Signaling Power of Open Market Share Repurchases in Germany: Andreas Hackethal Alexandre Zdantchouk

Fin Mkts Portfolio Mgmt (2006) 20:123–151
DOI 10.1007/s11408-006-0011-9
Signaling power of open market share repurchases

in Germany
Andreas Hackethal · Alexandre Zdantchouk
Published online: 24 May 2006

© Swiss Society for Financial Market Research 2006
Abstract This paper shows that abnormal stock price returns around the date
of open market repurchase announcements are four times higher in Germany
than in the USA (12 ver. 3%). We hypothesize that this observation can be
explained by national differences in repurchase regulations. Our empirical evi-
dence indicates that German managers primarily buy back shares to signal an
undervaluation of their firm. We demonstrate that the stringent repurchase pro-
cess prescribed by German law attributes a higher credibility to undervaluation
signals than do the lax US regulations, and thereby corroborates our hypothesis.
Keywords Open market share repurchases · Event study ·

Undervaluation signaling · Repurchase policy and regulation
JEL Classification Numbers G14 · G35
1 Introduction
In May 1998 the “Corporation Control and Transparency Act” (KonTraG)

abolished the legislation restricting share repurchasing in Germany. In the
Financial support from the E-Finance Lab, Frankfurt am Main, and from Freitag & Co., Frankfurt
am Main, is gratefully acknowledged. We would like to thank two anonymous referees for their
helpful comments.
A. Hackethal (B)
European Business School,
65375 Oestrich-Winkel,
Germany
e-mail: andreas.hackethal@ebs.de
A. Zdantchouk
Freitag & Co.,
Frankfurt am Main, Germany
124 A. Hackethal, A. Zdantchouk
subsequent 5 years, more than 180 German firms took advantage of this new
freedom to make over 240 share repurchase announcements.
The new German laws on share repurchase programs differ in important
aspects from the laws and regulations that govern share repurchase transac-
tions in the USA. For example, managers of German firms must first obtain
approval for a share repurchase program at their annual shareholder meeting
and then publicly announce the share repurchase. Management must then give
a full statement at the next shareholder meeting on the reasons for the trans-
action, its volume, and the price paid per share. In contrast, US firms need
only obtain approval from their company board and must publicly announce
the establishment of a repurchase program. They do not have to disclose the
details of any actual repurchase transactions either to the authorities or to
their shareholders. The existing empirical literature on US open market share
repurchases cited below provides strong evidence that many US firms announce
repurchase programs to convey their assessment to investors that their shares
are undervalued. A change in disclosure requirements would perhaps affect the
quality of such a signal and thus have an effect on the motivation of firms to
engage in share repurchases. An empirical analysis of share repurchases in Ger-
many therefore promises to provide new insights into the role of specific legal
provisions in instigating corporate insiders to successfully disseminate private
information to capital markets.
This paper proceeds from this general conjecture and pursues two goals.
In order to find out whether German share repurchase announcements have a
market impact different from the repurchase announcements in other countries,
we measure the abnormal share price effects around the two major publicly ob-
servable events in the context of share repurchases in Germany, namely a firm’s
initial voluntary statement to seek shareholder approval and the subsequent
obligatory announcement to begin share repurchasing. We then test four pop-
ular hypotheses on why managers repurchase shares and thereby investigate
whether motivations of German firms differ systematically from the motiva-
tions of their US counterparts. Our main empirical finding is that although both
German and US firms seem primarily to repurchase shares in order to signal
that their firm is undervalued, announcement price effects tend to be consider-
ably greater in Germany than in the USA. We discuss three possible explana-
tions for this observation and conclude that German repurchase regulations are
stricter than US regulations and therefore provide a more powerful signaling
tool.
The paper unfolds as follows: the next section describes the German legal
framework governing repurchase programs and compares this framework to
US regulations. Section 3 briefly reviews the empirical literature on repurchase
transactions in various countries. Section 4 presents the dataset, and Sect. 5
describes the methodology. Section 6 reports and discusses the empirical results.
The last section summarizes the paper and concludes with a side note to regula-
tors. Throughout the paper we concentrate on open market programs because
they have been by far the most popular vehicle in Germany.
Signaling power of open market share repurchases in Germany 125
2 Repurchase motivations
The management’s motivation to repurchase shares has already been discussed

extensively in the literature.1 The following provides only a brief review. To this
extent we have grouped the most widely discussed motivations into two cate-
gories. The five motivations from the first category are generally considered to
be in line with the shareholders’ interests. The second category contains three
motivations which tend to contravene the shareholders’ interests.
Motivations broadly in line with shareholder interests include the attempt by
the management to signal to investors that the true value of their corporation’s
equity exceeds its current market value. Such a signal might be based on the
management’s assessment that the true mean of the probability distribution of
the firm’s future cash flows is actually higher than perceived by the market.
Alternatively, the management might agree with the market on the mean of the
distribution but might believe that the variance of future cash flows around the
mean value is higher than expected by markets (Dann 1981). In the first case, all
of the firm’s risky securities appear to be undervalued. In the latter case, only
equity claims appear to be undervalued, whereas claims in the form of risky debt
might in fact be overvalued. Share repurchases might then lead to a reduction of
debtholders’ wealth to the benefit of shareholders. It is typically assumed that a
firm’s management is better informed about the firm’s true current competitive
position and its future value creation prospects than its outside investors. How-
ever, a straight public management announcement that it considers its firm’s
shares to be undervalued generally lacks credibility. Since outside investors can-
not distinguish between the true and deliberately misleading announcements,
they will regard all undervaluation announcements as cheap talk unless the
cost of producing false announcements is sufficiently high. Share repurchase
announcements incur two types of costs for overvalued firms. Firstly, firms that
repurchase overvalued shares must assume that the share price will soon decline
to its true intrinsic value so that they incur a loss from such a transaction. Sec-
ondly, firms which announce a share repurchase but subsequently decide not
to do so must expect a damaging effect on their reputation for honest market
communication. Depending on the legal and regulatory provisions for share
repurchase programs, such behavior can also attract the interest of the author-
ities to investigate potential price manipulations. Given these potential costs
as a deterrent for false announcements, share repurchase announcements can
serve as a trustworthy device to enhance the credibility of an undervaluation
signal. Such credible signals should then lead to an appreciation in stock price.
Also in line with shareholders’ interests are share repurchases through which
a firm aims to distribute excess cash to its shareholders. Excess cash gives rise to
agency conflicts as self-interested managers could use these funds for negative
net present value investments such as fringe benefit consumption or empire
building and thereby harm the firm owners (Jensen 1986). Agency difficulties
1 See for example Comment and Jarrell (1991), Stephens and Weisbach (1998) and Grullon and
Ikenberry (2000).
might also arise in situations where a firm’s management does not engage
in outright value destruction but merely runs out of value-adding investment
opportunities and retains excess cash on the balance sheet. Shareholders are
not able to reallocate their capital to more productive uses in the economy.
Both types of agency conflicts are ameliorated if excess cash is used to repur-
chase the firm’s own shares. As a consequence, share price effects of such share
repurchases should be ceteris paribus stronger for firms where manager and
shareholder interests are less aligned. Alignment is typically attained through
incentive-based manager compensation contracts or through the concentration
of control rights in the hands of large blockholders, who have stronger incen-
tives to monitor and discipline the management than dispersed owners (Shleifer
and Vishny 1986).
A third motivation concerns the optimization of a firm’s capital structure.
However, in many countries such as Germany, France, Italy, and Hong Kong,
the volume of shares to be repurchased must not exceed 10% of total shares
outstanding. Firms from such countries are therefore not able to implement
repurchase programs to substantially increase their debt-to-capital ratio and
transfer value from debt holders to shareholders. As Grullon and Ikenberry
(2000) point out, firms might nevertheless use repurchase programs to fine-
tune their capital structure in response to potential dilution effects from their
employee and executive stock options incentive plans. If the subsequent change
in the capital structure is only marginal, and if – as is typically the case – the
announcement does not provide new information on the structure of the com-
pensation plan, price effects should be quite moderate.
In countries where the tax burden on an investor’s income is typically higher
for dividend income than for capital gains, shareholder-oriented firms have a
fourth motivation to repurchase shares. Such firms should substitute dividend
payouts with share repurchases in order to maximize after-tax proceeds for
their shareholders. Although shareholders will prefer repurchases to dividends
in this scenario, price effects from individual tax-induced repurchase announce-
ments need not necessarily be strong. If the management of a given firm has
a reputation for shareholder-oriented acting, the shareholders of that firm will
expect the management to return cash in the form of repurchases and not via
dividends anyway. Repurchase announcements will then convey no extra tax-
efficiency signal. Rather these firms should experience tax-induced abnormal
share price returns in the instance where the applicable tax regime is amended
in favor of capital gains. Following such a change in the tax regime, one should
also observe an increased ratio of repurchasing firms to dividend paying firms.
The last motivation from this category is also tax-induced and applies to firms
who plan to acquire another firm. In many jurisdictions, an exchange of shares is
more tax-efficient for the target firm’s shareholders than the receipt of cash. The
acquiring firm can therefore repurchase its own shares to obtain a tax-efficient
currency for M&A transactions. Tax advantages for the target firm may then
translate into a lower acquisition price and thereby benefit the shareholders
of the acquiring firm. If the characteristics of the acquisition deal are known
ex ante, the repurchase announcement will, however, not create new market
information and should therefore leave the acquirer’s market value unchanged.
Motivations that tend to contravene shareholders’ interests include manage-
ment’s efforts to fend off a value-creating takeover attempt. Target management
must fear that it will be ousted as a consequence of such a takeover and that it
will typically not be compensated for any losses in future income and private
benefits. Target management might then use share repurchases as a defense
instrument to reduce the amount of outstanding shares available to the raid-
ing firm from dispersed outside shareholders as well as to deplete any cash
reserves obtainable through the acquisition. Bagwell (1991) provides a more
subtle argument as to how share repurchases can deter a takeover. She argues
that shareholders who tender in a repurchase typically have lower valuations
for the firm than the average shareholder. This heterogeneity in valuations
might leave the raider with a more “expensive” pool of shareholders after the
repurchase, possibly deterring him from making a takeover offer. Given the
above-mentioned restrictions on the volume of shares to be repurchased in
Germany, the chances of fending off a takeover by the sole means of share
repurchases are probably quite low. However, share repurchase can be just one
of several defensive measures taken by incumbent target management and as
such might indeed contribute to shareholder value destruction.
A second situation in which share repurchases can violate the interests of
at least one group of shareholders arises when only inside shareholders are
informed of the exact timing of repurchase transactions. They can then use this
knowledge to dispose of their shares at a higher price than under normal market
conditions (Ikenberry and Vermaelen 1996). This would cause a wealth transfer
from outside shareholders to inside shareholders and, if anticipated by outside
shareholders, lead to a negative announcement effect.
Finally, managers who hold a substantial equity stake in their firm might
launch a repurchase program in an attempt to dilute the control rights of other
shareholder groups. Even if these other shareholders are not willing to sell their
shares to the firm, the transaction costs associated with such an attempt could
have a negative value impact.
If the market believes that a firm is driven by one or several motivations
from the first (second) category, one should observe positive (negative) price
effects around the repurchase announcement date. Contrarily, if the market
has no prior awareness of the motivations of a given firm, its share price should
not react at all in response to an announcement. Repurchase firms are then
believed to pay out cash to shareholders that would have yielded a return on
capital equal to the cost of capital if kept inside the firm. Thus, unless the firm
uses underproductive assets to finance the payout (equivalent to the excess
cash distribution hypothesis above), total future earnings will decline by the
same proportion as the number of shares outstanding, and earnings per share
(EPS) will remain unchanged. Repurchase firms that solely attempt to boost
valuations based on increased EPS should not be successful if the market is
aware of such an attempt. The “EPS bump” argument, which is often advocated
by investment banks, analysts, and the firms themselves, can therefore be ruled
out by simple logic (see Grullon and Ikenberry 2000).
In this paper we confine our testing to four out of the eight hypotheses
regarding potential motivations of German firms to repurchase shares: the
“undervaluation signal”, the “excess cash”, the “takeover defense”, and the
“tax efficiency” hypotheses. As will be shown in the next section, the “rent
seeking by insiders” motivation is largely ruled out by German law, so that
the associated hypothesis can be falsified immediately. There are two reasons
why we refrain from testing the remaining three hypotheses in this paper. The
first is methodological. Our empirical approach is based on regressing abnormal
returns from share buy-back announcements on firm characteristics. As we have
argued above, buy-back announcements that are driven either by the “capital
structure optimization”, the “acquisition currency”, or the “control dilution”
motivation would most likely result in very small share price reactions. We
therefore have reason to believe that even covariates that ideally captured any
of these three motivations would carry statistically insignificant coefficients in
our regression model. The second reason concerns data availability. Informa-
tion on optimal capital structure, acquisition plans, and on the balance of power
among shareholder and stakeholder groups is generally not available.
3 Share repurchase regulation in Germany and in the USA
The German Corporation Control and Transparency Act (KonTraG) became

effective on May 1, 1998, permitting German firms to repurchase common
and preferred shares under the following conditions and subject to the fol-
lowing requirements: a share repurchase program must first be authorized by
the firm’s annual general meeting of shareholders (AGM). The AGM decides
on the maximum amount of shares to be repurchased. The amount must not
exceed 10% of total shares outstanding2 , and the repurchase must be made out
of distributable profits. The AGM also determines the time frame during which
transactions can take place. This period must not exceed 18 months. In addition,
shareholders decide on the precise buy-back procedure unless the firm plans
to repurchase shares over the open market.3 AGM approval is immediately to
be reported to Germany’s financial services authority (BaFin). AGM approval
does not oblige a firm to actually repurchase shares. In section 4 we show that
more than two thirds of German firms did not act upon AGM approval. When
2 A 5% threshold applies to financial institutions trading for their own purposes [section 71 (1) Nr.
7 AktG]. The law does not specify whether the thresholds apply to the total stock of repurchased
shares held in treasury or solely to one 18-month period. In the latter case, firms could in principle
buy back a substantially higher portion of own shares by obtaining AGM approval in subsequent
years. For a discussion of this ambiguity see Kraft and Altvater (1998) and Bosse (2000).
3 Existing types of non-open-market buy-backs include fixed-price tender offers, where the corpo-
ration offers to buy a specified amount of shares at a fixed price – typically exceeding current market
prices – during a pre-specified period; Dutch-auction tender-offers, which are similar to fixed-price
tender offers, except that prices are set in a book-building procedure and targeted buy-backs, where
the corporation negotiates with a particular shareholder over the purchase of a block of shares.
a firm wishes to repurchase shares over the open market, it must make a pub-
lic announcement in advance. This announcement does not have to state the
volume of shares to be repurchased and is not binding for the firm, i.e., the
firm can still choose not to transact. Should it repurchase shares, transactions
must be conducted in such a way that all the firm’s shareholders are treated
equally. Moreover, transactions must not be used for the purpose of trading. In
the AGM following a transaction, the firm has to issue a full statement as to the
reason for the share repurchase, how many shares were involved, and at what
price they were repurchased.
In their totality, these legal provisions strongly mitigate the motivations that
we discussed in our introduction as not being commensurate with the interests
of (outside) shareholders. Firstly, the requirement for equal treatment of all
shareholders in combination with the obligation to obtain an explicit AGM
authorization for tender offers or targeted buy-backs strongly impedes wealth
transfers from one shareholder group to another. In fact, a mere four out of
the 237 buy-back announcements in our initial sample were not open market
programs. Secondly, because the amount of equity to be repurchased is capped
at 10% of total nominal capital, the opportunities for substantially changing a
firm’s capital structure or deterring a takeover are fairly limited. For example,
an inside blockholder must ex ante hold more than 45% of total share capital
to achieve a majority stake in excess of 50% of share capital after a full 10%
repurchase transaction.4 Moreover, the fact that repurchased shares held in
treasury are not entitled to voting rights impedes control right dilution.
German regulations can also impose considerable costs on firms who make a
misleading repurchase announcement. Firstly, the costs of establishing a repur-
chase program are not trivial because AGM approval is required. Secondly,
firms who publicly announce an imminent repurchase transaction, but then do
not actually repurchase any or only a miniscule amount of shares, must fear
that regulators suspect price manipulation and initiate investigations. Share-
holders of these firms will most likely also demand inquiries, possibly calling
into question the managers’ reputation for truthful disclosures. Repurchasing
and immediately reselling shares is also not a viable option for this type of firm
since such behavior would certainly be viewed as trading in own shares, which
is explicitly prohibited by law. Generally, higher expected costs of misleading
repurchase announcements will reduce the occurrence of such announcements.
In turn, such costs increase the strength of the signal that honest managers can
communicate to the market by means of a repurchase announcement. Arguably
then, the strictness of German repurchase regulations allows for fairly strong
signals.
4 In fact, Gerke et al. (2003) report that German firms have on average only bought back 3.2% of
their outstanding shares. This figure is actually not too far off the corresponding US figure. Grullon
and Michaely (2002) report that the median US firm sought to repurchase 5% of its outstanding
shares and Stephens and Weisbach (1998) find that US firms completed roughly 75% of their
authorized shares during a 3-year period after the announcement.
US regulations on open market share repurchasing differ in several impor-

tant aspects from German laws.5 In the USA, share repurchase programs only
require approval from the board of directors rather than the AGM. There is
neither a restriction on the duration of the program nor on the number of
shares to be repurchased. Stephens and Weisbach (1998) report that it is indeed
not uncommon that US open market programs are spread out over several
years. Apart from making an initial public announcement, firms are not obliged
to formally disclose any details of their repurchase programs or their individ-
ual repurchase transactions. As a consequence, both the costs for establishing
a repurchase program and the penalties for not buying back shares after an
announcement are lower in the US than in Germany. Moreover, US firms have
more flexibility in terms of transaction volume and timing. This leaves more
opportunities for corporate insiders to extract rents from corporate outsiders.
Two broad empirical implications follow from these discrepancies between
the German and US repurchase regulation. We would expect a smaller portion
of negative abnormal announcement returns in Germany than in the US and, if
both German and US firms are mainly motivated by signaling undervaluation,
we would also expect that positive returns are on average higher in Germany
than in the USA.
4 Related empirical literature
The empirical literature on stock buy-backs has so far largely focused on US

markets. A number of clear-cut results have emerged. Share repurchases lead to
significant positive abnormal returns on average; however, stock price reactions
to tender offers tend to be at least twice as strong as reactions to open market
transactions. Masulis (1980), Dann (1981), Vermaelen (1981), and Comment
and Jarrell (1991) find that abnormal returns from fixed price tender offers are
well in excess of 10% and that the average premium of the tender over the mar-
ket price is more than 20%. According to Comment and Jarrell (1991), Dutch
auction tender offers lead on average to an abnormal return of 8% during the
3 days around the announcement. In contrast, open market transactions by
US corporations were found by virtually all studies to result in much smaller
abnormal returns of approximately 3% (see Table 1).
The studies cited so far all provide strong evidence for the validity of the
undervaluation signal hypothesis. Ikenberry et al. (1995) observe a strong neg-
ative relationship between the market-to-book ratio prior to the buy-back
announcement and the magnitude of positive abnormal returns thereafter.
Abnormal returns were also found to be larger for firms whose stocks un-
derperformed in the market during the days before announcement (Stephens
and Weisbach 1998; Comment and Jarrell 1991; Ikenberry et al. 1995). Both
results reconcile neatly with the view that the higher the potential is for
5 For an international overview on the open market share repurchase regulations see Kim et al.
(2004). The regulations in other European Union countries are fairly similar to those in Germany.
Table 1 Prior empirical results on abnormal returns from announcing open-market repurchase
programs (OMR)
Country Study Abnormal returns Dataset
US McNally (1999) CAR [−1; +1]: 2.5% 702 OMR (1984–1988)

Grullon and Michaley (2002) CAR [−1; +1]: 2.7% 4,443 OMR
(1980–1997)
Vermaelen (1981) CAR [−1; +1]: 3.7% 243 OMR (1970–1978)
Stephens and Weisbach (1998) CAR [−1; +2]: 2.7% 591 OMR (1981–1990)
Ikenberry et al. (1995) CAR [−2; +2]: 3.5% 1,239 OMR
(1980–1990)
Comment and Jarrell (1991) CAR [−1; +1]: 2.3% 1,197 OMR
(1984–1988)
Australia Lamba and Ramsay (2000) CAR [−1; +1]: 3.3% 103 OMR
(1989–1998)
Canada Li and McNally (1999) CAR [−2; +2]: 3.6% 183 OMR (1989–1992)
Ikenberry et al. (2000) CAR [−15; +15]: 0.9% 1,060 OMR
(1989–1997)
France Ginglinger and L’Her (2006) CAR [0; +1]: 0.6% 363 OMR (1998–1999)
Germany Schremper (2002) CAR [−1; +1]: 4.1% 112 (mostly) OMR
(1998–2000)
Gerke et al. (2003) CAR [−1; +1]: 6.1% 120 OMR (1998–2000)
Seifert and Stehle (2003) CAR [−1; +1]: 5.9% 192 OMR (1998–2003)
Japan Zhang (2002) CAR [−1; +2]: 6.0% 39 OMR (1995–1999)
Korea Jung and Lee (2003) CAR [0; +5]: 2.8% 382 OMR (1994–1998)
Switzerland Dumont et al. (2004) CAR [−2; +2]: 1.8% 10 OMR (1999–2003)
UK Rau and Vermaelen (2002) CAR [−2; +2]: 1.1% 126 OMR (1985–1998)
Oswald and Young (2002) CAR [−1; +1]: 1.4% 266 (mostly) OMR
(1995–2000)
Rees (1996) CAR [−2; +2]: 0.3% 882 OMR (1981–1990)
an actual undervaluation, the stronger are the signaling effects. Vermaelen

(1981) shows evidence that the strength of the signal is also a function of
its credibility. He discovers that abnormal returns increase in the amount of
shares held by management as well as in the announced portion of outstand-
ing equity to be repurchased (see also Comment and Jarrell 1991; Ikenberry
et al. 1995). The assumption is that signal credibility increases if manager wealth
is at risk. Moreover, the extent of information asymmetries between manage-
ment and investors also seems to have a bearing on announcement effects.
Ikenberry et al. (1995) document that price effects are inversely related to
firm size. Given that smaller firms disclose less information to capital markets
and are less researched by equity analysts, information asymmetries should
decrease with firm size. Taken together, buy-backs seem to serve as a credible
signaling device for managers who seek to convey to investors that the market
capitalization of their firm is lower than its true value.6
Among others, Shoven and Simon (1987), Bagwell and Shoven (1988), Evans
et al. (2000), and Li and McNally (1999) have explicitly tested the validity of the
6 Further studies that underscore this insight include Netter and Mitchell (1989) and Bartov (1991).
Wansley et al. (1989) directly assess buy-back motivations by means of questionnaires and found
that perceived undervaluation was indeed one of the most frequently quoted motivations.
free cash flow hypothesis. They find a positive correlation between abnormal
returns and measures of excess funds at the discretion of management. They
conclude that buy-backs can be an effective means of convincing the market
that management does not invest excess funds into high-private-benefit, low-
NPV projects. Moreover, Stephens and Weisbach (1998) observe that firms with
more excess cash ceteris paribus tend to buy back a larger volume of shares,
indicating that repurchases are indeed used by some firms to reduce excess cash.
Bagwell and Shoven (1989) provide some evidence that is inconsistent with
the tax efficiency hypothesis. Cash distributions through repurchases have not
declined in the US immediately subsequent to the 1986 Tax Reform Act al-
though the act abolished the tax advantage of repurchases over dividends. Lie
and Lie (1999) qualify this result by showing that a large number of US firms
did indeed prefer regular dividend increases over open market repurchases in
the late eighties.
Some studies have measured market reactions to US repurchase announce-
ments that were perhaps motivated at least to some extent by a firm’s objective
to deter a takeover attempt. Dann and DeAngelo (1988), Davidson and Gar-
rison (1989), and Denis (1990) observe negative abnormal stock price returns
and thereby corroborate the hypothesis that this type of buy-back transaction
violates shareholders’ interests.
In summary and not surprisingly, there is no single overriding motivation for
US firms to repurchase shares. However, “undervaluation signaling” seems to
be the most prominent motivation.
Empirical results for other countries are broadly in line with those for the
USA. Cumulative returns around the announcement day are on average strictly
positive (see Table 1), and evidence of the motivation to repurchase shares is
mostly consistent with the undervaluation signaling hypothesis. The UK, how-
ever, marks an exception. Rau and Vermaelen (2002) argue that legal restric-
tions severely constrain UK firms in using repurchase announcements as an
undervaluation signaling device. For example, UK firms are not permitted to
repurchase shares in the 2-month period preceding earnings or when directors
possess price-sensitive but unpublished information about the firm. The authors
suggest that repurchases are largely motivated in the UK by tax consequences
for institutional shareholders such as pension funds.
We are aware of three related empirical studies for Germany. Schremper
(2002) analyses 112 buy-back announcements from the period between May
1998 and December 2000 and finds significant abnormal returns of around
2.6%. The sample of Gerke et al. (2003) comprises 120 buy-back announce-
ments from May 1998 to December 2002, which are uncontaminated by other
coincidental news events. The authors find average abnormal returns on the
announcement day of 6.1%. They subdivide their sample to measure differ-
ences in abnormal returns between a) firms that either belong to the DAX
100 index (+2.7%), the Nemax index (+9.0%), or the small cap index (+4.8%),
b) firms that either stated undervaluation (+8.9%) or the exchange of cash into
a superior acquisition currency (+5.2%) as their main repurchasing motivation,
and c) announcements that occurred during the general upturn of German
equity markets between May 1998 and February 2000 (+3.7%) and announce-
ments that occurred during the subsequent bear market (+7.1%). Seifert and
Stehle (2003) largely confirm the results of Gerke et al. (2003) but reject their
findings on the effect of bull and bear markets on price effects. We extend the
existing empirical literature on German repurchase announcements by using
a larger sample size, by investigating price effects around the initial disclosure
to seek AGM approval for a buy-back plan, and by conducting multivariate
regression analyses on a richer set of independent variables.
5 Data
Data on AGM approvals of share repurchase plans can be downloaded from the
website of Germany’s financial services authority BaFin (http://www.bafin.de).
The BaFin reports the names and addresses of the firms and the day on which
they obtained AGM approval. From May 1998 until April 11, 2003, 483 corpo-
rations sought AGM approval for a total of 785 buy-back plans. Roughly 70%
of the approvals were granted in the three months May, June, and July, when
most AGMs take place in Germany. However, we do not treat AGM approval
as a price-relevant event for two related reasons. Firstly, the information that a
firm plans to establish a repurchase program has to be communicated to cap-
ital markets well in advance of the AGM. Secondly, repurchase programs are
approved by the AGM in the vast majority of cases, so that “surprises” are
very rare. As a consequence, we conducted a key-word search on several news
databases such as Reuters, Bloomberg, and Factiva to find reports on initial
statements by German firms which were considering establishing a repurchase
program in the near future. This search strategy yielded 321 such statements.
We matched initial statements with AGM approvals to measure the time that
typically elapsed between these two events. As shown in Figure 1 below, AGM
approval occurred on average 27 weeks after the initial statement.
Finally, we searched the ad hoc announcements database of the Deutsche
Börse AG and the news databases mentioned above to find announcements by
firms with authorized repurchase programs that they intend to buy back shares.
For our observation period from May 1, 1998, to April 11, 2003, we identi-
fied 237 common share buy-back announcements by 181 different German
firms. Figure 2 shows the number of announcements per month. Repurchase
announcements were made on average 21 weeks after the AGM took place
(see Figure 1 above). Taking into account that 761 AGM approvals occurred
Intention to obtain AGM AGM authorization Announcement(s) of imminent

authorization for buy-back plan of buy-back plan buy-back transaction
time
3- 125 weeks 3- 77 weeks
(average: 27 weeks) (average: 21 weeks)
Fig. 1 Time line of share repurchase programs in Germany

15
'98: 4 '99: 51 '00: 67 '01: 63 '02: 43 '03: 9
12
10 9
8 8 8 8 8 8 8
7 7 7 7 7 7 7
6 6 6
5 5 5 5 5
5 4 4 4 4 4 4
3 3 3 3 3 3 3
2 2 2 2 2 2
1 1 1 1 1 1 1 1 1 1 1
0 0 0 0 0 0
May-98
Nov-98
May-99
Nov-99
May-00
Nov-00
May-01
Nov-01
May-02
Nov-02
Jul-98
Sep-98
Jan-99
Mar-99
Jul-99
Sep-99
Jan-00
Mar-00
Jul-00
Sep-00
Jan-01
Mar-01
Jul-01
Sep-01
Jan-02
Mar-02
Jul-02
Sep-02
Jan-03
Mar-03
Fig. 2 Share repurchase announcements in Germany (N = 237)
in the period from May 1, 1998, to Nov. 15, 2002 (22 weeks prior to the end of
our observation period), this implies that only three out of ten AGM approvals
were actually followed by a repurchase announcement.
For the purpose of our event study, we dropped all initial statements for
which we were not able to pinpoint the exact day of the very first news release
(e.g., because the statement was part of the invitation letter to the AGM) or
for which we identified coincident, confounding news (e.g., because the state-
ment was buried in a more comprehensive disclosure of material information).
This filtering technique significantly reduced the number of initial statement
observations to 111. Of the 237 observations on repurchase announcements,
we dropped four because they concerned tender offers.7 We excluded another
nine observations due to coincident confounding events such as a board change
or an earnings disclosure. Thus, 224 repurchase announcement observations
remained in the sample.
For the sake of brevity and for the sake of comparability with US studies,
we decided to conduct a regression analysis only for the abnormal returns from
repurchase announcements and not for abnormal returns from initial state-
ments. In the following we define the variables used as covariates. Table 2
below shows the corresponding descriptive statistics.
• MTB: The Market-to-Book (MTB) ratio is defined as the market value of
equity 2 days before the announcement date divided by the book value
of equity as reported in the most recent financial statement prior to the
repurchase announcement. The higher the MTB ratio of a firm, the higher
investors’ expectations are with regards to the firm creating economic value
7 These are AGIV (4-Apr-00, fixed-price tender offer to common shareholders), Friedrich Gro-
he (7-Oct-99, fixed-price tender offer to minority holders of preferred stock), Kögel Fahrzeuge
(7-Dec-98, fixed-price tender to common shareholders) and Krones AG (18-Jan-99, Dutch-auction
tender offer to common shareholders).
Table 2 Descriptive statistics (N = 224)
Dependent variables Independent variables Independent dummy variables

AR CAR CAR MTB SIZE PAST CASH Averages
[0] [−1; +1] [−1; +10] RETURN
(%) (%) (%) (%) (%)
Max. 40.6 36.8 56.5 14.80 11.55 49.6 125.3

Min. −13.6 −18.5 −36.6 0.18 1.76 −71.8 1.3 NMLISTING 0.43 TARGET 0.08
Avg. 4.9 6.0 7.0 2.55 5.49 −11.1 39.3 UNDERVAL 0.43 CONT.25 0.33
Median 3.1 4.6 5.0 1.71 5.06 −7.9 32.1 SERVICE 0.29 CONT.50 0.35
Stdev. 7.8 9.4 14.3 2.78 2.10 21.2 30.4 FINANCIAL 0.13 CONT.75 0.11
in the future. Firms with high MTB ratios are therefore often referred to as
“growth” firms. Expectations are more modest for so-called “value” firms
with low MTB ratios. As is done in most other related studies, we argue
that for value firms perceived undervaluation is a more likely factor in the
decision to repurchase than for growth firms. A negative relation between
abnormal returns and MTB would then be consistent with the “undervalua-
tion signaling” hypothesis.
• SIZE: Firm size is expressed as the logarithm of the firm’s enterprise value
in million Euros. Enterprise value is defined as the sum of the market value
of equity and the book value of interest bearing debt. Size is treated as a
proxy for the extent of information asymmetries between a firm and capi-
tal markets. The larger a firm, we argue, the more stringent the disclosure
requirements will be, and the more analysts will cover the firm resulting in a
greater amount of firm-specific information being publicly available. Manag-
ers of small firms thus have more potential in signaling private information
by means of repurchase announcements than managers of large firms.
• NMLISTING: This dummy variable is set to 1 if the firm was traded on the
Neuer Markt – a by now abolished segment of the German stock exchange for
young and innovative firms. Like SIZE, NMLISTING also serves as a proxy
for information asymmetries between the company and its investors. Firms
listed on the Neuer Markt are typically characterized by shorter track records
and a higher degree of uncertainty regarding future industry prospects than
more mature firms listed on other exchange segments. As a consequence,
signals should be more powerful and abnormal returns should be higher for
Neuer Markt firms.
• PASTRETURN: This variable measures the cumulated returns of a firm’s
stock over the 30 day-period prior to our event window [−31; −2].8 Like the
variable MTB, it attempts to capture the potential for undervaluation of a
firm’s stock. Of course, a poor stock price performance prior to a repurchase
announcement may simply reflect a true decline in firm value. However,
8 We have used both absolute and abnormal returns in our regressions. The coefficients and their
statistical significance levels are virtually the same for the two alternative specifications.
Table 3 Motivations to repurchase shares as declared by management (N = 185)
Number of declarations Percent of 185 sample firms
Acquisition currency 107 58

Undervaluation 96 52
Employee participation programs 32 17
Cancellations/pay-outs to shareholders 27 15
Other 5 3
Sum 267
there is ample empirical evidence that markets tend to overshoot in both

directions in their assessments of firms’ fundamental value (Shiller 2000).
Arguably then, the potential for undervaluation is larger for firms with a
poor prior stock performance than for those with positive past returns. We
expect a negative relation between PASTRETURN and price effects around
the announcement. While not shown in this paper, we also ran regressions
with PASTRETURN variables for the 45-day and the 60-day periods preced-
ing the announcement event. We found that results are not affected by the
choice of period length.
• UNDERVAL: This dummy variable is set to 1 if a firm states “undervalua-
tion” as a main motivation for repurchasing own shares. Although German
firms are not legally obliged to disclose their motivations for share buy-backs
ex ante, it is common practice that they provide such information voluntar-
ily as part of the announcement. Out of the 224 firms in our final sample,
185 disclosed their motivations.9 In many cases more than one motivation
was stated. Table 3 below reports the total number of declarations and the
percentage of firms per type of motivation. 96 or roughly one half of the
firms stated a perceived undervaluation of their stock as a primary reason to
buy back shares.10 If such an undervaluation were credible, we would expect
abnormal returns for repurchase firms that state undervaluation as their main
motivation to be ceteris paribus higher. However, because there is no penalty
for wrong statements, also firms that are in fact not undervalued would face
strong incentives to declare undervaluation as one of their motivations. We
therefore assume that rational investors treat voluntary statements regarding
repurchase motivations as cheap talk, and we expect to observe no difference
in announcement effects between firms stating different motivations.
• CASH: This variable is defined as the amount of liquid assets over the book
value of equity.11 It is used as a proxy for the amount of free cash that is
at the disposal of managers in relation to the amount of capital provided by
shareholders. If the cash position is large, and if the firm does not possess
9 UNDERVAL was set to zero for the 39 firms that did not specify their motivations.
10 In the Canadian sample of Li and McNally (1999), more than two-thirds of the 183 firms stated
undervaluation as their main motivation.
11 In section 6 we also discuss empirical results for an alternative specification that carries the
market value instead of the book value of equity in the denominator (CASH/MTB).
enough profitable investment opportunities, investors will welcome share

repurchases as a means to avoid negative-NPV projects in general and pri-
vate benefit consumption by managers in particular.
• CONTROL25, CONTROL50, and CONTROL75: These dummy variables
are set to 1 if the aggregate holdings of the two largest shareholders exceed
certain threshold values.12 Control25 is 1 for holdings greater or equal to 25%
and below 50% of total shares outstanding. CONTROL50 is 1 if holdings are
greater or equal to 50% and smaller than 75%. CONTROL75 is 1 if holdings
are 75% or greater. We attempt to measure any price effects that might arise
from a firm’s specific governance structure. If a firm is controlled by only a
few large blockholders, minority outside shareholders may have to fear that
inside blockholders will exercise their power in their own interest, e.g., by
inducing the firm’s management (which in the case of manager- and family-
controlled firms might actually be identical with or at least closely related to
blockholders) to transact with them at favorable terms or to invest in pro-
jects that one-sidedly benefit them.13 If the extraction of private benefits by
inside shareholders is indeed prevalent, one should expect greater positive
price effects for firms with highly concentrated ownership. In these cases, a
buy-back implies an unexpected payout of cash that outsiders might interpret
as a signal for a closer alignment of insider and outsider interests.
• TARGET: In section 1 we argued that managers can destroy shareholder
value by repurchasing shares solely in an effort to fend-off a value-creating
hostile takeover attempt by a raider. Because the threat of such an attempt
may have only been known to target firm managers but not to the public
at the announcement date, it posed a big challenge to identify target repur-
chase firms in our sample. We therefore searched for situations in which it
was more likely that target firm managers indeed used repurchases to pro-
tect their control rights against potential raiders. TARGET only takes on the
value 1 if both of the following conditions are satisfied: Firstly, repurchas-
ing shares must bear the potential of reducing the free float held by outside
shareholders to a level that would make it difficult for raiders to acquire a
controlling stake in the firm over the open market. Consequently, we require
that the free float on the announcement date be below 25%.14 Secondly,
we require that managers or family owners have a substantial but not the
12 Alternative specifications based on the holdings of the largest single shareholders and the
aggregate shareholding of the three largest shareholders leave empirical results regarding control
structure and announcement effects unchanged.
13 Ehrhardt and Nowak (2003) show in their empirical analysis that private benefits for family
blockholders can indeed be very large in German firms and that stocks of firms where founding
families own more than 75% underperformed their peers significantly over a three-year period.
Nenova (2003) finds that the value of corporate voting rights, which can be interpreted as lower
bound for actual private benefits of the controlling shareholders, was more than twice as high in
Germany than in the US in 1997.
14 While not reported in this paper we also ran regressions based on alternative threshold values
for the free float (30 or 35%). Empirical results remained unchanged.
majority equity stake in the firm.15 Only then must inside shareholders fear
that raiders can acquire sufficient control in the firm and subsequently curb
existing opportunities for insiders to extract private benefits from the firm.
This situation is most likely if the combined stake of managers and family
owners is between 25 and 50%.
• FINANCIAL and SERVICE: We introduced two industry dummies to con-
trol for industry effects. FINANCIAL is 1 if a firm belongs to the financial
services sector, and SERVICE is 1 if a firm belongs to all other service indus-
tries. For firms from the manufacturing industry, both dummies are set to zero.
In an extended model, we have also controlled for time effects by including
dummies for the years 1999–2003. Because no trend emerged, and because
the results for the other variables remained unchanged, we omit the results
for such an extended model in this paper.
If the “undervaluation signal” hypothesis holds, the coefficients for MTB,

SIZE, and PASTRETURN should all carry negative signs, and NMLISTING
should carry a positive sign. If managers aim to reduce agency difficulties by
liberating excess cash, the coefficient for CASH should carry a positive sign.
Positive coefficients for CONTROL50 and CONTROL75 would provide addi-
tional evidence for a reduction of conflicts of interests between corporate insid-
ers and outsiders. Finally, a negative and statistically significant coefficient of
TARGET would be consistent with the “takeover deterrence” hypothesis.
6 Methodology
We conduct a standard market-model event study to measure price effects from

buy-back announcements. Price effects correspond to abnormal returns on a
firm’s stock on the announcement day [0] or over a short time window sur-
rounding that date (e.g., days [−1; +1]). Expected “normal” daily returns R∗it
are derived from a CAPM market model. We use daily share price returns dur-
ing the time window [−270; −60] and the ordinary least square (OLS) model in
(1) to estimate the parameters for the market model.
Rit = αi + βi Rmt + εit for t = −270, −269, . . . , −60

with E(εit ) = 0 and Var(εit ) = σ 2 (εit ). (1)
Share price data are taken from Datastream, and daily returns for day t are
computed by subtracting the natural logarithm of the share price at the end of
day t-1 from the natural logarithm of the share price at the end of day t. Market
returns are based on the broadly defined Composite DAX (CDAX) index.
15 Because managers affiliated with the owner family could well have a different surname, we were
not able to distinguish between managing families and pure owner families.
Coefficient estimates from (1) and daily market returns are entered into (2)
to obtain expected returns R∗it for the shares of firm i.
R∗it = ai + bi × Rmt
for t = −30, −29, . . ., +29, +30. (2)
Abnormal returns for day t are defined as the difference between the observed
return and the expected return for that day [see (3)].
ARit = Rit − R∗it

for t = −30, −29, . . ., +29, +30. (3)
The t statistics in equations (4) and (5) are used to test the null hypothesis that
abnormal returns on a particular day and cumulative abnormal returns for a
given period [t; t+n] are not different from zero.
ARit
T= with σ (ARi ) equal to the standard error of the
σ (ARi )
estimate from (1) (4)
CARit+n
t+n
T= √ with CARit+n = ARi,j . (5)
( n · σ (ARi ))
j=t
We use OLS-regression with White-corrected standard errors to directly test

three hypotheses regarding the motivations of German firms to repurchase
shares. As noted above, the “tax efficiency” hypothesis cannot be tested this
way. However, because Germany experienced a substantial shift in its tax regime
in the middle of our observation period, we are able to provide indirect evidence
on the validity of this fourth hypothesis.
7 Empirical results
7.1 Abnormal returns
Figure 3 below plots average cumulative abnormal stock returns for the 121-day
period surrounding the 111 initial statements by German firms that they seek
AGM approval for a share repurchase plan.
Cumulative abnormal returns are virtually zero until 5 days before the event,
but significantly positive thereafter. While the average price effect on the event
day itself is only a moderate 1.5%, cumulative price effects jump to over 5% for
the 11 days surrounding the event day. There are two mutually non-exclusive
explanations why positive abnormal returns can already be observed shortly
before day zero. Firstly, although we have carefully searched for the very first
CAR, %
10%
AR [0] = 1.47% (4.86)
CAR [-1;+1] = 2.53% (4.84)
CAR [-1;+5] = 2.87% (3.59)
CAR [-5;+5] = 5.21% (5.19)
CAR [-15;+15] = 6.89% (4.10)
5%
Days
0%
-60 -50 -40 -30 -20 -10 0 10 20 30 40 50 60
-5%
Fig. 3 Average cumulative abnormal returns from statements to seek AGM approval for a buy-
back plan (N = 111) Note: Parentheses show t-statistics. Corresponding median values are 0.89%
for AR[0], 1.75% for CAR[−1; +1], 1.69% for CAR[−1; +5], 4.43% for CAR[−5; +5] and
−5.22% for CAR[−15; +15]
point in time when information on the initial statement was publicly available,
we may have missed some items of public information that had been disclosed to
the markets in advance. Secondly, positive pre-announcement abnormal returns
can indicate that no public information was available prior to the firm’s state-
ment, but that firm insiders traded on their private information regarding such
an imminent statement.
Given that cumulative abnormal returns around the initial statement to seek
AGM approval total around 5%, we can roughly infer the expected average
magnitude of abnormal returns from a subsequent repurchase announcement.
The price reaction (RA = 1 + rA ) around date A of the initial statement should
be a positive function of the expected abnormal share price appreciation on
the later repurchase announcement date B(RB = 1 + rB ) and the probability p
that investors assign to the actual occurrence of a buy-back announcement.16
16 We use the same value for p for all firms and thereby implicitly assume that investors do not
estimate that probability conditional on some observable firm characteristics. Would they do so,
abnormal returns around the initial announcement to seek AGM approval should be different for
firms with a high probability and for firms with a low probability to subsequently repurchase shares.
To test for differences in abnormal returns from the initial announcement we subdivided the sample
of 111 firms into a subsample of repurchase firms and a subsample of non-repurchase firms. We
found that average abnormal returns do not differ in a statistically significant way between the two
subsamples. Therefore, one can largely rule out the possibility that investors are ex ante able to
systematically discriminate between firms that subsequently repurchase shares and those that do
not.
Taking on the perspective of a risk neutral investor who, at date A, determines

the maximum share price appreciation RA at which it is no longer worthwhile
to buy the stock in question, we can write:17
RA = p × (RA × RB ) + (1 − p)1. (6)
Collecting terms and solving for RB yields
1 (1 − p)
RB = − . (7)
p (p × RA )
From section 4 we know that the unconditional probability that AGM approval
of a share repurchase plan is followed by a repurchase announcement is 237/
761=31.1%. Inserting p = 0.311 and rA = 5.21% (=CAR[−5; +5]) into equa-
tion (7) yields an expected abnormal return of rB = 11.0% for the repurchase
announcement. If we insert rA = 2.87% (=CAR[−1; +5]), rB drops to 6.2%.
Figure 4 below shows average cumulative abnormal returns around the 224
dates in our sample when German firms announced their intention to repur-
chase their own shares over the open market. Average abnormal returns on the
event day are positive at 4.9%, with 83% of the sample firms showing positive
abnormal returns. Abnormal returns are also positive on average over the
subsequent days. Cumulative abnormal returns are roughly 6% for the event
window [−1; +1] and almost 7% for the event windows [−1; +5] and [−1; +10].
All return figures are significantly different from zero at the 1% level. Figure 4
also shows that share prices of German sample firms experienced a conspicuous
abnormal downward trend over the thirty trading days before the announce-
ment date. Comment and Jarrell (1991) document a very similar pattern in
their analysis of some 1,200 US open market repurchase programs. Announce-
ments are preceded in their study by negative net-of-market stock performance,
and positive excess price effects reverse about half of this underperformance.
In Germany, abnormal returns for the thirty post announcement days reverse
almost the entire 30-day pre announcement underperformance. However, if
one looks at a wider event window from day −60 to day +60, in fact the very
same pattern as in the USA emerges.
Can observed price effects around date B be reconciled with the expected
price effects implied by the abnormal returns around date A? In fact, observed
post announcement returns (roughly 7%) lie within the expected range (roughly
6% to 11%). However, observed cumulative returns for a wider event window
of, say, 60 days before date B to 60 days after date B are negative on average
and therefore clearly lie outside the expected range. Given that positive post
announcement returns typically do not fully compensate for preannouncement
underperformance, rational investors should factor in such a pattern into their
assessments of a firm’s value on date A. In such a scenario, we would expect
17 For the sake of simplicity, we assumed a discount rate equal to zero.

CAR, %
5%
Days
0%
-60 -50 -40 -30 -20 -10 0 10 20 30 40 50 60
-5%
AR [0] = 4.90% (19.58)
CAR [-1;+1] = 5.97% (13.77)
CAR [-1;+5] = 6.82% (10.30)
CAR [-1;+10] = 6.99% (8.07)
CAR [-30;-2] = -7.54% (-5.59)
-10%
Fig. 4 Average cumulative abnormal returns from buy-back announcements (N=224) Note:
Parentheses show t-statistics. Corresponding median values are 3.06% for AR[0], 4.55% for
CAR[−1; +1], 5.62% for CAR[−1; +5], 4.97% for CAR[−1; +10] and −6.40% for CAR[−30; −2]
insignificant or even negative average abnormal returns on date A. The magni-

tude of positive announcement returns around date A poses a puzzle for which
we have no full answer.18
Taken together, we find aggregate abnormal returns for the two announce-
ments to establish and to conduct a repurchase plan of between 10 and 12%
for Germany. These effects are considerably higher than those documented for
other countries and in particular higher than the 3% typically found for the US
market (see Table 1 above). We now turn to the analysis of the motivations of
German firms to repurchase shares.
7.2 Regression analysis
Table 4 below presents the results of six OLS regressions. The full model includes
12 independent variables. For the reduced model we have dropped three vari-
ables that are strongly correlated (correlation coefficients exceeding 0.25) to
18 Possibly, the market assigns to all firms, irrespective of whether they establish a repurchase
plan or not, a certain probability that stock prices will experience a prolonged period of negative
abnormal returns in the future. However, only those firms with an approved repurchase plan have
the opportunity to respond to a potential undervaluation by means of a repurchase transaction.
All other undervalued firms lack such an instrument to signal undervaluation. On date A, rational
investors will then only partially factor in the likely negative price effects prior to date B since the
ex ante probability for such an underperformance does not necessarily depend on the existence of
a repurchase plan. As a consequence, investors might perceive the establishment of such a plan as a
signal that the firm in question finds future undervaluation likely and that its management endows
itself with an instrument to combat information asymmetries.
Table 4 OLS regression results (N = 224)
AR[0] CAR [−1; +1] CAR [−1; +10] AR[0] CAR [−1; +1] CAR [−1; +10]
CONSTANT 11.53%*** 11.63%*** 15.02%*** 11.60%*** 12.69%*** 13.53%***

(0.000) (0.001) (0.003) (0.000) (0.000) (0.000)
MTB −0.51%*** −0.45%*** −0.69%** −0.44%*** −0.38%*** −0.63%**
(0.000) (0.003) (0.013) (0.001) (0.009) (0.020)
SIZE −0.93%*** −1.00%*** −1.29%*** −1.01%*** −1.13%*** −1.26%***
(0.001) (0.001) (0.003) (0.000) (0.000) (0.001)
NMLISTING 2.95%*** 2.43%* 2.31%
(0.006) (0.058) (0.266)
PASTRETURN −3.13% −7.430%** −13.56%*** −3.94% −7.95%** −14.09%***
(0.243) (0.033) (0.001) (0.155) (0.026) (0.001)
UNDERVAL 0.91% 1.83% 5.12%*** 1.35% 2.10%* 5.59%***
(0.369) (0.125) (0.007) (0.172) (0.068) (0.002)
CASH 0.09% 1.56% −0.45%
(0.957) (0.406) (0.871)
TARGET 0.21% −3.25% −5.81% 0.36% −3.25% −5.80%
(0.922) (0.141) (0.127) (0.873) (0.131) (0.113)
CONTROL25 −2.09% −1.42% −2.98%
(0.183) (0.414) (0.227)
CONTROL50 −1.41% −1.26% −2.00%
(0.340) (0.490) (0.437)
CONTROL75 0.23% 3.05% 2.40% 0.91% 3.39%* 3.84%
(0.902) (0.155) (0.500) (0.571) (0.065) (0.230)
SERVICE −2.78%** −3.60%** −4.63%** −2.65%** −3.44%*** −4.67%**
(0.030) (0.013) (0.048) (0.034) (0.018) (0.042)
FINANCIAL −2.24%* −2.98%* −3.65%* −3.02%** −3.55%** −4.28%**
(0.079) (0.054) (0.080) (0.018) (0.020) (0.041)
R2 0.218 0.216 0.216 0.184 0.196 0.177
F Stat 4.51 3.98 4.53 5.21 5.426 6.998
Significance F 0.000 0.000 0.000 0.000 0.000 0.000
Reported results are OLS regression coefficients with White-corrected standard errors (p-values
in parentheses)
* Significantly different from zero at the 10%-level
** Significantly different from zero at the 5%-level
*** Significantly different from zero at the 1%-level
one or more of the other variables. Independent variables are abnormal returns
on the announcement date and cumulative abnormal returns for the two event
windows [−1; +1] and [−1; +10], respectively.
All six models show unequivocally that abnormal price effects from repur-
chase announcements are on average greater for firms with lower MTB, for
firms with a smaller enterprise value (SIZE), for firms that experienced lower
share price returns prior to announcement (PASTRETURN), and for firms
that stated undervaluation as a motivation for the share repurchase (UNDER-
VAL). For the other variables results are more ambiguous. NMLISTING is
highly correlated with firm size and does not seem to provide too much addi-
tional explanatory power as compared to SIZE for wider event windows. The
coefficients of both CONTROL25 and CONTROL50 are negative but not sig-
nificant. The coefficient of CONTROL75 always carries a positive sign but is
only weakly significant for the reduced model and CAR[−1; 1]. Price effects
from repurchases that are potentially perceived by investors as a takeover
defense device (TARGET) are virtually zero on the announcement day but
strongly negative (and slightly significant) when measured over a 2- or 11-day
observation period. Finally, the amount of cash on a firm’s books does not affect
share price reactions at all (CASH).
We interpret these results as providing strong evidence in favor of the sig-
naling hypothesis. Investors seem to be more willing to update their beliefs
regarding a firm’s current market position and its future prospects if there is
a bigger potential for repurchase announcements to provide new information
to market participants and if undervaluation of the firm’s equity is more likely.
We have argued above that an undervaluation signal carries more information
content for smaller firms because information asymmetries between managers
and investors are presumably larger. We have also argued that undervaluation
tends to be more likely if the firm is a value stock with a low MTB ratio and if
share prices experienced a dip, given that uncertainty is high enough to indeed
justify this dip.
The fact that past share price returns, whether measured in absolute or abnor-
mal terms, are inversely related to announcement effects indicates a deliberate
timing of the announcement by management; and deliberate timing is consis-
tent with the view that firms use buy-backs to signal undervaluation. Over the
30-day period prior to announcement 162 of the 224 sample firms experienced
negative cumulative stock returns.
For these observations, CAR[−1; +10] is significantly higher at 7.6% as com-
pared to 5.4% for the 62 firms with a positive value for the variable PASTRE-
TURN.19 We conduct a simple check for deliberate timing. If the repurchase
decision of most of the 162 firms with negative values for PASTRETURN was
indeed triggered by poor stock price performance, we should not observe too
many prior instances in their recent stock price history where prices experi-
enced a dip of similar magnitude. For each of these 162 firms, we therefore
counted the number of trading days over the period between AGM approval
and repurchase announcement on which cumulative returns over the prior 30
trading days had been similarly bad or even worse than the 30-day performance
prior to announcement. For 59 firms we could not find a single day where
this had been the case. However, for the remaining 103 firms, we counted on
average 28 days with a similar or worse history of declining stock prices. These
figures change somewhat if we only consider observations with values for PAST-
RETURN smaller than −15% (−30%). For 44 (22) out of 81 (39) firms, the
cumulative stock price performance prior to announcement had indeed been
the worst since AGM approval, and the average number of days with a similar
or worse 30-day history drops to 20 (18) for the other firms. Taken together,
we find that over half of the sample firms with a particularly poor stock price
19 Cumulative abnormal returns during the thirty days prior to announcement were negative for
159 firms. The average CAR[-1; +10] for this sample was 7.4% as opposed to 5.8% for the 65
observations with positive abnormal past returns.
performance over the 30 pre-announcement trading days had not experienced a

similar dip since AGM approval. For these firms, cumulative abnormal returns
around the repurchase announcement were especially high at CAR[−1; +10] =
11.9%. We conclude that a number of repurchase announcements in our sample
had at least been partially triggered by a poor and, according to the firm’s man-
agement, apparently unjustified performance and that investors were factoring
in past performance in their assessment of the credibility of an undervaluation
signal.
Coincident voluntary statements by managers that they view their firm as
undervalued also seem to have measurable effects on abnormal announcement
returns. Table 4 shows that cumulative abnormal returns between day −1 and
day +10 are on average more than 5% points higher if a firm made such a state-
ment. This result is surprising given the fact that the statement itself is virtually
free of cost and should therefore lack any credibility. Apparently, however, the
market assigns some credibility to it, perhaps since managers have to justify
such a statement in the subsequent AGM. Interestingly, Ikenberry et al. (1995)
document a similar phenomenon for their sample of 1,239 US open market
repurchase announcements which took place over the course of the 1990s. Fif-
teen percent of the firms stated a reason for the repurchase in the associated
press release and 38 firms stated undervaluation as their primary motivation.
Average abnormal returns for this subsample of 38 firms are 5.3% versus 3.5%
for the full sample of 1,239 observations. We conclude that a voluntary underval-
uation statement might invigorate an undervaluation signal in a similar fashion
as a poor recent stock performance.
We find no evidence corroborating the “excess cash” hypothesis. In section 1
we argued that low MTB ratios in conjunction with large cash positions could
indicate financial slack on a firm’s books. Cash-based share repurchases reduce
financial slack and thereby mitigate agency problems between managers and
owners, potentially leading to higher valuations. Although the coefficient for
MTB carries the expected sign in Table 4, we do not observe any clear rela-
tionship between abnormal returns and a firm’s cash position. While not shown
in Table 4, we also ran a regression on an extended model specification that
included the interaction term CASH/MTB. For all three independent variables
the coefficients for this interaction term were statistically insignificant. We also
tested whether the effect of large cash positions on abnormal announcement
returns sets in only for specific control structures, i.e., for cases where the com-
pany is largely controlled by inside blockholders who might be in a position
to extract rents from outside minority stockholders. It emerged that the coeffi-
cients for the relevant interaction terms with CONTROL50 and CONTROL75
variables were statistically insignificant. On a more general level, however,
we detected some indication that agency conflicts between inside blockhold-
ers and outside minority shareholders are mitigated through repurchases. The
coefficients for CONTROL75 are always positive and in one instance also sta-
tistically significant. If a firm is controlled by two shareholders with a combined
ownership stake in excess of 75% (25 firms in the sample), cumulative abnor-
mal returns were on average roughly 3% higher than for firms with dispersed
ownership (49 firms in the sample). We assume that minority investors of firms
with highly concentrated ownership infer from a repurchase announcement
that manager interests are now closer aligned to their own interests. Hence,
we cannot fully rule out that some German firms repurchase shares to reduce
agency problems.
The negative coefficients of the TARGET variable provides some, albeit
weak, evidence for a negative relationship between abnormal returns and the
perception by investors that a buy-back transaction aims at deterring a hostile
takeover. The fact that coefficients for TARGET were negative only for wider
event windows and very weakly significant only for the widest event window
CAR[−1; +10] may point to a large degree of initial uncertainty regarding the
true motivations of management that can only be resolved after (time-consum-
ing) further investigations.
As already stated above, we are not able to test the validity of the
tax-efficiency hypothesis directly. This hypothesis presumes that a firm should
substitute share repurchases for dividend payments if capital gains are tax-
advantaged over dividend income for the most important shareholders. In Ger-
many, capital gains have in fact enjoyed a more investor-friendly tax treatment
than dividend income over the entire period from 1998 to 2003. However, the
German Tax Reform 2000 substantially increased the relative attractiveness of
repurchases by cutting the corporate tax rate on retained earnings.20 In 2000
the marginal tax imposed on dividend income was 61.3% for investors in the
highest tax bracket, and the marginal tax imposed on capital gains was 51.6%.
In 2001, taxes on dividends were 59.1% for the same clientele, and taxes on
capital gains were only 38.4%, implying a tax differential of over 20% points. If
repurchases by German firms were strongly motivated by tax efficiency, firms’
propensity to substitute share repurchases for dividend payments should have
increased substantially from 2000 to 2001.
Pan (2005) documents that the Tax Reform 2000 indeed brought substantial
changes in the dividend payout behavior of publicly listed German firms. While
the fraction of dividend payers among all listed German firms had hovered
around 75% between 1990 and 2000, it dropped sharply to 56% in 2001, further
down to 53% in 2002, and finally to 47% in 2003. And while the aggregate
amount of dividend payments by listed German firms had been growing annu-
ally and in real terms for seven straight years between 1993 and 2000, it declined
by over 20% between 2000 and 2001. Pan (2005) concludes that taxation is the
leading factor to explain the decline in dividend payments in Germany. While
dividend payout behavior of German firms thus appears to be largely tax driven,
share repurchase behavior of German firms does not appear to have been pos-
itively affected by the Tax Reform 2000. Figure 2 shows that the number of
repurchase announcements declined from 67 in 2000 to 63 in 2001 and further
down to 43 in 2002. We are inclined to conclude that taxation-induced dividend
20 At the same time, the minimum holding period after which capital gains from selling shares
are tax-exempt was extended from six months to twelve months. Our example above applies to
long-term investors with an investment horizon greater than 1 year.
substitution is unlikely to be the key motivation for German firms to repurchase

own shares.
In summary, our empirical results show that the overriding motivation of
German firms to repurchase shares seems to be undervaluation signaling. We
thereby confirm for Germany one of the main findings of the existing inter-
national literature. However, we find that average announcement effects on
share prices are of much greater magnitude in Germany than in other countries
(5% + 7% = 12% as compared to roughly 3% in the US). There are three
potential explanations for this phenomenon. The first is based on international
differences in general disclosure requirements for firms. The other two are
based on international differences in the laws governing share repurchases.
Leuz and Wüstemann (2004) demonstrate that it is not the primary aim of the
German accounting system to maximize information dissemination to outside
investors, but rather to support private information channels to privileged inside
capital providers such as “Hausbanks” and large blockholders. Empirical stud-
ies show that the information content of financial statements is indeed less
value-relevant and less timely than in the US and the UK.21 As a consequence,
information asymmetries between managers and (outside) investors might gen-
erally be larger in Germany than in the two capital market based financial sys-
tems. An additional public disclosure by a German firm would then potentially
embody more new material information than the very same disclosure by a
US or a UK firm. If different degrees of general information asymmetries are
indeed the main determinant of country differences in repurchase announce-
ment effects, one should observe similar differences in abnormal returns from
other types of announcements. However, Gebhardt (2001) documents in his
literature survey that this is not the case. Neither announcements of changes in
dividend payouts nor of seasoned equity offerings lead to stronger price effects
in Germany than in the USA. We therefore tend to reject this first explanation.
The second explanation proceeds from the conjecture that certain German
laws for repurchase programs largely rule out repurchases that harm (groups
of) shareholders. The obligation to obtain AGM approval and to treat all share-
holders equally in a repurchase transaction can be very effective in deterring
managers from transferring wealth from one shareholder group to another
and from all shareholders to themselves. In contrast, US managers theoreti-
cally have much more leeway in designing and timing their repurchase plans.
We therefore expect to observe a larger portion of repurchase announcements
with negative announcement effects in the USA than in Germany. Bhattach-
arya and Dittmar (2002) report that abnormal returns for the 2,405 US open
market repurchase announcements in their sample are on average 3.6% for
the event window [−1; +1] and have a standard deviation equal to 9.21%. If
we assume that these abnormal returns are normally distributed, we obtain an
estimated portion of announcements with negative abnormal returns of approx-
imately 35%. For our German sample we observe a portion of only 17%. Legal
21 See, e.g., Joos and Lang (1994) and Harris et al. (1994).
deterrence of repurchases that are not in line with shareholders’ interests can
thus be assumed to explain international differences in average announcement
effects to some extent.
The third explanation holds that the strictness of German repurchase regula-
tion allows for credible undervaluation signals. In section 2 we have argued that
the prescribed repurchase process makes misleading announcements costly.
These costs would make repurchase announcements less attractive for over-
valued firms and would thereby increase the portion of undervalued firms in
the pool of repurchasing firms. Investors might then be induced to attribute a
higher credibility to undervaluation signals wrapped in repurchase announce-
ments. Grullon and Ikenberry (2000, p. 44) summarize the situation in the
USA: “A primary concern of both regulators and investors is that, because of
the flexibility and modest disclosure requirements associated with open market
repurchase programs, there is some potential for companies to mislead inves-
tors by announcing repurchase programs while having no intention of buying
stock”. As a consequence, investors should treat repurchase announcements by
US firms with more skepticism. Ikenberry et al. (1995) show that repurchase
firms outperform a control portfolio of non-repurchase firms by an average of
12% over the four post-announcement years. Repurchase firms with very low
MTB ratios outperform the control portfolio by even 45%. The authors con-
clude that markets largely ignore the information conveyed by US open market
repurchases and, as a consequence, systematically under-react to undervalua-
tion signals. We argue that, given the much stricter repurchase regulations in
Germany, markets take more notice of the information contained in repur-
chase announcements by German firms and, as a consequence, under-reaction
to repurchase announcements is less of an issue in Germany than in the USA.22
Given that undervaluation signaling is the major repurchase motivation of both
US and German firms, differences in under-reaction patterns could largely
explain the differences in repurchase announcement effects.
8 Conclusion
In this paper we have analyzed abnormal share price returns from German
open market repurchase announcements. Share repurchases are only a recent
phenomenon in Germany and are governed by fairly strict laws. We aimed
to provide new insights into the role the legal and regulatory environment
plays in inducing corporate insiders to successfully reveal private information
on true firm value. With this aim we measured abnormal price effects around
two events, namely the initial statement by a German firm that it plans to
establish a repurchase plan and the firm’s subsequent announcement that it
intends to repurchase shares over the open market. Total abnormal returns
around these two events add up to roughly 12% and are much higher than
22 Because long-term post-announcement returns are not yet available for a sufficient number of
German repurchase firms, we cannot test this hypothesis in this paper.
the 3% typically reported for US repurchase announcements. We tested four

hypotheses regarding the primary motivations of German repurchase firms.
Our empirical evidence strongly favors the undervaluation signal hypothesis
and thereby confirms the results obtained for other countries. We discussed
three possible explanations for the large discrepancy in average announcement
effects between German and US firms and identified differences in repurchase
regulations as the most likely explanation. The stringent repurchase process
prescribed by German law attributes a much higher credibility to undervalua-
tion signals than do the lax US regulations.
We conclude this paper with a side note for regulators. The patterns of abnor-
mal returns around German repurchase announcements reinforce the legal
requirement that German firms must report an imminent repurchase transac-
tion through a public ad hoc disclosure. Since the preceding initial statement
by managers to seek AGM approval is also accompanied on average by con-
siderable price effects, we are inclined to suggest that such a statement should
also be subject to ad hoc disclosure requirements. Otherwise, opportunities
remain for insider trading – and insider trading is illegal in Germany since 1994.
Figure 3 above shows that substantial abnormal returns occurred during the
5 days before the respective voluntary statement, thus indicating that insider
trading in the context of repurchase transactions might still be an issue in
Germany.
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Author’s Biography
Andreas Hackethal holds the HCI endowed chair for

Financial Services Sales & Distribution at the European
Business School in Oestrich-Winkel, Germany, and is a
director of the E-Finance Lab, Frankfurt/Main. He earned
his doctorate degree and his postdoctoral lecturer qualifi-
cation from Johann Wolfgang Goethe-Universität, Frank-
furt/Main, and has a ten-year working experience with
a large German bank and a global consulting company.
His principal fields of research are comparative financial
systems, financial institutions and services, and corporate
finance.
Alexandre Zdantchouk is an Associate at Freitag & Co, an

independent German mergers & acquisitions advisory firm.
He focuses on the execution of complex national and interna-
tional transactions. Prior to his time at Freitag & Co he held
positions at the asset management and advisory firm Lazard
and the consulting firm Tillinghast-Towers Perrin. He holds
a degree in Business Administration from Johann Wolfgang
Goethe-Universität, Frankfurt/Main, and a B.A. degree in
International Economics from Belarus Economics Univer-
sity, Minsk.

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Fin Mkts Portfolio Mgmt (2006) 20:123–151

Signaling power of open market share repurchases

Andreas Hackethal · Alexandre Zdantchouk

Published online: 24 May 2006

Keywords Open market share repurchases · Event study ·

JEL Classification Numbers G14 · G35

In May 1998 the “Corporation Control and Transparency Act” (KonTraG)

The management’s motivation to repurchase shares has already been discussed

3 Share repurchase regulation in Germany and in the USA

The German Corporation Control and Transparency Act (KonTraG) became

US regulations on open market share repurchasing differ in several impor-

4 Related empirical literature

The empirical literature on stock buy-backs has so far largely focused on US

Country Study Abnormal returns Dataset

US McNally (1999) CAR [−1; +1]: 2.5% 702 OMR (1984–1988)

an actual undervaluation, the stronger are the signaling effects. Vermaelen

Intention to obtain AGM AGM authorization Announcement(s) of imminent

Fig. 1 Time line of share repurchase programs in Germany

Table 2 Descriptive statistics (N = 224)

Dependent variables Independent variables Independent dummy variables

Max. 40.6 36.8 56.5 14.80 11.55 49.6 125.3

Table 3 Motivations to repurchase shares as declared by management (N = 185)

Number of declarations Percent of 185 sample firms

Acquisition currency 107 58

there is ample empirical evidence that markets tend to overshoot in both

enough profitable investment opportunities, investors will welcome share

If the “undervaluation signal” hypothesis holds, the coefficients for MTB,

We conduct a standard market-model event study to measure price effects from

Rit = αi + βi Rmt + εit for t = −270, −269, . . . , −60

ARit = Rit − R∗it

We use OLS-regression with White-corrected standard errors to directly test

7.1 Abnormal returns

Taking on the perspective of a risk neutral investor who, at date A, determines

RA = p × (RA × RB ) + (1 − p)1. (6)

Collecting terms and solving for RB yields

17 For the sake of simplicity, we assumed a discount rate equal to zero.

insignificant or even negative average abnormal returns on date A. The magni-

7.2 Regression analysis

Table 4 OLS regression results (N = 224)

CONSTANT 11.53%*** 11.63%*** 15.02%*** 11.60%*** 12.69%*** 13.53%***

performance over the 30 pre-announcement trading days had not experienced a

substitution is unlikely to be the key motivation for German firms to repurchase

the 3% typically reported for US repurchase announcements. We tested four

Gebhardt, G.: Announcement effects of financing decisions by German companies: synthesis of an

Andreas Hackethal holds the HCI endowed chair for

Alexandre Zdantchouk is an Associate at Freitag & Co, an

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CONSTANT 11.53%* 11.63%* 15.02%* 11.60%* 12.69%* 13.53%*