2.

Table 2 Variables description Variables Descriptions

R i The cumulative abnormal returns covering 9 days before and 10 days after the announcements (CAR [-9, 10]).

DM i Dummy = 0, if announcing companies are listed on China mainland markets (Shenzhen Exchange or Shanghai Exchange); =1, if announcing companies are not listed on China mainland markets.

Size i Control variable for firm size, measured by the natural log of total assets.

SG i, Control variable for sales growth, measured by the natural log of the ratio of

operation revenues one year before the announcements to the same figure two year before the announcements.

OC i Control variable for operating cash flow ratio, equals the firms’ operating cash

flow one year prior to the announcements divided by their current liabilities. Lv i Control variable for firm leverage, measured by the ratio of total assets to the

total equity.

MB i Control variable for market-to-book ratio, equals the ratio of the book value of

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4.2.3 The multiple regression model

This study employs the ordinary least squares (OLS) analysis to investigate the difference of abnormal market performance between China mainland markets and Hong Kong market. The multiple regression model is developed as follows:

R i = α +β1 * DM i + β2 * Size i +β3 * SG i,+ β4* OC i+ β5* Lv i+β6 * MB i + ε

Since this study proposes thatChina mainland markets react more to share repurchase announcements than the Hong Kong market does, I expect a significantly negative sign for the coefficient of the dummy independent variable.

5. Empirical results and discussion

This section presents the empirical results of my study. The univariate analysis is done to examine whether there are positive abnormal market reactions to share repurchase announcements on both China mainland markets and the Hong Kong market.

Furthermore, this thesis runs a multiple regression to test the difference of

announcement effects between China mainland and Hong Kong, and also conducts robustness tests.

5.1 The market reaction to share repurchase announcements

Figure 1 provides the abnormal returns analysis for the whole sample of China mainland markets and the Hong Kong market. Regarding the average abnormal returns (AR) on China mainland markets, AR (-6), AR (-5), AR (2), AR (3), AR (5) and AR (9) are negative as presented in figure 1, but the t-tests of them are not significant (See tableA1 in the Appendix). Except for these six figures, the daily abnormal returns during the entire event window [-9, 10] are all positive. Specifically, the highest abnormal return is observed on the day of the announcement at 3.17%, which is statistically significant at the 1% level. Even one day before the

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also contribute to the abnormal returns on announcement day. This is consistent with Chen & Han (2005)’s study that stock returns rise significantly on the announcement day, and coincides with studies on Western countries (Stephens & Weisbach, 1998; Seifert & Stehle ,2003; Gonzalez, 2004).

Figure 1 the average abnormal returns around the announcement day of Whole sample (%)

Moreover, AR (-4), AR (4), AR (6) and AR (8) also pass the significant tests. Overall, both before and after the announcement, there are positive abnormal returns around share repurchase announcements. These results confirm the hypothesis 1 that stock prices react positively to firms’ share repurchase announcements on China mainland markets. This also supports the signaling motivation that investors on China mainland markets regard repurchase announcements as good news and react positively to this favorable information conveyed through the announcements.

The results on Hong Kong market present less abnormal market performance than that on China mainland markets. As showed in figure 1, the most of the average abnormal returns are negative during the 9-day period before the announcements. AR (-5) even shows a negative return of -0.02% at the 10% significant level. This is in accordance with Stephens & Weisbach (1998) and Dittmar (2000)’s findings, indicating that firms repurchase shares when their share prices are perceived as undervalued. As

hypothesized, the abnormal returns turn to be positive on the announcement day and maintain positively in the following 10 days. Only AR (2), AR (8) and AR (9) are negative returns but with insignificant t-statistics. The highest positive abnormal

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return is observed on the announcement day at 0.06%. However, this result is also not statistically significant. AR (4) and AR (10) confirm the hypothesis 1 with

significantly positive abnormal returns of 0.03% and 0.04%, respectively.

Table 3 Cumulative abnormal returns of whole sample in different time horizons

China mainland Hong Kong

Time horizons Mean (%) t-statistic Time horizons Mean (%) t-statistic CAR[-9,-1] 3.20 3.26*** CAR[-9,-1] -3.15 -3.30*** CAR[-5,-1] 2.67 3.19*** CAR[-5,-1] -1.97 -2.61** CAR[-2,1] 5.52 4.15*** CAR[-2,1] -0.81 -0.74 CAR[-1,1] 4.86 3.88*** CAR[-1,1] -0.10 -0.11 CAR[-2,2] 5.42 3.75*** CAR[-2,2] -1.00 -0.81 CAR[-5,5] 7.22 3.61*** CAR[-5,5] -0.28 -0.19 CAR[-9,10] 10.2 3.87*** CAR[-9,10] 0.11 0.05 CAR[-2,10] 9.08 3.53*** CAR[-2,10] 2.05 1.20 CAR[-1,10] 8.43 3.36*** CAR[-1,10] 2.75 1.66 CAR[0,6] 5.58 2.73*** CAR[0,6] 2.26 1.83* CAR[0,7] 6.10 2.68*** CAR[0,7] 2.52 1.74* CAR[0,10] 7.00 2.91*** CAR[0,10] 3.26 2.20**

T-statistics: * 10% significance level; ** 5% significance level; *** 1% significance level

In table 3 the cumulative average abnormal returns (CAR) with associated significance are reported in different time horizons around the share repurchase initiation announcements. For the whole sample of China mainland markets, the average cumulative abnormal returns in all split time horizons are significantly

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announcing firms signal undervaluation of their current share prices or good prospect of the future development. Meanwhile, as given in table 3, there are positive abnormal returns in the event window before the initial announcement day. This indicates that the information of repurchases is leaked to the market in advance, which also confirms Wang et al. (2006)’s study.

While looking at repurchase announcements overall on the Hong Kong market, there is negative cumulative abnormal return during the period preceding the repurchase announcement (days -9 to -1) totaling -3.15% at the 1% significance level. Moreover, this downward drift in abnormal return is as well found between day -5 and day -1 at -1.97%, which is statistically significant. The evidence suggests that the initiation announcement is triggered by a period of share price underperformance, which is also shown by Vermaelen (1981) and Comment & Jarell (1991). Furthermore, the average three-day abnormal return around the announcement day is – 0.1% (from days -1 to 1) but is not significantly different from zero. This is different from previous studies on other markets, such as the three-day abnormal return of 2.39% reported by Peyer & Vermaelen (2009) for the U.S. market and the three-day abnormal reaction of 0.73% reported by Li & McNally (2007) for the Canadian market. Besides, CAR [-2, 1], CAR [-2, 2] and CAR [-5, 5] also appear to be negative but not statistically significant. These findings can be partly explained by the continuous underperformance in the stock price before the announcements.

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Comparing the abnormal returns observed in different event windows on the China mainland markets and the Hong Kong market, sample firms on Hong Kong market do not obtain continuous and significant abnormal returns as announcing firms listed on China mainland markets do. Additionally, announcing firms on Hong Kong market experience a period of share price underperformance before the initial announcements, while China mainland markets are observed to have information leakage during the period prior to the announcement. On the one hand, due to the less perfect financial regulations and more restriction in policies of China mainland markets, the China mainland markets are perceived as less efficient compared to the Hong Kong market. Consequently, the China mainland markets react strongly to repurchase

announcements and even the leakage of information occurs before the announcements are publicly released. On the other hand, although the return impact on Hong Kong is not as large as the positive impact from the China mainland, I find significantly positive price impacts over the post-event period compared to pre-event period. These findings are consistent with the signaling hypothesis, the share repurchase

announcement signals that the stock is undervalued.

5.2 The difference of market reaction between China mainland and Hong Kong Table 4 statistic descriptions of regression variables on the whole sample

variable Mean Median Maximum Minimum Std. Dev.

CAR[-2,10] 0.0499 0.0135 0.8132 -0.2327 0.1607 Control variables Size 21.8226 22.2611 26.6305 8.4049 3.3905 SG 0.2492 0.1694 2.7544 -0.5600 0.4144 OC 0.2913 0.1667 2.7087 -1.0027 0.4818 Lv 2.1607 1.7265 7.3353 1.0850 1.1581 MB 2.6177 1.5322 73.4344 0.0061 6.9148

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period of days -2 to 10 as dependent variable. Even though the CAR [-2, 10] of the Hong Kong sample is not statistically significant in my analysis, this study assumes that there is a positive announcement effect associated with market performance during this period in Hong Kong.

As reported in table 4, the mean of the dependent variable CAR [-2, 10] is 4.99%, and the maximum and minimum value are 81.32% and 23.27% respectively. Clearly, the market reactions to repurchase announcements reveal huge difference among the whole sample. Additionally, control variables also present big difference in their descriptive statistics. This suggests that announcing firms vary widely in their firm size, profitability, cash flow management and capital structure. Some companies are significantly undervalued or overvalued by the market before announce share repurchases.

Table 5 Multiple regression results of cumulative abnormal returns in period [-2, 10] Variable Coefficient Std. Error t-Statistic Prob.

DM -0.0777 0.0326 -2.3861 0.0188** LV -0.0073 0.0139 -0.5287 0.5981 MB 0.0040 0.0022 1.8546 0.0665* OC -0.0440 0.0329 -1.3387 0.1836 SG 0.0121 0.0367 0.3290 0.7428 SIZE -0.0015 0.0048 -0.3215 0.7485 C 0.1385 0.1021 1.3563 0.1779 R-squared 0.1136 Adjusted R-squared 0.0624 F-statistic 2.2205 Prob(F-statistic) 0.0468

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Table 5 reports the multiple regression results. As hypothesized I observe a negative coefficient of the independent dummy variable of -0.0777 at 5% significance level, which indicates that the cumulative abnormal returns during event window [-2, 10] are significantly less on the Hong Kong market than that on the China mainland markets. This empirical evidence confirms the Hypothesis 2 that China mainland markets react more to share repurchase announcements than the Hong Kong market does. Furthermore, I also observe a significantly positive relation between

market-to-book ratios and the abnormal market performance.

5.3 Robustness test

For the robustness test, I firstly change the cumulative abnormal returns calculated from period [-2, 10] to period [-1, 10] and re-run the multiple regression to examine the difference of market responses regarding share repurchase announcements in China mainland and Hong Kong. I also split the sample into subgroups basing on firm size to give more information and different insights. I choose the 25 observations with biggest firm size both from China mainland sample and Hong Kong sample as a group, and put the rest of observations as another group, and then do regressions on both subgroups. Furthermore, as shown in table 1, the announcements observations of China mainland mainly distribute in 2006, and this thesis argues that this may due to the reform of non-tradable shares implemented in China mainland in 2006. To take this effect into account, I add a dummy variable (DY) in the regression defining DY = 0, if year is 2006; year = 1, if the year is not 2006, and do the regression.

Table 6 Robustness test results

Variable Coefficient Std. Error t-Statistic Prob.

The cumulative abnormal return CAR [-1,10]

DM -0.0607 0.03137 -1.9341 0.0558*

R-squared 0.0959

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Sample of observations with top 25 biggest firm size on China mainland and Hong Kong markets

DM -0.0439 0.0466 -0.9429 0.3510

R-squared 0.1900

Adjusted R-squared 0.0770 F-statistic(P-value) 1.6812(0.1488)

Sample of the rest of observations excluding 25 biggest firm size

DM -0.1048 0.0514 -2.0396 0.0463**

R-squared 0.1305

Adjusted R-squared 0.0339 F-statistic(P-value) 1.3510(0.2512)

Adding dummy variable (DY = 0, if year = 2006; = 1, if year ≠ 2006)

DM -0.0562 0.0332 -1.6956 0.0930*

DY -0.0882 0.03757 -2.3485 0.0208**

R-squared 0.1586

Adjusted R-squared 0.1014 F-statistic(P-value) 2.7738 (0.0111)

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announcements than the Hong Kong market does. Moreover, the coefficient of DY is also negative (-0.0882) at a 5% significance level, demonstrating that share

repurchase announcements induce more abnormal returns in 2006 than in other years. I further do the same regression with sample in China mainland and in Hong Kong, respectively, and the results show that only China mainland significantly react more to repurchase announcements in 2006 than in other years (See appendix tableA6 and table A7). Since all share repurchase announced on China mainland markets in 2006 are non-tradable shares, this thesis concludes that China mainland react more to non-tradable share repurchase announcements than tradable share repurchase announcements. Furthermore, I also re-run the multiple regression with the data excluding all non-tradable share repurchases in China mainland. But the result is not significant (See tableA8). I finally add a year dummy variable defining DD =0, if year is 2008; =1, if year is not 2008 in the regression to test if the 2008 financial crisis have impacts on the market performance in China mainland and Hong Kong. The result show a significant negative coefficient of DM, showing that the financial crisis have little effect on the difference of market reactions in share repurchase

announcements between China mainland and Hong Kong (See tableA9).

6. Conclusion

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The empirical results show that listed firms from China mainland are associated with a significant positive average cumulative abnormal return of about 3.17% on their announcements, similar to the announcement effects found in prior Western countries’ studies (e.g. Stephens & Weisbach, 1998; Seifert & Stehle, 2003; Gonzalez, 2004). Furthermore, there are significantly positive abnormal returns in the period covering days before the initial announcement day, indicating that the information leakage occurs on China mainland markets. On the Hong Kong market, the cumulative abnormal returns for firms announcing share repurchases are significantly negative prior to the announcements (e.g. CAR [-9,-1] totaling -3.15% at the 1% significant level), which reveals that firms’ current share prices experience a decline before they announce share repurchases. However, these figures increase after the repurchase announcements are released. This provides strong evidence of signaling hypothesis that in order to prevent further decreases, firms use share repurchase announcements as signals to convey positive information to the market.

Comparing the abnormal market performance between China mainland and Hong Kong, this thesis concludes that the China mainland markets react more to repurchase announcements than the Hong Kong market does. Furthermore, due to the less efficient markets and various specific reasons for repurchasing shares in China, such as firms required to complete the reform of non-tradable shares, China mainland markets tend to overreact to the announcements compared to the Hong Kong market. I also find that the announcement effect is larger for small firms compared to larger firms.

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firms or insiders manipulating markets and expropriating small investors’ interests. Meanwhile, if such conducts happen frequently, the signaling effects of share repurchase announcements will become weak as well as repurchase announcement impacts on stock prices. Therefore, it is vital for financial regulators in China mainland take further actions to improve relevant laws and supervision measures, and regulate the listed firms and insiders’ behaviors thereby avoiding market manipulation and protecting small investors on markets.

This thesis also enriches the studies of share repurchases on the Hong Kong market. Compared to the listed firms in China mainland, firms in Hong Kong do not obtain as much abnormal returns as firms on China mainland markets get. This can be explained that China mainland markets tend to overreact to the share repurchase announcements, but also can be attributed to the fact that there is no disclosure requirement for share repurchases in Hong Kong. Considering this unique regulation, it can prevent firms from deliberately timing the share repurchases. However it makes the outsider investors cannot fully, timely and quickly learn the information of companies, and listed firms also miss a method to communicate to the market prior to their repurchases. Therefore, the regulations regarding share repurchase activities in Hong Kong may need to be improved, and this study provides empirical findings as the reference for future improvements.

Additionally, this thesis is also the first study that compare the difference in market reactions to share repurchase announcements between the China mainland markets and the Hong Kong market. It provides suggestions for companies that are planning to implement repurchase programs, especially for firms holding both A-shares and H-shares. And it also gives a reference for investors who intend to invest in the Hong Kong market or the China mainland markets.

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can use larger sample if available. Furthermore, since this thesis focuses on the short-term market reactions regarding share repurchase announcements, future research focusing on long run performance around share repurchase announcements is also needed. Finally, this thesis does not take the relation between the market reactions and the actual number of shares repurchased into account, further studies can include this factor in their investigations.

Reference

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Bagwell, L.S., & Shoven J.B., 1991. Cash distributions to shareholders. Journal of Economic Perspectives, 3(1): 120-140.

Baker, H.K., Powell, G.E., & Veit, E.T., 2003. Why Companies Use Open-Market Repurchases: A Management Perspective. Quarterly Review of Economics & Finance, 43(3): 483-504.

Bartov, E., Krinsky, I., & Lee, J., 1998. Evidence on How Companies Choose Between Dividends and Open-Market Share Repurchases. Journal of Applied Corporate Finance, 11:89-96.

Barth, M.E., & Kasznik, R., 1999. Share Repurchases and Intangible Assets. Journal of Accounting and Economics, 28(2): 211-241.

Bens, D.A., Nagar, V., Skinner, D.J., & Wong, M.H., 2003. Employee Stock Options, EPS Dilution and Stock Repurchases. Journal of Accounting and Economics, 36, 51-90.

The Market Reaction to Share Repurchase Announcements ------An Empirical Study of China Mainland and Hong Kong