A compelling reason for engaging in on-market buy-backs is that it providesa signal about the undervaluation of the company. In this paper an alternative,accounting based, method of determining fundamental value and undervaluationis used, namely the Ohlson residual income valuation framework. It is found thatprior to the announcement buy-back companies are significantly undervaluedrelative to comparable non-buy-back companies. This undervaluation is largelybut not totally removed in the period immediately following the on-marketbuy-back implying on-market buy-backs are predominantly an effectivesignaling mechanism. Where the firm cites undervaluation as a specific motivefor the buy-back then, in fact, a higher degree of undervaluation prior to thebuy-back is evident. The results provide evidence that management can, anddoes, identify undervaluation and reduces this through the signaling mechanism of on-market buy-backs (JEL: G34, G35, G38).
|Journal||Multinational Finance Journal|
|Publication status||Published - 2006|