Author(s): Bishal BC, Yatin N. Bhagwat, Marinus De Bruine
This paper studies the extent of firm level over- and under-investment in capital projects among firms with excess cash flows. Whereas most prior research looks for either the signaling or free cash flow hypothesis, we find that the motives for share repurchases differ depending on the firm’s concurrent investments in capital projects. Our initial sample contains 3,417 firm-year observations from 1998 through 2014 where we match share repurchasing firm-year observations with non-repurchasing counterparts by 8-digit GICS industry code, by fiscal year, and by size. Using two sample t-tests, we find evidence that consistent with free cash flow explanations over-investment is concentrated in repurchasing firms that face relatively lower growth opportunities, while consistent with the signaling hypothesis under-investment is concentrated in repurchasing firms that face relatively higher growth opportunities. We also find that the market reaction to share repurchases corroborates our arguments. These findings support the assertion made by others that firms shave investments in order to signal their undervalued equity with share repurchases.