Changes in bid-ask spreads surrounding the announcement of open-market repurchase programs with implications for corporate payout policy

James M Miller, Purdue University

Abstract

This study examines changes in NYSE bid/ask spreads surrounding the announcement of open-market repurchase programs. The time period analyzed encompasses the period January 1984 through June 1988. The data include a sample of 184 NYSE firms which announced the initiation of an open-market repurchase program and 105 NYSE firms which announced the continuation of an open-market repurchase program. For each announcement, a time-series of daily closing bid/ask spreads is collected for the 180 trading-day period immediately surrounding the announcement. Test results indicate that absolute bid/ask spreads decrease following the announcement of both repurchase initiation and continuation announcements. This evidence of a spread decrease is contrary to the prediction and empirical evidence of Barclay and Smith (1988). Further, the decrease in absolute bid/ask spreads following repurchase announcements is accompanied by a significant decrease in return volatility. An exception to the above results occurs for the repurchase announcements made during the period June 1987 through December 1987. For this subsample of firms, both absolute spreads and return volatility are found to increase following repurchase announcements. These increases are attributed to the stock market crash occurring in October 1987. A cross-sectional analysis of spread changes provides evidence that the spread decrease results from the volatility decrease. This finding is consistent with inventory models of the bid/ask spread (e.g., Ho and Stoll (1981)). Further, the cross-sectional analysis presents evidence in support of the conjecture of Barclay and Smith. That is, the introduction of better-informed managers into the stock market during an open-market repurchase program does exert a positive influence on the specialist's bid/ask spread. This influence, however, is counterbalanced by a decrease in the bid/ask spread resulting from a decrease in return volatility following repurchase announcements. The net effect of these two influences is a decrease in the bid/ask spread following repurchase announcements. Therefore, we cannot conclude that the corporate preference for cash dividends results from wider bid/ask spreads following open-market repurchase announcements.

Degree

Ph.D.

Advisors

McConnell, Purdue University.

Subject Area

Finance

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