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Review of Pacific Basin Financial Markets and Policies

Vol. 8, No. 1 (2005) 81–112
c World Scientific Publishing Co.

and Center for Pacific Basin Business, Economics and Finance Research

Stock Repurchase in Korea: Market Reactions and

Operating Performance

Youngkyu Park
Graduate School of Management
Korea Advanced Institute of Science and Technology
Seoul, Korea

Kooyul Jung∗
Graduate School of Management
Korea Advanced Institute of Science and Technology
207-43 Chongyangni2-dong, Dongdaemoon-gu, Seoul 130-722, Korea
kyjung@kgsm.kaist.ac.kr

This study examines the motive for stock repurchase. We examine four
hypotheses — undervaluation, signaling, free cash flow, and optimal leverage
hypotheses — using both short-run and long-run market reactions. We find that
the undervaluation hypothesis is most consistent with both short-run and long-run
tests. Improvement in operating performance following repurchase suggests the sig-
naling hypothesis. However, the signaling hypothesis is supported only in the long-
run test, not in the short-run test, suggesting that market underreaction exists to
the signaling initially. Of the control variables, the target purchase ratio and owner-
ship by the largest shareholders are found significant, suggesting that the magnitude
of repurchase and the ownership increase motive by the largest shareholders are also
important factors that explain the repurchase.
Keywords: Stock repurchase; undervaluation; signaling; free cash flow.

1. Introduction
Many studies have investigated causes and effects of stock repurchases. Most
of these studies focus on US firms. International evidence on stock repurchase
is limited although buyback activities have increased worldwide recently.
Different regulations in each country cause different strategic behaviors

∗
Corresponding author.

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82 • Youngkyu Park & Kooyul Jung

by the managers and market reactions to the stock repurchases. For exam-
ple, Rau and Vermaelen (2002) find that stock repurchase activities in the
United Kingdom are mainly influenced by the tax consequences for pen-
sion funds and that firms announcing stock repurchases experience smaller
abnormal returns than those by US firms. Also, Ikenberry, Lakonishok and
Vermaelen (2000) investigate stock repurchases in Canada, where, unlike in
the US, stock repurchase activities can be traced in detail monthly. They
show that stock repurchase firms with high book-to-market ratios tend to
experience higher abnormal returns drift following the repurchase announce-
ments than those with low book-to-market ratios, and that completion rate
of the repurchases is sensitive to the degree of mispricing.
Furthermore, Zhang (2002) investigates stock price performance sur-
rounding stock repurchase in Japan. He finds that evidence from Japanese
repurchases is consistent with the undervaluation hypothesis. These studies
indicate that the institutional differences among countries present different
results related to the stock repurchase.
This paper investigates stock repurchases in Korea. Stock repurchases in
Korea are of interest for several reasons. First, Korean firms face stricter reg-
ulatory and disclosure requirements than US firms. For example, unlike US
firms, Korean firms have to complete the repurchases within three months
after the repurchase announcement and report the results to the Finan-
cial Supervisory Service (FSS) within five days after the completion of the
repurchase. Also, they are required to disclose the actual number of shares
repurchased, attach documents of trading history, and explain the reason
if they do not repurchase the target number of shares. 1 These require-
ments induce most repurchase firms to actually complete the repurchase
as announced and enable us to perform the study on the actually com-
pleted repurchases. Second, dividend payments are not substantial in Korea
and therefore stock repurchases are generally used as a means to distribute
excess cash to shareholders.2 Third, in the US, three methods of stock repur-
chases — open market repurchases, self-tender offers and private negotiation

1
US firms need not disclose the progress or completion of stock repurchases. Also, unless
voluntarily disclosed, only quarterly dollar amounts are available ex-post. Further, stock
repurchase in the US lasts approximately three years while it must be completed in three
months in Korea (Stephens and Weisbach, 1998). Therefore, a significant number of repur-
chases is not actually completed in the US.
2
There have been about 1,200 stock repurchases from 1994 to 2002 in Korea.
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Stock Repurchase in Korea • 83

repurchase — are allowed, whereas in Korea only open market repurchases

are allowed.3
These unique environmental features give us the motive to study stock
repurchases in Korea. Most Korean studies focus on the initial market reac-
tions. However, this paper examines the motives of stock repurchases. We
examine four prevailing motives for stock repurchase: undervaluation, sig-
naling, free cash flow (FCF) and leverage hypotheses.
These hypotheses are tested using both short-run and long-run stock
performance. For the signaling hypothesis, we examine the improvement in
operating performance after stock repurchase also. However, since improved
operating performance could be due to asset sales rather than improved
growth opportunities, we examine the change in capital expenditures and
asset sales around stock repurchase to differentiate the signaling and free
cash flow hypotheses as further explained later. 4
Our empirical results show that the undervaluation hypothesis is most
consistent with both short-run and long-run market reactions. The improved
operating performance after repurchase implies the signaling hypothesis.
However, it is supported only in the long-run market test, not in the short-
run. We interpret the result as suggesting that market underreaction exists
to the signaling initially.5 Additional tests further support the signaling
hypothesis. Other hypotheses are not generally supported. Of the control
variables used, the target repurchase ratio and the ownership by the largest
shareholders are found significant. The significance of the largest ownership
variable suggests that repurchase is also used as a means to increase the
ownership of the largest shareholder as a defense against a possible hostile
take-over.
The remainder of the paper consists of the following. Section 2 presents
major hypotheses and stock repurchases in Korea. Data and variables used

3
Only open market repurchase was allowed before 1999, but self-tender offers have also
been allowed since the amendment of the law in 1999.
4
As explained later, Nohel and Tarhan (1998) suggest that operating performance
improves as a result of asset sales, and managers distribute cash from these sales through
stock repurchase. This supports the free cash flow hypothesis rather than signaling
hypothesis.
5
Such underreaction is also found in Ikenberry, Lakonishok and Vermalen (1995). They
observe larger abnormal returns following repurchase announcements for high B/M firms
over the long-run, whereas no positive drift in abnormal returns is found for low B/M
firms, suggesting that the marketers in its initial response for high B/M firms and appears
to ignore much of the information conveyed through repurchase announcements.
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84 • Youngkyu Park & Kooyul Jung

for the test are described in Sec. 3. Section 4 reports empirical evidence and
Sec. 5 concludes the paper.

2. Literature Review and Stock Repurchases in Korea

2.1. Prevailing hypotheses for stock repurchase
Most studies related to the stock repurchases document positive market
reactions around repurchase announcements. Major hypotheses to explain
the positive market reactions are the signaling, undervaluation, free cash
flow and leverage hypotheses. Alternative explanations of tax savings and
expropriation hypotheses were only found to be marginally important. This
study considers these four major hypotheses related to stock repurchases
in Korea. The signaling hypothesis is generally interpreted in two ways.
First, the “earning/operating signaling” suggests that the announcement of
buyback activity signals future improvement in the firm’s earnings/operating
performance. Second, the undervaluation signaling implies that when firms
are currently undervalued, mangers alert investors to the “undervaluation”
through stock repurchase. The operating and undervaluation signaling are
not clearly differentiated in previous studies. Signaling in this study signifies
the former, the operating signaling.

2.1.1. Undervaluation hypothesis

According to the undervaluation hypothesis, if managers believe that a firm
is undervalued according to their superior private information, they could
attempt to disclose value-increasing information through stock repurchase.
Recently, D’mello and Shroff (2000) test whether firms that repurchase
stock via fixed-price tender offers are in fact undervalued relative to their
economic values, which represents the intrinsic value of a firm. They esti-
mate the economic value using the earnings based valuation model, and
test the undervaluation hypothesis by comparing the perfect foresight eco-
nomic value of a firm with its prevailing market price. They find that 74%
of the repurchase firms are undervalued. Chan, Ikenberry and Lee (2003)
also find that repurchase firms experience higher long-run stock perfor-
mance, consistent with the undervaluation hypothesis. Dittmar (2000) tests
the various hypotheses — free cash flow, undervaluation, leverage, manage-
ment incentive and takeover deterrence hypotheses — using Tobit regression,
which includes firm size, prior abnormal return and market-to-book variables
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Stock Repurchase in Korea • 85

for undervaluation. She shows that managers announce stock repurchases

because firms are undervalued.

2.1.2. Signaling hypothesis

As previously mentioned, “signaling” in this study refers to the improvement
in future operating performance, not undervaluation. When managers pos-
sess more information about the firm than individuals outside the firm do,
they have incentives to clearly signal such information to investors. Usually,
dividends or stock repurchases convey managers’ information about future
earnings, cash flow and operating performance.
Before stock repurchases become popular, many studies using dividend
changes tested and supported the signaling hypothesis. Yoon and Starks
(1995) analyze the extent to which dividend changes or their wealth effect
are related to the firms’ investment opportunities or cash flow expectation.
They find that dividend increases (decreases) are associated with subsequent
increases (decreases) in capital expenditures following the dividend changes.
Dividend increases signal firms’ good investments, consistent with the signal-
ing hypothesis. Howe, He and Kao (1992) show that there are no significant
differences in excess returns on the announcement of stock repurchases and
specially designated dividends between high q (value-maximizing) and low q
(overinvesting) firms. This suggests that stock repurchases or dividend ini-
tiations signal future performance improvement irrespective of the q levels,
consistent with the signaling hypothesis. It is inconsistent with the free cash
flow hypothesis which predicts that the low q firm with high free cash flows
will be the most likely candidate for overinvestment and thus to have larger
abnormal returns. Gup and Nam (2001) examine the change in operating
performance and find that the operating performances of buyback firms are
better than those of non-buyback firms in the year following the initiation
of the buyback, supporting the signaling hypothesis.

2.1.3. Free cash flow (FCF) hypothesis

The FCF hypothesis focuses on the agency problem between managers and
shareholders on the distribution of free cash flows. The FCF hypothesis
asserts that managers with substantial FCF will invest it in the projects
that earn below the cost of capital (i.e., a negative NPV project) or waste
it on organizational inefficiencies rather than distribute it to shareholders.
This action causes poor performance for firms with high free cash flows. The
FCF hypothesis, therefore, predicts that the amount of wasteful investments
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86 • Youngkyu Park & Kooyul Jung

for firms with poor investment opportunities is a source of economic ben-

efit for stock repurchases. In other words, stock repurchases avoid making
investments in unprofitable projects, thereby resulting in significant positive
valuation effects.
Many studies test the signaling and the free cash flow hypotheses using
dividends as well as stock repurchases. Agency theory predicts a positive
relationship between the stock price reaction of stock repurchase and cash
levels for low q firms and no relationship for high q firms, while the sig-
naling hypothesis is indifferent between the two groups. Lie (2000) finds
that announcement returns around self-tender and special dividends are
positively related to the cash level. In particular, the relationship between
returns and cash levels are significantly more positive for firms with a
low Tobin’s q than for those with a high Tobin’s q, consistent with the
FCF hypothesis. Lang and Litzenberger (1989) also find that the returns
are significantly higher for low q (overinvesting) firms announcing dividend
increases than for high q (value-maximizing) firms.
Nohel and Tarhan (1998) examine the changes in operating performance
surrounding tender offer share repurchases to differentiate between the sig-
naling hypothesis and the free cash flow hypothesis. They find that oper-
ating performance following repurchases improves only for the low growth
firms, suggesting that the positive market reaction to repurchase announce-
ments is best explained by the free cash flow hypothesis, not the signaling
hypothesis.

2.1.4. Leverage hypothesis

When firms repurchase shares, equities are reduced, and therefore leverage
ratios increase. Firms with low leverage ratios relative to the optimal lever-
age can approach the optimal capital structure through repurchases.
Dittmar (2000) investigates the leverage hypothesis using the Tobit
regression and reports that firms repurchase shares to increase leverage
ratios. Chan, Ikenberry and Lee (2003) suggest that the managers attempt
to increase the leverage ratios by actually repurchasing shares. If achieving
the optimal leverage is the source of benefit from repurchases, then these
benefits should be contingent on the actual buyback activity, and investors
will slowly respond after they recognize the change in the leverage ratio. 6

6
As previously mentioned, in the US, unlike Korea, firms may not actually engage in stock
repurchases as announced. In this case, the leverage ratio will not change.
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Stock Repurchase in Korea • 87

2.2. Stock repurchases in Korea

Prior to 1994, firms had been legally prohibited from buying back their own
shares. The Securities Exchange Law allowed firms to repurchase their own
stocks within a 5% limit in 1994.7 The limit was extended to 10% in 1996,
and then to 100% in 1998. Now, firms can repurchase shares within the
amount available for dividend payments.
Firms planning to repurchase shares should obtain approval from the
board of directors with regards to the repurchase purpose, dollar amount,
method to be used, type and number of securities to be repurchased, etc.
After firms announce their repurchase plans to the Financial Supervisory
Service, they are required by the Securities Exchange Law to complete the
stock repurchase within three months following the repurchase announce-
ment day.
Under the Securities Exchange Law, firms may hold and resell repur-
chased securities. However, they are prohibited from reselling repurchased
stocks within six months after the stock acquisition date and purchasing
their own shares during the three months following the disposal.
The process of disposing of the repurchased stocks is similar to that
of repurchasing stocks. Firms should obtain approval from the board of
directors with regards to the purpose, dollar amount, type and number of
securities, pricing and method of disposal. After the approval, they should
immediately report to the Financial Supervisory Service. The Financial
Supervisory Service can take necessary steps if (1) the company does not sub-
mit the stock repurchase statement, stock disposal statement, stock repur-
chase outcome statement, or stock disposal outcome statement, (2) any item
stated in the statement is deemed false or missing, or (3) the company, or
any of its related parties, is accused of violating the related regulations.
Evidence shows that most firms in Korea abide by the law and repurchase
the shares as announced. Managers in US firms need not disclose specific
information such as timing, price and number of shares that firms intend to
repurchase, and unless voluntarily disclosed, only quarterly dollar amounts
are publicly available ex-post. Stephens and Weisbach (1998) report that
actual reacquisitions are small relative to the firms’ announced intentions
and argue that the announcement of an open-market repurchase is merely
an attempt by management to raise the firm’s stock price at little or no

7
Open market stock repurchases have been allowed on the KSE (Korea Stock Exchange)
since 1994 and on the KOSDAQ (Korea Securities Dealers Automated Quotation)
since 1999.
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88 • Youngkyu Park & Kooyul Jung

cost. In this regulatory environment, the issues discussed above related to

the stock repurchase are becoming difficult to substantiate. 8

3. Data and Variables

3.1. Sample
We obtained the announcement information of stock repurchases for all firms
listed on the Korea Stock Exchange (KSE) and the Korea Securities Dealers
Automated Quotation (KOSDAQ) between 1994 and 2000. We consider only
common stocks. Nine hundred and forty-four open market stock repurchases
are initially available.
From this initial sample, we exclude the following firms: (1) firms in the
financial industry, (2) stock repurchases with information not available, (3)
firms without matched control firms, (4) firms without stock price data in
the Korea Securities Research Institute (KSRI) Stock Database and finan-
cial statement data in the Korea Listed Companies Association (KLCA)
Database. This procedure resulted in the final sample of 336 repurchase
announcements. The sample selection procedures are presented in Table 1.
Since all the variables used in the tests are calculated as the paired
differences between sample and control firms, we use control firms which
are matched based on SIC, size and book-to-market ratio. The matching
procedure is as follows. Control firms are first obtained by matching on the
industry and then firm size (market value of equity in the month immediately
preceding the announcement) and book-to-market (book value of equity over
market value of equity) ratio. Industry matches are based on the four-digit
SIC code provided by the KLCA. If no match is available at the four-digit
level, three- and two-digit levels are used, respectively. After the industry
and the size are matched, the firm that is closest in book-to-market ratio to
the sample firm is selected as a control firm.

3.2. Variables for the hypotheses

This section explains all the variables used to test the four hypothe-
ses explained earlier. To examine the undervaluation hypothesis, we use

8
In the US, firms do not have to report their actual buyback activities. In Korea, however,
firms must report their actual share repurchases within five days after the stock repur-
chase. According to the August 1997 issue of “Sangjang”, 237 firms announced 363 stock
repurchases between April 1994 and June 1997. Only five of these companies failed to do
the stock repurchases following their announcements, and the remaining 232 companies
repurchased 83.7% of the announced amount.
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Stock Repurchase in Korea • 89

Table 1. Sample selection procedure.

Panel A: Full Sample

All 954
Less
Financial firms (119)
Information unavailable (126)
No control firms (146)
Financial info. missing (227)
(618)
336
Panel B: By Exchange
KSE 315 (93.75%)
KOSDAQ 21 (6.25%)
336 (100%)

Panel A reports the selection procedure of sample

firms listed on the KSE (Korea Stock Exchange) and
KOSDAQ (Korea Securities Dealers Automated Quo-
tation) that announced open market stock repurchases
during 1994–2000. Panel B presents the number of
firms by each stock exchange.

two proxies to measure the degree of undervaluation — prior CAR

(−60,−2), cumulative abnormal return, and the book-to-market (B/M)
ratio immediately preceding the announcement day. A history of low
prior returns reflects the situation where prices may have fallen below
the fair value. Prior return is calculated by delineating the cumula-
tive abnormal return using an equally weighted market index. Firms
with a high B/M or low prior returns are more likely to be underval-
ued than those with a low B/M or high prior returns. Evidence shows
that firms with high B/M or low prior returns exhibit higher long-run
stock market performance than low B/M firms following stock repurchase
announcements.
For the FCF hypothesis, firms with high financial slack are inclined to
announce buyback programs and undergo higher abnormal returns than
those with low financial slack. We use two variables to measure excess cash:
the first is the FCF variable, measured by free cash flow over total assets,
and the other is CASH, defined as cash plus cash equivalents over total
assets (Lie, 2000).
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90 • Youngkyu Park & Kooyul Jung

For the leverage hypothesis, we use a proxy variable for the optimal
leverage ratio. The difference in the leverage ratio in the year prior to the
stock repurchase between the sample and the control firm is used as a proxy
for the optimal leverage ratio.
The change in abnormal operating performance and capital expenditure
(CAPEX) are used to investigate the signaling hypothesis. The profit margin
(PM), and the cash flow ROA (CFROA) are used as measures for operating
performance. Abnormal performance is defined as the difference in operating
performance between the sample and the control firm. CAPEX is used to
differentiate the FCF and signaling hypotheses. If repurchase firms have
good investments, CAPEX will increase after repurchase. However, if firms
distribute free cash flow to reduce the agency cost, CAPEX will decrease
following the repurchase. Therefore, increase in CAPEX following the stock
repurchase suggests the signaling hypothesis while its decrease is consistent
with the free cash flow hypothesis.
For stock performance, we use both short-run and long-run stock perfor-
mance surrounding the repurchase announcement. For the short-run stock
performance, we calculate the daily market adjusted cumulative abnormal
return (CAR). An equally weighted composite index is constructed as a
proxy for the market return. For the long-run stock performance, we use buy-
and-hold returns for one year measured by compounding monthly returns.
Buy-and-hold abnormal stock returns are calculated by subtracting the con-
trol firm’s stock returns from those of the sample firm.
Additionally, we use control variables, percentage of shares that are
announced to be repurchased (Target ratio), the ownership by the largest
shareholder (Ownership), and some proxies for information asymmetry.
The target ratio is used because previous studies find that the higher
the announced target ratio, the higher the abnormal initial announcement
returns. In Korea, repurchase firms occasionally disclose that the objective
of buyback is to increase the ownership of the largest shareholders. Stock
repurchase enables a firm to possess the stability of insider ownership as a
defense against a possible threat to M&A. McNally (1999) suggests that mar-
ket reactions to stock repurchase are positively related to the entrepreneur’s
(the firm’s controlling shareholder) stock holdings. The Ownership variable
controls for this effect.
To control for the information asymmetry between insiders and outside
investors, we use size, R&D expense and intangible assets. Firms with high
information asymmetry are more likely to repurchase their shares and have
larger positive initial market reactions. Inversely related to the magnitude of
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Stock Repurchase in Korea • 91

undervaluation, size is the key measure of information asymmetry (D’mello

and Shroff, 2000). Lakonishok and Vermaelen (1990) suggest that small firms
are more likely to repurchase shares to reveal information, whereas repur-
chases by large firms may be a part of corporate restructuring activity. In
this study, we use both total assets and the market value of common equity
for the size and report the latter only. 9 Barth and Kasznik (1999) find that
firms with more intangibles are more likely to repurchase stocks and have
more positive initial market reactions. We use R&D and intangible assets
as measures of the intangibles. Intangibles assets recognized in the financial
statements refer to the firm’s long-lived income generating assets. Intangi-
bles to total assets capture the situation in which a firm capitalizes costs
associated with intangible assets (Healy and Palepu, 1995).
The correlations between the above variables used in the test are reported
in the appendix.

4. Empirical Evidence
4.1. Descriptive statistics
Panel A of Table 2 provides descriptive statistics for the financial variables
of both sample and control firms around the repurchase announcement year,
defining year 0 as the year of the repurchase announcement.
LnMV is measured as a natural log of market value prior to the repur-
chase announcement day. Although the firms were matched on the size,
Table 2 shows that the sample firms are larger than the control firms when
compared in both LnMV and LnTA (natural log of total assets).
R&D is measured by R&D expense over total assets. It is larger for non-
repurchase control firms than the repurchase firms. This is not consistent
with Barth and Kasznik (1999) and suggests that the differences in infor-
mation asymmetry between the repurchase and non-repurchase firms due to
the intangible assets are trivial in Korea.
The average BHR (buy and hold returns from −6 to −1 month to the
repurchase) of sample firms is 90.63% and lower than 98.5% for control firms.
There is no significant difference in LnBM, a natural log of book-to-market
ratio, between the sample and control firms, indicating that the sample and
control firms are well matched on the book-to-market ratio. 10
9
The results using the total assets are similar to those using the market value of equity.
10
The book value of equity over the market value of equity is calculated using the book
value prior to the announcement year and market value prior to the announcement month.
Except market value, all variables are measured for the year previous to the announcement.
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92 • Youngkyu Park & Kooyul Jung

Table 2. Descriptive statistics for the variables.

Variables Sample Control Diff

Mean Median Mean Median Mean Median

Panel A: Descriptive Statistics, N = 336

LnTA 19.2416 19.0098 19.0176 18.7012 0.224*** 0.2927***
LnMV 18.1051 17.8085 17.7940 17.7061 0.3111*** 0.1998***
R&D 0.0074 0.0035 0.0049 0.0006 0.0025*** 0.0006***
ITA 0.0071 0.0012 0.0087 0.0014 −0.0016 0.0000
LnBM 0.2725 0.1715 0.2572 0.1566 0.0153 0.0237
BHR (%) 90.6332 82.8223 98.5015 88.2150 −7.8684** −2.3174*
FCF 0.0199 0.0194 0.0076 0.0042 0.0122*** 0.0085***
CASH 0.0767 0.0567 0.0508 0.0295 0.0259*** 0.0164***
LEV 0.5436 0.5710 0.5767 0.6055 −0.033*** −0.0367***
CAPEX 0.0452 0.0241 0.0625 0.0261 −0.0173** −0.0035**
PM (%) 4.7731 3.5600 1.0521 2.2150 3.721*** 1.0400***
CFROA (%) 9.2864 8.8415 7.0658 6.9383 2.2206*** 1.8833***
Dpayout (%) 35.7407 22.7650 27.3410 11.1200 8.3997* 5.8450***
Ownership (%) 29.6494 28.0600 35.6667 33.1300 −6.0173*** −4.6800***
Target ratio (%) 3.3034 2.9950
Panel B: Completion Rate, N = 78
CP (%) 99.14 100
Days 59 56

LnTA is natural logarithm of total assets. LnMV is based on the market value of equity
on the day prior to the announcement date. R&D is R&D expense divided by total assets.
ITA represents intangible assets over total assets. LnBM is natural logarithm of book-
to-market based on the ratio of the book equity value at the fiscal year-end prior to the
announcement year over total market value on the day prior to the announcement date.
BHR is buy-and-hold return from 6 to 1 month prior to the announcement month. FCF
represents free cash flow. Cash represents cash and cash equivalents over total assets.
LEV is calculated by total debt to total assets. PM represents profit margin. CFROA is
defined as EBITDA over total assets. CAPEX is capital expenditure over total assets.
Dpayout represents dividend payout ratio. Ownership means stock holdings by the largest
shareholder. Target ratio is the percentage of announced repurchase shares relative to total
outstanding shares. Diff is the difference between sample and control firms. All variables are
measured using data for the year prior to the repurchase announcement. Panel B presents
the reports on the repurchase to the Financial Supervisory Service, which is available since
year 2000. Of our sample, only 78 reports are available. CP means completion rate (%)
and is calculated as the number of shares actually repurchased over the number of shares
announced. Days is measured as the difference in calendar days between the announcement
of repurchase and completion. *, **, and *** indicate significance levels at the 10%, 5%
and 1% levels, respectively.
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Stock Repurchase in Korea • 93

The average FCF and CASH for sample firms is 1.99% and 7.67%, respec-
tively compared with 0.76% and 5.08% for control firms. Both variables are
greater for the sample firms than the control firms, similar to the studies
reported in the US (Dittmar, 2000; Lie, 2000).
Stock repurchase reduces the equity and increases the leverage ratio.
Firms are more likely to buy back stocks if their leverage ratio is low rela-
tive to that of the control firms (Dittmar, 2000). For leverage, we use debt
to equity ratio (LEV). The leverage hypothesis suggests that the leverage
of a repurchase firm should be lower than that of a non-repurchase firm.
The mean leverage for the sample is 0.54 and significantly lower than for
control firms.
PM (profit margin) and CFROA (EBIITDA to total assets), measures
for operating performance, are much higher for sample firms than control
firms. The capital expenditure of sample firms is lower than that of con-
trol firms, suggesting that sample firms have less good investments than con-
trol firms.
The largest shareholder’s ownership variable, Ownership, is lower for
sample firms than control firms. Firms with low ownership by the largest
shareholders are more likely to announce the stock repurchases to decrease
risk caused by low ownership, such as threat of M&A.
Panel B shows the completion rate. It is based on the 78 disclosures of
repurchases only because reports are not available until 1999. We find that
Korean firms repurchased 99.14% of their announced target ratios. Stephens
and Weisbach (1998) report that US firms buyback about 54% of the target
number of shares within a year of the initial announcement and 74% within
three years. Zhang (2002) reports that Japanese firms repurchased 83.5%
of their announced target shares. The completion rate in Korea is much
greater than those reported in the US, Canada and Japan. This is because
the regulations in Korea are stricter than in other countries. For instance,
Japanese firms are required to provide the reasons, if they repurchase less
than 50% of the announced shares. Korean firms should provide reasons if
they do not repurchase the number of shares as announced.
It takes an average of 59 calendar days for firms to complete the repur-
chase. Under the Securities Exchange Law, firms are required to complete
the repurchase within three months. It appears that the regulation enforces
the firm to complete repurchase within a short period of time. In the US,
Stephens and Weisbach (1998) report that the repurchase program lasts
three years.
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94 • Youngkyu Park & Kooyul Jung

Table 3. Change in operating performance around the announcement year.

PM (%) CFROA (%)

Mean Median Mean Median

Year −2 1.99*** 0.88*** 1.55*** 1.32***

−1 3.91*** 1.20*** 2.34*** 1.94***
0 4.11*** 2.13*** 2.63*** 1.99***
+1 5.86*** 2.87*** 3.21*** 2.88***
Year +2 6.46*** 2.74*** 4.30*** 3.54***
∆(−1, +1) 1.95 1.02** 0.87 0.93**

This table reports abnormal operating performance (the difference between

sample minus control) and their changes around the announcement year.
PM represents profit margin. CFROA represents EBITDA over total assets.
Year 0 is the stock repurchase announcement year. *, **, and *** indicate
significance levels at the 10%, 5% and 1% levels, respectively.

4.2. Changes in operating performance

Before investigating market reactions, we investigate the change in operating
performance and examine the signaling hypothesis. We use two measures
of operating performance, PM and CFROA. We use the difference in the
variables between the sample and the control firms to control for the industry
effects. Table 3 reports mean and median tests for paired differences in each
of the performance measure between the sample and the control firms on a
year-by-year basis and for the change from −1 to +1 year.
Table 3 shows that the sample firms outperformed the control firms in
the years −2, −1, 0, +1, and +2, respectively. The results show that the
repurchase firms outperformed the control firms before the announcement
year, suggesting that good performers are likely to announce repurchases. All
measures for operating performance significantly improved between the years
−1 and +1, implying that the announcement of stock repurchases signals the
improvement of future operating performance, consistent with the signaling
hypothesis. As previously mentioned, the completion requirement in Korea
makes it unlikely for Korean firms to provide false signals to the market
through stock repurchase.

4.3. Market reactions to the stock repurchase

announcements
Table 4 provides analyses of both short-run and long-run abnormal returns
around the stock repurchase announcements. 11 Short-run abnormal returns

11
For the long-run test, we also used CAR instead of BHAR. The results are similar.
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Stock Repurchase in Korea • 95

are measured as cumulative abnormal returns (CAR). For the long-run stock
performance, we use buy-and-hold abnormal returns (BHAR). Both CAR
and BHAR are calculated relative to the corresponding control firms. 12
We find that both short run- and long-run abnormal returns are positive.
The average short-run abnormal returns to the stock repurchases, measured
from the announcement day through day 3 (day 2), is 3.89% (3.01%). This
is similar to the results reported in previous studies (Ikenberry, Lakonishok
and Vermaelen, 1995; Zhang, 2002). There is a 5.82% upward drift in the
CAR from day 0 to day 60. This increases to 13.68% for one-year BHAR.
This result suggests that the market underreaction hypothesis suggested by
Ikenberry, Lakonishok and Vermaelen (1995) also exists in the Korean stock
market.
The table also reports the prior returns. Repurchase firms experience
poor stock performance prior to the announcement of repurchases. CAR
from day −60 to day −2 is significantly negative (−8.43%), consistent with
the previous results.
Then, we further partition the sample and perform additional tests. The
partition is based on the variables that are found relevant in the previous
studies. Since firms announcing repurchase programs are likely to be under-
valued, we first partition the sample according to book-to-market (B/M)
ratio, a proxy for the degree of undervaluation. To partition the sample, we
sort all firms on the KSE and KOSDAQ by B/M, divide into deciles, and
classify them as low and high B/M groups. The lowest and the highest five
groups are classified as low and high B/M groups, respectively. Then the
repurchase sample is assigned to each category partitioned above accord-
ing to their respective B/M ratios. Therefore, each group of the repurchase
sample may not be of equal size.
Table 4 shows that there are 129 firms in the low B/M group and 207
firms in the high B/M group. The initial market reaction (CAR (0, +2)) of
high B/M samples is higher than that of low B/M samples but the difference
is not significant. For long-run abnormal performance, however, firms with
high B/M ratio have larger abnormal returns than those with low B/M ratio
and their difference is negative and significant, suggesting that the tendency
of underreaction explained above is more evident in the high B/M ratio
group, consistent with Ikenberry, Lakonishok and Vermaelen (1995).

12
Since we are using one-year BHAR, there may be some overlapping samples if the same
firm announces stock repurchases multiple times within a year. We perform the test with
these overlapping firms excluded. The results do not change.
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Table 4. Abnormal returns around the announcement of repurchases.

N (−60, −2) (0, +1) (0, +2) (0, +60) BHAR

Full 336 −8.43*** 3.01*** 3.89*** 5.82*** 13.68***

(0.000) (0.000) (0.000) (0.000) (0.003)

B/M
Low 129 −5.54*** 2.73*** 3.36*** 3.88 −0.43
(0.008) (0.000) (0.000) (0.187) (0.956)
High 207 −10.22*** 3.19*** 4.21*** 7.03*** 22.47***
(0.000) (0.000) (0.000) (0.000) (0.000)
Diff (t-value) 1.80* −0.72 −1.04 −0.96 −2.47**
(0.072) (0.471) (0.300) (0.336) (0.014)

Op
Non-Imp 146 −9.20*** 3.20*** 4.14*** 2.86 −6.12
(0.000) (0.000) (0.000) (0.207) (0.275)
Imp 190 −7.83*** 2.87*** 3.69*** 8.09*** 28.89***
(0.000) (0.000) (0.000) (0.000) (0.000)
Diff (t-value) −0.55 0.52 0.55 −1.81* −4.05***
(0.585) (0.603) (0.581) (0.072) (0.000)

LEV
Below 197 −7.41*** 3.08*** 4.09*** 8.51*** 15.61***
(0.000) (0.000) (0.000) (0.000) (0.006)
Above 139 −9.87*** 2.91*** 3.60*** 2.01 10.94
(0.000) (0.000) (0.000) (0.364) (0.153)
Diff (t-value) 0.96 0.28 0.61 2.24** 0.51
(0.340) (0.778) (0.545) (0.026) (0.614)

FCF
Low 113 −8.63*** 3.57*** 4.46*** 6.66** 6.73
(0.000) (0.000) (0.000) (0.010) (0.369)
High 223 −8.32*** 2.73*** 3.59*** 5.39*** 17.19***
(0.000) (0.000) (0.000) (0.002) (0.003)
Diff (t-value) −0.11 1.28 1.03 0.42 −1.09
(0.909) (0.202) (0.303) (0.677) (0.277)
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Stock Repurchase in Korea • 97

Table 4. (Continued)

N (−60, −2) (0, +1) (0, +2) (0, +60) BHAR

Target ratio
Low 168 −8.67*** 1.24*** 1.79*** 3.78* 9.25*
(0.000) (0.001) (0.000) (0.081) (0.061)
High 168 −8.18*** 4.78*** 5.99*** 7.86*** 18.10**
(0.000) (0.000) (0.000) (0.000) (0.019)
Diff (t-value) −0.19 −6.04*** −5.50*** −1.42 −0.97
(0.847) (0.000) (0.000) (0.157) (0.331)
Size
Small 69 −11.24*** 3.89*** 4.86*** 6.70** 33.79***
(0.000) (0.000) (0.000) (0.035) (0.000)
Large 267 −7.70*** 2.78*** 3.63*** 5.59*** 8.48
(0.000) (0.000) (0.000) (0.001) (0.120)
Diff (t-value) −1.13 1.45 1.24 0.31 3.01***
(0.260) (0.147) (0.215) (0.756) (0.003)
This table reports abnormal returns (%) measured by market adjusted returns except
BHAR. BHAR is one-year buy and hold abnormal returns after stock repurchase
announcements. The t-statistics and p-values for BHAR are calculated following Barber
and Lyon (1997). B/M is book-to-market based on the ratio of the book equity value at
the fiscal year-end prior to the announcement year over total market value on the day
prior to the announcement date. Op represents the change in abnormal operating per-
formance (the difference between sample minus control firms). LEV is the proxy for the
optimal leverage measured as the paired difference between sample and control firms. FCF
is free cash flow over total assets. Target ratio is the percentage of announced repurchase
shares relative to total shares outstanding. Size is based on the market value of equity on
the day prior to the announcement date. Numbers in parentheses denote p-values of the
significance levels. *, **, and *** indicate significance levels at the 10%, 5% and 1% levels,
respectively.

To examine market reactions according to the improvements in operating

performance (Op), we divide the sample into improvement (Imp) and non-
improvement groups (Non-imp). The signaling hypothesis suggests that the
market reactions are related to the improvement in operating performance.
The abnormal operating performance is measured as the paired difference
between the sample and the control firms to control for the industry effects,
as explained earlier. If the change in operating performance from −1 to +1
year is positive, the firm is considered as part of the improvement group,
otherwise, the non-improvement group. We observed the improvement in
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98 • Youngkyu Park & Kooyul Jung

operating performance after stock repurchase, in the previous section, con-

sistent with the signaling hypothesis. The initial market reactions are not
different between the improvement and non-improvement groups, seemingly
not supporting the signaling hypothesis. However, the difference in the mar-
ket reactions between the two groups becomes greater and more significant
as the return window is extended (t-value for 60 days is −1.81 which is sig-
nificant at the 10% significance level and for one-year BHAR, it decreased
to −4.05 which is significant at the 1% significance level). This suggests that
the market initially errs and underreacts to the signal for the improvements
in further operating performance. The full impact of the signal is gradually
recognized in the long-run. We interpret the result as consistent with the
signaling hypothesis, which is coupled with market underreaction. 13
The free cash flow hypothesis suggests that firms with more free cash
flow decrease agency cost and receive positive valuation effects. Partitioning
the sample according to FCF, in a way similar to the partition by B/M ratio
as explained earlier, we do not find differences in market reactions between
low and high FCF groups both in short- and long-run stock performance.
This is not consistent with the FCF hypothesis.
To test the optimal leverage hypothesis, we partition the sample accord-
ing to the proxy for optimal leverage, the difference in the leverage between
sample and control firms. If the difference is below zero, firms are classified
as part of the Below group, otherwise they are part of the Above group.
The differences in short- and long-run stock performance between the two
groups are not significant, not supporting the leverage hypothesis.
The target ratio indicates the magnitude of the repurchase and the inten-
sity of the managers’ information. We partition the sample according to the
median value of the target ratio. Previous studies show that the target ratios
are positively associated with abnormal announcement period returns. Our
results show that repurchase firms with high target ratios experience higher
abnormal returns for short-run market performance. However, the difference
in long-run performance is not significant.
Size indicates the degree of information asymmetry. Small firms are more
likely to be misvalued and, therefore, are more likely to announce stock
repurchases. We group firms into small and large size categories in a manner

13
As previously mentioned, Ikenberry, Lakonishok and Vermaelen (1995) report that the
market reaction to the repurchase is not completed over short time periods for high B/M
firms and that the full impact of announcements can extend over the long-run. However,
they do not clearly explain why the underreaction occurs only for high B/M firms.
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Stock Repurchase in Korea • 99

similar to the partition by B/M. The initial market reactions are not much
different between the two groups although there is significant difference in
the long-run return.
In sum, the results of univariate tests for the market reactions show
that the initial market returns strongly react to the target ratio, and that
long-run stock market returns react to the B/M ratio, improvement in oper-
ation performance and size. These results are generally consistent with the
undervaluation and signaling hypothesis.

4.4. Multivariate evidence: short-run and long-run market

performance
4.4.1. Short-run evidence
This section examines initial market reactions to repurchase announcements
with respect to the four hypotheses described earlier using multivariate
regression models.
Table 5 reports the regression results where the abnormal announce-
ment returns are regressed on the variables related to the four hypotheses. 14
Three-days CAR from day 0 to day +2 is used as the dependent variable.
The results show that the coefficients of B/M are positive and significant,
and those of CAR (−60, −2) are negative and significant. Firms with low
prior returns or with high B/M prior to the stock repurchase announcements
have higher announcement returns, suggesting that investors favorably react
to the degree of undervalution. In other words, firms with a high degree of
undervalution experience higher positive initial returns than those with low
degree of undervalution, consistent with the undervalution hypothesis.
The FCF variable is not significant, not supporting the FCF hypothe-
sis. Chan, Ikenberry and Lee (2003) suggest that one plausible reason for
the insignificance of the FCF variable might be that the market may have
expected an open market repurchase announcement for the firms with high
free cash flow. We further examine the free cash flow hypothesis by including
an interaction variable between FCF and q ratio. According to free cash flow
hypothesis, the stock price reaction is related to cash level for low q firms,
not for high q firms (Lie, 2000). The q variable, High q, is a dummy variable
which takes the value of one if it is greater than one, otherwise zero. The

14
For Leverage and ∆CFROA (−1, +1) variables, we use the adjusted amount to control
for the industry effect, which is calculated as the difference between sample and control
firms. We also used the unadjusted amount, and the results are similar. The FCF variable
is not adjusted. However, the use of adjusted FCF does not change the result.
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100 • Youngkyu Park & Kooyul Jung

coefficient on this variable is expected to be negative but not significant.

These results do not support the free cash flow hypothesis.
For the leverage hypothesis, we do not find supportive evidence. The
coefficient of leverage, LEV, is negative but not significant. The optimal
leverage hypothesis does not seem to be an important motive for repurchases.
For the signaling hypothesis, we examine the change in CFROA from
year −1 to year +1 in Models 3 and 4. The results show that initial market
reactions are not significantly related to the change in operating perfor-
mance, not supporting the signaling hypothesis. However, in Table 3 earlier,
we reported that operating performance improved following the stock repur-
chase, consistent with the signaling hypothesis. Also, the univariate test of
market reaction reported in Table 4 earlier find significant market reaction
for the long-run test. It is possible that stock repurchases is the signal for the

Table 5. Regression for short-run stock performance.

Model 1 Model 2 Model 3 Model 4

Intercept 11.5806* −1.4003 −1.3520 −0.4962

(0.081) (0.840) (0.846) (0.944)
Target ratio (%) 0.8530*** 0.9777*** 0.9995*** 0.9845***
(0.000) (0.000) (0.000) (0.000)
LnMV −0.6013* −0.1129 −0.1222 −0.1518
(0.089) (0.749) (0.730) (0.670)
LnBM 1.0639* 1.0659** 1.0462** 0.8528
(0.051) (0.037) (0.040) (0.161)
CAR (−60, −2) (%) −0.0593*** −0.0616*** −0.0614***
(0.002) (0.001) (0.001)
FCF 2.4569 2.5898 −6.4084
(0.813) (0.807) (0.644)
LEV −2.6866 −2.8708 −2.7441
(0.183) (0.157) (0.177)
Ownership (%) 0.0995*** 0.0991*** 0.1004***
(0.004) (0.005) (0.005)
R&D 26.2139 27.2076 20.3614
(0.616) (0.600) (0.685)
ITA −4.7602 −4.6834 −1.5525
(0.874) (0.875) (0.958)
∆CFROA (−1, +1) (%) 0.0347 0.0322
(0.192) (0.215)
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Stock Repurchase in Korea • 101

Table 5. (Continued).

Model 1 Model 2 Model 3 Model 4

High q −0.0593*** −0.0593*** −0.0616*** −0.8536

(0.426)
FCF*High q 22.4659
(0.219)
F-statistic 11.19 5.70 5.25 4.76
Adj. Rˆ2 0.115 0.183 0.184 0.184

This table reports short-run regression results of market reactions on various explana-
tory variables. The dependent variable is CAR (0, +2). Target ratio is the percentage of
announced repurchase shares relative to total shares outstanding. LnMV is based on the
market value of equity on the day prior to the announcement date. LnBM is natural loga-
rithm of book-to-market based on the ratio of the book equity value at the fiscal year-end
prior to the announcement year over total market value on the day prior to the announce-
ment date. FCF is free cash flow over total assets. LEV is the proxy for the optimal
leverage calculated by the paired difference between sample and control firms. Ownership
means stock holdings by the largest shareholder. R&D is R&D expense divided by total
assets. ITA is intangible assets over total assets. CAR (−60, −2) is cumulative abnormal
returns from −60 day to −2 day to the repurchase announcement. One year BHAR is
buy-and-hold abnormal return after announcement months. ∆CFROA (−1, +1) is paired
difference in change in CFROA from −1 year to +1 year between sample and control firms.
High q is a dummy variable that takes one if firms have higher q than 1, otherwise takes
zero. FCF*High q is calculated by multiplying FCF by High q. Numbers in parentheses
denote p-values of the significance level. The p-values are calculated using standard errors
following White (1980). *, **, and *** indicate significance levels at the 10%, 5% and 1%
levels, respectively.

improvement in operating performance, but initially market does not react

to the information at the announcement of the stock repurchase. We pursue
this issue further when we explain the long-run test in the next section.
The target ratio variable is highly significant in explaining the initial
market reactions, consistent with the existing evidence. We find that the
ownership variables of the largest shareholder is positive and significant,
suggesting that the signal through the repurchase by the firms with a large
ownership by the largest shareholder is more credible to outsider investors
than that of the low ownership firms. The variables measuring information
asymmetry, market value (LnMV), R&D expense (R&D), and intangibles
(ITA) are not significant. The results suggest that information asymmetry
is not a major factor in explaining the initial market reaction in Korea.
In sum, short-run regression results show that the target ratio and
prior return variables are highly significant, and B/M variable is marginally
significant at the 10% significance level. The results for B/M and prior
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102 • Youngkyu Park & Kooyul Jung

return support the undervaluation hypothesis, but other hypotheses are not
clearly supported. However, since we observed the market underreaction as
explained in Table 4, we perform further analysis using long-run stock return
in the following section.

4.4.2. Long-run empirical evidence

This section examines the four hypotheses using long-run tests. Table 6
reports the regression results using one-year BHAR as the dependent
variable.15

Table 6. Regression for the long-run stock performance.

Model 1 Model 2 Model 3 Model 4

Intercept 48.1127 86.6346 88.2700 94.4929

(0.438) (0.166) (0.149) (0.111)
Target ratio (%) −0.4053 −0.7288 0.0122 0.0054
(0.847) (0.731) (0.995) (0.998)
LnMV −2.1922 −3.5116 −3.8293 −4.5523
(0.501) (0.301) (0.252) (0.153)
LnBM 19.7872*** 23.2089*** 22.5411*** 27.5667***
(0.005) (0.002) (0.003) (0.002)
CAR (−60, −2) (%) 0.1787 0.1011 0.1308
(0.303) (0.553) (0.454)
FCF 258.6062** 263.1127** 267.9674*
(0.016) (0.011) (0.088)
LEV 10.9976 4.7550 5.8252
(0.658) (0.842) (0.803)
Ownership (%) −0.4509 −0.4648 −0.4415
(0.191) (0.169) (0.188)
R&D −883.6075* −849.9316* −922.3168*
(0.064) (0.075) (0.089)
ITA 349.6103 352.2140 338.6072
(0.171) (0.160) (0.203)
∆CFROA (−1, +1) (%) 1.1775*** 1.2385***
(0.000) (0.000)

15
The Leverage, ∆CFROA (−1,+1), FCF variables were calculated in the same way as
for the short-run test explained in note 14. The results are similar whether we use the
variables adjusted for the industry effect or unadjusted amounts.
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Stock Repurchase in Korea • 103

Table 6. (Continued)

Model 1 Model 2 Model 3 Model 4

High q 18.5872*
(0.076)
FCF*High q −32.0758
(0.879)
F-statistic 4.67 2.79 4.33 3.59
Adj. Rˆ2 0.029 0.040 0.074 0.076

This table reports long-run regression results of market reactions on various explanatory
variables. The dependent variable is one-year BHAR. Target ratio is the percentage of
announced repurchase shares relative to total outstanding shares. LnMV is based on the
market value of equity on the day prior to the announcement date. LnBM is natural
logarithm of book-to-market based on the ratio of the book equity value at the fiscal
year-end prior to the announcement year over total market value on the day prior to the
announcement date. FCF is free cash flow over total assets. LEV is the proxy for the
optimal leverage calculated by the paired difference between sample and control firms.
Ownership means the holdings of the largest shareholder. R&D is R&D expense divided
by total assets. ITA is intangible assets over total assets. CAR (−60, −2) is cumulative
abnormal return from −60 day to −2 day of the announcement. ∆CFROA (−1, +1) is
paired difference in change in CFROA from −1 year to +1 year between sample and control
firm. High q is a dummy variable that takes one if firms have higher q than one, otherwise
zero. FCF*High q is calculated by multiplying FCF by High q. Numbers in parentheses
denote p-values of the significance level. The p-values are calculated using standard errors
following White (1980). *, **, and *** indicate significance levels at the 10%, 5% and 1%
levels, respectively.

We find that the coefficient on B/M is positive and significant. Firms with
high B/M have higher returns after repurchase announcements, consistent
with the undervaluation hypothesis. Both the long-run and short-run tests
strongly support the undervaluation hypothesis in Korea. 16
The FCF variable is positive and significant in contrast to the short-
run result. However, as previously explained, the variable should be more
significant for the firms with low investment opportunity (q < 1). To test
this, we include the interaction variable between FCF and High q (one if
q is greater than 1, otherwise zero) as for the short-run regression model.
The coefficient for the interaction variable is negative as expected but not
significant, thus not supporting the FCF hypothesis. The result suggests
that the FCF hypothesis is not conclusive in Korea.

16
The B/M ratio is more significant than it is for the short-run test, showing the tendency
of market underreaction as found in Ikenberry, Lakonishok and Vermaelen (1995).
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104 • Youngkyu Park & Kooyul Jung

For the signaling hypothesis, we examine the coefficient on the change of

CFROA from year −1 to +1. The coefficient is found positive and significant
although it was insignificant for the initial market reaction in Table 5. The
result that the signaling hypothesis is supported only in the long-run test
confirms our conjecture that the market underreacts to the signaling in the
short-run, but gradually recognizes the signal in the long-run as explained
earlier when we discussed the univariate results. The result seems to sug-
gest that the signaling hypothesis is supported, but coupled with market
underreaction.
The coefficient on LEV is insignificant as in the short-run regression
model, not supporting the leverage hypothesis.

4.5. Robustness tests: Signaling versus free cash flow

hypothesis
Table 3 reports the improvement in operating performance after repurchases,
consistent with the signaling hypothesis. The signaling hypothesis was fur-
ther confirmed by the long-run market reaction in the previous section.
However, the improved operating performance does not necessary imply sig-
naling. It could suggest the free cash flow hypothesis as Nohel and Tarhan
(1998, p. 189) argue. That is, a firm’s operating performance could improve
when a firm sells off poorly performing assets and distributes its cash through
stock repurchase, which is more related to the FCF hypothesis than the sig-
naling hypothesis.
In order to distinguish between these two hypotheses, we perform the
additional analysis following Nohel and Tarhan (1998). Since the free cash
flow hypothesis is more related to the low growth firm than the high growth
firm whereas the signaling hypothesis is independent of the growth status of
the firm (Lie, 2000; Lang and Litzenberger, 1989), we first divide the sample
into low and high growth firms according to the q ratio. In Panel A, we
partition the sample according to Tobin’s q and find that the improvement in
performance (∆PM (−1, +1) and ∆CRROA (−1, +1)) is significant for low
q firms, while it is insignificant for high q firms. If improvement in operating
performance appears in both low and high q firms, it would clearly support
the signaling hypothesis. However, the improved performance in only low q
firms could be explained by either the free cash flow or signaling hypotheses.
Our results are inconclusive with respect to the signaling or the free cash
flow hypothesis, and we perform two additional tests in order to further
examine this issue.
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Stock Repurchase in Korea • 105

First, we examine the change in asset sales around repurchases. Nohel

and Tarhan (1998) suggest that the manager dispose of poorly performing
assets and distribute cash through stock repurchase. The sale of inefficient
assets automatically improves operating performance following repurchase.
They find substantial asset sales prior to repurchase and show that asset sales
are positively related to the improved operating performance. They argue
that this supports the free cash flow hypothesis rather than the signaling
hypothesis.17 We examine the asset sales prior to repurchase as in Nohel and
Tarhan (1998) and report the result in Panel B. We do not find the increase
in asset sales prior to repurchase for all q levels. This is inconsistent with
the free cash flow hypothesis.
Second, we examine the change in capital expenditure (CAPEX). If the
repurchase is caused by the signaling motive, firms will undertake good
investments, increasing CAPEX after repurchase. On the other hand, if free
cash flow is the motive for repurchase, capital expenditure will decrease
after repurchase (Grullon and Michaely, 2004; Yoon and Starks, 1995). The
change in capital expenditure is reported in Panel C of Table 7. The change
in CAPEX from year −1 to +1 is positive and significant, consistent with
the signaling hypothesis.
In sum, the above additional tests show that the improvement in oper-
ating performance is best explained by the signaling rather than free cash
flow hypothesis.

5. Conclusion
This study examined the motive for the stock repurchase. We examined four
major hypotheses — undervaluation, signaling, FCF and leverage hypothe-
ses. These hypotheses were examined using both short-run and long-run
market reactions.
The undervaluation hypothesis was most consistent with both short-run
and long-run market reactions. The improvement in operating performance
following stock repurchase is consistent with the signaling hypothesis. How-
ever, the signaling hypothesis is not supported in the short-run and found
only in the long-run market test. This result seems to suggest that the mar-
ket initially underreacts to the signaling, but the result is recognized through
the long-run drift of market reactions.

17
Asset sales are measured as assets at the end of year t minus assets at end of year t − 1,
minus capital expenditures in year t, plus depreciation in year t over total assets in year
t − 1 following Nohel and Tarhan (1998).
 January 19, 2005
106 • Youngkyu Park & Kooyul Jung
Table 7. Change in operating performance, asset sales, and CAPEX around the announcement year.

Panel A: Operating performance

17:11
PM(%) CFROA(%) PM(%) CFROA(%)

Mean Median Mean Median Mean Median Mean Median

WSPC/155-RPBFMP
Low q (< 1), N = 234 High q (> 1), N = 102
Year −2 1.01* 0.55** 0.55 0.68 4.22*** 2.27*** 3.87*** 3.74***
−1 3.28*** 0.90*** 1.51** 1.83*** 5.36*** 3.95*** 4.25*** 3.30***
0 2.44*** 2.05*** 1.85*** 1.87*** 7.94*** 4.57*** 4.42*** 2.21***
+1 5.92*** 2.87*** 3.32*** 2.98*** 5.72*** 2.81*** 2.96* 2.83***
Year +2 6.19* 2.30*** 4.80*** 3.52*** 7.03*** 4.21*** 3.22*** 3.55***
∆(−1, +1) 2.64 1.21*** 1.81** 1.39*** 0.36 0.04 −1.28 0.41

Panel B: Asset sales

Mean Median Mean Median Mean Median

Full sample, N = 336 Low q (< 1), N = 234 High q (> 1), N = 102
Year −2 0.0608*** 0.0444*** 0.0322* 0.0377*** 0.1245** 0.0729***
−1 0.0253* 0.0330** 0.0147 0.0274 0.0497* 0.0443**
0 0.0236* 0.0071 0.0079 −0.0044 0.0597** 0.0500***
+1 0.0172 0.0169* 0.0249* 0.0234** −0.0006 −0.0170
Year +2 0.0506*** 0.0292*** 0.0475*** 0.0276*** 0.0577* 0.0400**

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∆(−1, +1) −0.0081 −0.0055 0.0103 0.0162 −0.0503 −0.0594

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17:11
Table 7. (Continued)

WSPC/155-RPBFMP
Panel C: CAPEX
Mean Median Mean Median Mean Median

Full sample, N = 336 Low q (< 1), N = 234 High q (> 1), N = 102

Year −2 −0.0328*** −0.0071*** −0.0336*** −0.0051** −0.0311** −0.0102

−1 −0.0177** −0.0035** −0.0300*** −0.0101*** 0.0105 0.0089
0 −0.0174*** −0.0091*** −0.0251*** −0.0154*** 0.0004 −0.0034
+1 0.0085 0.0077 0.0095 0.0059 0.0062 0.0120
Year +2 0.0076 0.0118** 0.0089 0.0114* 0.0046 0.0123

Stock Repurchase in Korea • 107

∆(−1, +1) 0.0262*** 0.0097** 0.0396*** 0.0129*** −0.0043 −0.0017

Firms are classified as high q (low q) if q is greater (smaller) than one. Panel A reports abnormal operating performance and
changes around the announcement year. PM represents profit margin. CFROA represents EBITDA over total assets. Year 1 is stock
repurchase announcement year. Panel B shows asset sales around the repurchase year. Panel C reports the change in CAPEX
around the announcement year. All variables are paired differences between sample and control firms. *, **, and *** indicate
significance levels at the 10, 5, and 1% level, respectively.

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108 • Youngkyu Park & Kooyul Jung

In order to examine the assertion that improved operating performance

could be due to asset sales and stock repurchase, which suggests FCF
hypothesis, rather than signaling, we performed additional tests. They fur-
ther confirm the signaling hypothesis.
Of the control variables used in the test, the target ratio and ownership by
the largest shareholder are found significant, suggesting that the magnitude
of repurchase and the ownership increase motive by the largest shareholders
are also important factors that explain the stock repurchase.
 January 19, 2005
Appendix

17:11
Table A1. Correlation among variables.

Panel A: Pearson Correlation

Panel B:

WSPC/155-RPBFMP
Spearman Target CAR ∆CFROA
Correlation ratio LnMV LnBM FCF LEV Ownership R&D ITA (−60,−2) (−1,+1)

Target −0.205*** 0.284*** −0.191*** 0.093* 0.050 −0.181*** −0.032 0.065 −0.075
ratio (0.000) (0.000) (0.000) (0.088) (0.364) (0.001) (0.557) (0.238) (0.172)
LnMV −0.261*** −0.276*** 0.091* 0.114** −0.267*** 0.170*** 0.075 0.131** 0.053
(0.000) (0.000) (0.097) (0.037) (0.000) (0.002) (0.169) (0.016) (0.336)
LnBM 0.283*** −0.324*** −0.230*** 0.176*** 0.018 −0.098* −0.169*** −0.153*** 0.000
(0.000) (0.000) (0.000) (0.001) (0.747) (0.073) (0.002) (0.005) (0.999)

Stock Repurchase in Korea • 109

FCF −0.183*** 0.042 −0.247*** −0.180*** 0.082 0.304*** −0.110 0.015 −0.018
(0.001) (0.447) (0.000) (0.001) (0.133) (0.000) (0.044) (0.778) (0.749)
LEV 0.106* 0.116** 0.124** −0.159*** −0.175*** −0.067 0.085 −0.017 0.081
(0.051) (0.033) (0.023) (0.004) (0.001) (0.218) (0.118) (0.763) (0.136)
Ownership 0.061 −0.274*** 0.058 0.075 −0.191*** −0.214*** −0.223*** −0.064 −0.016
(0.262) (0.000) (0.291) (0.172) (0.000) (0.000) (0.000) (0.245) (0.771)
R&D −0.181*** 0.177*** −0.165*** 0.161*** −0.070 −0.254*** 0.112** 0.020 −0.014

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(0.001) (0.001) (0.003) (0.003) (0.199) (0.000) (0.041) (0.715) (0.792)

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110 • Youngkyu Park & Kooyul Jung
Table A1. (Continued)

17:11
Panel A: Pearson Correlation
Panel B:

WSPC/155-RPBFMP
Spearman Target CAR ∆CFROA
Correlation ratio LnMV LnBM FCF LEV Ownership R&D ITA (−60,−2) (−1,+1)

ITA −0.037 0.213*** 0.028 −0.180*** 0.174*** −0.346*** 0.442*** −0.003 0.000
(0.499) (0.000) (0.607) (0.001) (0.001) (0.000) (0.000) (0.961) (0.998)
CAR (−60,−2) 0.022 0.180*** −0.175*** 0.060 −0.041 −0.074 0.038 0.065 0.102*
(0.681) (0.001) (0.001) (0.271) (0.449) (0.174) (0.492) (0.234) (0.062)
∆CFROA (−1,+1) 0.029 0.023 0.034 −0.050 0.040 −0.053 0.066 −0.011 0.038
(0.593) (0.678) (0.530) (0.364) (0.469) (0.330) (0.228) (0.835) (0.490)

This table reports the correlations among the variables. Target ratio is the percentage of announced repurchase shares relative to total
outstanding shares. LnBM is the natural logarithm of book-to-market based on the ratio of the book equity value at the fiscal year-end
prior to the announcement year over total market value on the day prior to the announcement date. LnMV is based on the market value
of equity on the day prior to the announcement date. FCF is free cash flow over total assets. LEV, total debt to total assets, is calculated
as the difference between sample and control firms. Ownership means stock holdings by the largest shareholder. R&D is R&D expense
divided by total assets. ITA represents intangible assets over total assets. CAR (−60, −2) is cumulative abnormal returns from −60 to −2
day to the announcement of repurchase. ∆CFROA (+1, −1) is the paired difference in change in CFROA from −1 to +1 year between
sample and control firms. Numbers in parentheses denote p-values of the significance level. *, **, and *** indicate significance levels at
the 10%, 5% and 1% levels, respectively.

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Stock Repurchase in Korea • 111

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