Description
This is a report about empirical study on signaling effect with respect to bonus issues, stock splits, dividend announcements and buyback shares.
With respect to: Bonus Issues, Stock Splits, Dividend Announcements and Buyback of Shares
Corporate Finance 2 Final Project Report
Group 6 Aakriti Kakkar Aditi Bindlish Ankita Maheshwari Gourab Kundu H. Sanchay Grover Neha Kasturia 91001 91003 91007 91020 91021 91037
Trimester 3 FORE School of Management
An Empirical Study on the Signaling Effect in Stock Markets
ACKNOWLEDGEMENT
W
e would like to express our earnest gratitude towards Dr. Himanshu Joshi for the stupendous guidance and support that he provided to us during the execution of the project on the imprints of the Signalling effect with respect to the stock markets and the practical influence that it has on the all of us. His role in providing a vivid insight into the dynamics of Corporate Finance, the various determinants and the present day scenario that goes beyond the realms of any text-book; have really motivated us to work that bit harder to come out with this report. We’d also like to acknowledge the unending help that we received from our fellow classmates whilst the execution of this project report. Their help and concern goes on to reiterate the kind of bonhomie that exists at FORE School of Management.
Thanking You,
Aakriti Kakkar Aditi Bindlish Ankita Maheshwari Gourab Kundu H. Sanchay Grover Neha Kasturia
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An Empirical Study on the Signaling Effect in Stock Markets
PREFACE
S
tock market, being a vital institution, facilitates economic development. It is true that so many parties are interested in knowing the efficiency of the stock market. The small and medium investors can be motivated to save and invest in the stock market only if their securities in the market are appropriately priced. The information content of events and its dissemination determine the efficiency of the stock market. That is how quickly and correctly security prices reflect these information show the efficiency of the stock market. The companies may buy-back shares from the existing shareholders on a proportionate basis either through tender offer; or from the open market either by inviting tenders or by the book building process; or odd lot shares; or the shares issued to employees pursuant to a scheme of stock option or sweat equity. As a part of laid out procedure the management is required to inform the shareholders the necessity for the share buyback, basis of the offer price, sources of funds, and the management discussion on the likely impact of the buyback on the company in the offer document. Most of the Indian companies in their offer document have claimed that the share buyback programme is expected to contribute to the overall enhancement of the shareholder value. However, no supportive analysis has been provided in the discussion. In the India and elsewhere around the globe, many research studies have been conducted to test the efficiency of the stock market with respect to information content of events. Whereas in India, very few studies have been conducted to test the efficiency of the stock market with respect to stock split announcements, even after these studies have been conducted with different industries with different period. Hence the present study on the corporate finance project is an attempt to test the efficiency of the Indian stock market with respect to information content of stock split announcements, bonus issues, dividends and buyback of shares.
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An Empirical Study on the Signaling Effect in Stock Markets
TABLE OF CONTENTS
INTRODUCTION 5
RESEARCH METHODOLOGY Sources of Collection of Data The hypotheses of the study Tools used for the Analysis
7
REVIEW OF LITERATURE Share price behaviour around buy back and Dividend announcements in India Impact of dividend changes on the Indian Corporate bond market: signaling effects Testing the semi-strong form efficiency of Indian stock market with respect to information Content of stock split announcement – a study in it industry The effects on earnings from announcement Of open market Malaysian corporate share buyback
10
BONUS ISSUE STOCK SPLIT DIVIDEND ANNOUNCEMENT BUYBACK OF SHARES
21 26 31 38
LIMITATIONS OF THE STUDY CONCLUSION
44 45
APPENDIX BIBLIOGRAPHY
46 62
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An Empirical Study on the Signaling Effect in Stock Markets
INTRODUCTION
P
ayout policy of a firm is one of the most important areas in corporate finance. Managers have to decide about the amount and type of the payout repeatedly and regularly. Though a number of theoretical explanations have been proposed in the literature to explain the payout policy, the empirical support is scanty. The changes in corporate laws permitted share repurchase in the Indian market, however cash dividend continues to be the most prominent form of payout to the owners of the firm. The limited work on corporate dividend decisions in the Indian market have mainly focused on the valuation effects and determinants of firms’ dividend payout. Most of these studies have documented the behaviour of share prices and profitability/earnings measures around dividend changes. Corporate debt market has remained highly underdeveloped segment of Indian financial markets. On one hand bond issues from corporates are very low, with most of the corporate borrowing still made up of institutional and bank loans, on the other hand, most of the retail investors perceive corporate bonds nearly as risky as equity and do not show significant inclination in investing in corporate bonds. During 19962001, due to bearish trend in equity market companies sought to approach debt market but showed preference for private placements over public issues. Efforts by regulators to discourage private placement market have improved the number of listed bonds and market capitalisation in 2003-04; however we are yet to experience vibrancy in corporate bond market. In nineties, primary market for financial institutional issues is fairly developed, with ICICI and IDBI repeatedly approaching the market and successively raising significant amounts. Despite this secondary market lacks both width and depth, evidenced by thin trading and a few investors. Though corporate debt market is still immature, its significance cannot be undermined. Policy makers have realized importance of development of bond market and are making all-out efforts to achieve the same. This further makes it imperative to add to little available literature on fixed income market. The capital market plays a pivotal role in the allocation of economic resources into productive activities of the economy, which are possible only if the securities traded in the markets are priced appropriately. A capital market in which stock prices fully reflect all available information can be termed as efficient. The market efficiency can be classified into the following three categories depending on the information set that is fully reflected in the security prices. a. Weak - Form of Efficiency, popularly known as Random Walk Theory states that the current stock prices reflect all the information that is contained in the historical sequence of prices.
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An Empirical Study on the Signaling Effect in Stock Markets b. Semi - Strong Form of Efficiency, which states that current market prices not only reflect all information content of historical prices but also reflect all the information, which are publicly available about the companies being studied. c. Strong - Form of Efficiency, which states that current market prices reflect all information whether it is publicly available or private information (insiders information). SIGNALING EFFECT Dividend Declaration A model developed by Merton Miller and Kevin Rock in 1985 suggests that dividend announcements convey information to investors regarding the firm's future prospects. Many earlier studies had shown that stock prices tend to increase when an increase in dividends is announced and tend to decrease when a decrease or omission is announced. Miller and Rock pointed out that this is likely due to the information content of dividends. When investors have incomplete information about the firm (perhaps due to opaque accounting practices) they will look for other information that may provide a clue as to the firm's future prospects. Managers have more information than investors about the firm, and such information may inform their dividend decisions. When managers lack confidence in the firm's ability to generate cash flows in the future they may keep dividends constant, or possibly even reduce the amount of dividends paid out. Conversely, managers that have access to information that indicates very good future prospects for the firm (eg. a full order book) are more likely to increase dividends. Investors can use this knowledge about managers' behaviour to inform their decision to buy or sell the firm's stock, bidding the price up in the case of a positive dividend surprise, or selling it down when dividends do not meet expectations. This, in turn, may influence the dividend decision as managers know that stock holders closely watch dividend announcements looking for good or bad news. As managers tend to avoid sending a negative signal to the market about the future prospects of their firm, this also tends to lead to a dividend policy of a steady, gradually increasing payment.
Share Buyback Stock repurchases may have a signaling effect. For example, a positive signal might be sent to the market if management believed the stock were undervalued and they were constrained not to tender shares they owned individually. In this context, the premium in repurchase price over existing market price would reflect management’s belief about the degree of undervaluation.
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An Empirical Study on the Signaling Effect in Stock Markets
RESEARCH METHODOLOGY
O
ver the past few years, many firms have announced significant number of stock repurchases. The overwhelming reason given for stock repurchase announcements has been to reverse a trend of declining stock prices. Share buy backs have become an important area in financial research considering its strong implications for corporate policy. Indian companies have been permitted to buy back shares after the provisions of the Companies Act 1956 were suitably amended in 1999. Several studies have provided conclusive proof of signalling effect of stock repurchase and dividends announcements. In our project paper we attempt to analyse signalling of dividend announcements, stock splits, buyback, and issue of bonus shares. Sources of Collection of Data ? The data relating to announcement dates of buyback, dividend, stock splits and issue of bonus shares were obtained from moneycontrol.com. ? The share prices of the respective securities and closing market index was obtained from the BSE Website. The hypotheses of the study The objectives of the project are fourfold. First, we analyse if the market recognizes bonus issues as an instrument of change in sentiment and if it reacts favourably to the firms’ announcements. This leads to the hypothesis: H1: There is no positive signaling in Share price behaviour around bonus issues. H1alternate: There is a positive signalling in Share price behaviour around bonus issues. Second, we analyse if the market recognizes stock splits as an instrument of change in sentiment and if it reacts favourably to the firms’ announcements. This leads to the hypothesis: H2: There is no positive signaling in Share price behaviour around stock splits. H2alternate: There is a positive signalling in Share price behaviour around stock splits.
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An Empirical Study on the Signaling Effect in Stock Markets Third, we analyse if the market recognizes the announcement of dividend as an instrument of change in sentiment and if it reacts favourably to the firms’ announcements. This leads to the hypothesis: H3: There is no positive signaling in Share price behaviour around the announcement of dividend. H3alternate: There is a positive signalling in Share price behaviour around the announcement of dividend. Fourth, we analyse if the market recognizes the buyback of shares as an instrument of change in sentiment and if it reacts favourably to the firms’ announcements. This leads to the hypothesis: H4: There is no positive signaling in Share price behaviour around the buyback of shares. H4alternate: There is a positive signalling in Share price behaviour around the buyback of shares. Tools used for the Analysis: a. Daily returns The daily returns were calculated for both individual securities as well as Market Index using the following equation
Where, R i, t = Returns on Security i on time t. Pt = Price of the security at time t Pt-1 = Price of the security at time t-1
b. Abnormal Returns Abnormal Returns (AR) under market-adjusted abnormal returns is calculated using by the equation as below;
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An Empirical Study on the Signaling Effect in Stock Markets Abnormal Returns for each day (day -4 to +4) was computed by horizontal summation of abnormal returns on day t for all companies, divided by the number of companies. Where, ARi,t = Abnormal returns on security i at time t Ri,t = Actual returns on security i at time t Ri,m = Actual returns on market index, which is proxied by BSE Sensex, at time t. Thus daily actual returns over the announcement period (8 days) were adjusted against their corresponding market returns.
c. Average Abnormal Returns The Average Abnormal Returns is calculated by the equation given below:
Where, AARt = Average Abnormal Returns on day t ARi,t = Abnormal Returns on security i at time t which is calculated by using the equation. d. T-Test In order to ascertain whether the various announcements or events had a significant impact on the abnormal returns, a t-test (t-test: two sample assuming equal variances) was conducted. e. Cumulative Abnormal Returns (i) CAR before and after announcement was computed for each company (for every parameter considered), and a graph depicting the same was plotted. (ii) In order to study, whether the impact was felt more around the announcement dates, CAR for each company for each trading window was then computed (e.g. one day trading window is -1 to +1 days). Then, a mean value for each trading window was computed. A graph of the same was plotted.
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An Empirical Study on the Signaling Effect in Stock Markets
REVIEW OF LITERATURE
SHARE PRICE BEHAVIOUR AROUND BUY BACK AND DIVIDEND ANNOUNCEMENTS IN INDIA
Prepared by: Dr. P. Thirumalvalavan – Reader, Bharathiar School of Management and Entrepreneur, Development, Bharathiar University K. Sunitha – Research Scholar, Bharathiar School of Management and Entrepreneur Development, Bharathiar University Published August 2005 Abstract of the research paper Over the past few years, many firms have announced significant number of stock repurchases. The overwhelming reason given for stock repurchase announcements has been to reverse a trend of declining stock prices. Share buy backs have become an important area in financial research considering its strong implications for corporate policy. Indian companies have been permitted to buy back shares after the provisions of the Companies Act 1956 were suitably amended in 1999. Several studies have provided conclusive proof of signaling effect of stock repurchase and dividends announcements. This paper investigates and tests the following: 1) Signaling effect of a share buy - back and dividend announcements 2) The market reaction and share price behaviour to announcements of stock repurchases and dividends 3) Abnormal Returns across various repurchase levels. The analysis uses data of 22 firms in the BSE 500 index, which has announced stock repurchase option and dividends during the period 2002 –2004. An examination of share price behaviour around stock repurchases and dividends prove the signaling effect of these announcements. Stock repurchase programs recorded a high cumulative abnormal return of 3.2 percent within two days of the event whereas dividend announcement recorded a high cumulative abnormal return of 2.1 percent within one day of the event. There is no significant difference in abnormal returns as result of various repurchase levels. These results imply the strong signaling power of stock repurchases announcements and that the market reacts more favourably to repurchases compared to dividend announcements.
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An Empirical Study on the Signaling Effect in Stock Markets
This study is one of the work examining the impact of stock repurchase program and dividend nnouncements on share price behaviour and their relative signaling power with reference to Indian firms. The research methodology used: Hypotheses: The objectives of the research paper are twofold. Firstly, if the market recognizes any differences between stock repurchases and dividends and if it reacts more favourably to firms’ announcements of one of the payout instruments. This leads to the hypothesis: H1: There is no positive signaling in Share price behaviour around buybacks. H2: There is no positive signaling in Share price behaviour around dividend announcement. H3: There exist no significant difference between the cumulative abnormal returns of stock repurchases and dividend announcements. Secondly, as the market is assumed to be efficient, the expectation is that stock prices should reflect the level of stock repurchases, given that an abnormal return is evident upon the announcement. This leads to the fourth hypothesis: H4: Stock prices in the post announcement period will reflect the level of stock repurchases. Alternatively, if the market reaction to the repurchase announcement is in response to a signal of under pricing, then stock prices may not adjust to reflect the extent of actual stock repurchases. To test the hypothesis, market adjusted cumulative abnormal returns (the BSE 500 index was used as the market reference) was calculated for each stock for a 5-day period, starting on the announcement date. Next, the average cumulative abnormal returns are calculated and the means of abnormal returns for various level of repurchase are compared for statistical significance. Short-term Abnormal Returns The first step in the analysis of the impact of actual stock repurchase on the level of abnormal returns requires computing the market adjusted cumulative abnormal returns (CAR) for the sample of 22 firms over a five-day trading period starting on the announcement date. By examining this shorter interval, the analysis investigates whether the abnormal returns just after the announcement ultimately impact the
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An Empirical Study on the Signaling Effect in Stock Markets subsequent levels of repurchases. (The announcement date was included since the publication date would be normally a trading date and investors have the opportunity to respond to such announcements on the same date.) Standard event-study procedures as used by Comment and Jarrell (1991) and Stephens and Weisbach (1998) were used to calculate the abnormal returns. The abnormal return in any given period is the market model residual, which is the difference between the stock’ s actual return and the predicted return based on the market return for that period. Hence the market adjusted abnormal returns were calculated as: AR i, j = RT i, j - R m Where, AR i, j is the abnormal return for firm j on day i. RT i, j is the actual return for firm j on day i. The total percentage return to shareholders (RTt ) on day t is given by the expression: (RT t ) = [(P t - P t-1) + Dt ]/P t-1 And RMi is the return on the BSE 500 Index on day i. The market adjusted abnormal returns are calculated as above. The five-day cumulative abnormal returns for each firm is calculated as: 5-Day CARij = ?AR i, j, for days i = 0, 1, 2, 3, 4 where the announcement day is day 0. Cumulative abnormal returns are then averaged over the five-day period starting on the announcement date to obtain the five-day cumulative average abnormal returns as: 5-Day CAR = (?CARj)/n for all firms j = 1,2,…..n The average cumulative abnormal returns are then compared for statistical difference between the means in each quintile. Statistical significance in the difference in the means would indicate that abnormal return is related to the level of repurchases undertaken during the five-day period.
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An Empirical Study on the Signaling Effect in Stock Markets Findings of the research paper: The study indicates that stock repurchases and dividend announcements primarily serve as a signalling mechanism of management’s view that their firm’s stock is undervalued. Stock repurchases and dividend announcements have also been shown to result in positive and statistically significant abnormal returns around the announcement date. For stock repurchase and dividend announcements the markets immediately signalled an upward swing in the share price movement. But this positive signaling existed only for a day after the announcements, after which the extent of positivity of shares started decreasing. A possible explanation is that the market reaction in the Indian market to events or announcements such as stock repurchases and dividends was complete within a day or two. Hence, if management perceives that the announcement has worked to their advantage in contributing to the rise in price of the shares, they would have accomplished their main objective of enhancing shareholder value. At the same time, the nature of open market repurchase programs allows firms to take advantage of changes in stock price and provides flexibility to firms that face uncertain cash flows during the repurchase period. The findings contained in this paper have significant implications. The short-term effects of the announcements are consistent with earlier works with positive abnormal returns. More importantly, this study provides new insights over stock price performance, which is shown to be independent of the level of repurchase transactions, the implication is that firms will not reap additional stock price benefits from following through on repurchasing stock after announcing a plan to do so, and the repurchase announcement is sufficient to obtain abnormal returns. Alternatively, if the market reaction to the repurchase announcement is in response to a signal of underpricing, then stock prices may not adjust to reflect the extent of actual stock repurchases.
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An Empirical Study on the Signaling Effect in Stock Markets
IMPACT OF DIVIDEND CHANGES ON THE INDIAN CORPORATE BOND MARKET: SIGNALING EFFECTS
Prepared by: Prof. Varadraj B. Bapat Vice-Principal, S. K. Somaiya College of Arts, Science and Commerce, Vidyavihar, Mumbai Published 2004 Abstract of the research paper Corporate bond market is an important segment of financial market in terms of funds raised as well as potential for future growth though is sparsely researched. One of the two propositions on impact of dividend changes is signaling hypothesis (Bhattacharya, 1979) which suggests a positive effect on bond prices, on an announcement of dividend increase; whereas the other one is wealth transfer hypothesis (Handjinicolaou and Kalay, 1984) which proposes a negative impact on bond prices due to extortion of wealth from bond holders. By studying the impact of dividend policy decisions on Indian corporate bond prices, the paper examines these hypotheses and contributes to the literature on payout policy. Dividend increase and decrease announcements of 5% or more during a period of 5 years from year 1997-98 to 2001-02 have been identified and abnormal returns for bonds and stocks are computed. The analysis shows that abnormal bond and stock returns are positive and are statistically significant in the event month in case of dividend increase. It is concluded that signaling hypothesis is found to hold in Indian corporate bond market. Research Methodology used Sample Identification & Selection The database of daily bond prices available on the Stock Exchange, Mumbai (BSE) website is used. The data on percentage of dividend as made available in the capitaline 2000 database is utilized. The study relates to a 5-year time period viz. from financial year 1997-98 to financial year 2001-02. Although bond prices are reported on daily basis, the available series contain a number of missing values due to non-trading. Further, the daily return calculated from this series may lead to erroneous conclusions due to scanty trading of debt instrument. Therefore, closing month-end prices have been used for analysis. For the companies, which have issued more than one debt instrument in the market the debt security, which is most frequently traded on the exchange has been selected.
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An Empirical Study on the Signaling Effect in Stock Markets For the purpose of study, abnormal bond returns and abnormal stock returns have been calculated around the dividend distribution announcement. A. Calculation of Abnormal Bond return Monthly return for bond is calculated using Equation BR i, t = (P i, t – P i, t-1)/ P i, t-1 BR i, t is defined as the returns on bond i for the month t P i, t: Price of bond i at the end of month t P i, t-1: Price of bond i at the end of earlier month (t-1) Monthly return for I Bex is calculated using Equation RIBext = (I Bext-I Bext-1)/I Bexi, t I Bext: I Bex at the end of month t I Bext-1: I Bex at the month of t-1 I Bex is the bond index developed by ICICI. Abnormal bond returns are calculated using mean adjusted return model to account for changes in the term structure [methodology developed by Handjinicolaou and Kalay, 1984]. Bond prices are available on BSE as the principle plus accrued interest. Hence to account for changes in the bond returns related to shifts in term structure, IBEX (Total Return Index) developed by ICICI, is used as the benchmark bond index. We have calculated Premium Monthly Bond Return (PBR) for bond i; during month t as bond’ s monthly return (BRi) minus return on the IBEX in the same month. PBRi, t = BRi, t –RIBext The mean Expected Bond Return (EBR) for a bond; in the announcement month is equal to the average PBR for the previous 3 months. EBR i, t = ?PBR i, t /3 After calculating the expected return, the Abnormal Bond Return (ABR) for bond i in month t (event month) is calculated as follows. ABR i, t = PBR i, t - EBR i, t Similarly, Abnormal Bond Return (ABR) in the month t+1 is also calculated as follows. ABR i, t+1 = PBR i, t+1 – EBR i, t Mean, median and ‘ t-value’ of abnormal bond returns for all the events in each case viz. dividend increase, decrease and no change is calculated using standard formulae.
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An Empirical Study on the Signaling Effect in Stock Markets B. Calculation of Abnormal stock return The standard market-adjusted model for the calculation of abnormal stock return has been used. The abnormal return is defined as the return of the stock for the month less the return of the BSE Sensex for the corresponding month. AR i, t = R i, t – R m, t AR i, t = Abnormal return on security of firm i for the period t R i, t = return on security of firm i for the period t R m, t = return on BSE Sensex for the period t The statistical significance is arrived at using t-statistic calculated on the basis of the cross-sectional standard error. The proportion of firms with positive abnormal returns is reported additionally to verify whether the results are driven by outliers. Findings of the Research Paper It is found that investors in bond market react positively in the event of increase in dividend. This is characterized by a positive abnormal return in the month of dividend increase. Whenever there is a decrease in dividend or the dividends remain constant, abnormal bond returns in the month is not statistically different from zero. Further by analyzing the equity valuations for this sample, it is observed that the share price reaction to dividend changes as reported in literature holds. Though it is reported in some of the studies that the reaction to dividend decreases is significant, the present analysis shows that it not statistically significant. However, the market has reacted positively to dividend increases. Therefore, investor behaviour in Indian bond market is consistent with the signaling hypothesis. One of the limitations of the study is small sample size due to the nonavailability of traded bond prices. The power of the analysis may be poor, as scanty trading of the bonds has led us to carry out the analysis with monthly prices.
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An Empirical Study on the Signaling Effect in Stock Markets
TESTING THE SEMI-STRONG FORM EFFICIENCY OF INDIAN STOCK MARKET WITH RESPECT TO INFORMATION CONTENT OF STOCK SPLIT ANNOUNCEMENT – A STUDY IN IT INDUSTRY
Prepared by M.Raja Faculty in Finance, School of Management, Karunya University, Coimbatore J.Clement Sudhahar Professor & Head, School of Management, Karunya University, Coimbatore M.Selvam Reader & Head, Department of Commerce & Financial Studies, Bharathidasan University, Tiruchirappalli Published 2001 Abstract of the Research Paper An efficient market as a market in which price fully reflect all information. This means that no possibility exists of making sustainable excess returns and the prices follow a random walk. An efficient and integrated capital market is an important infrastructure that facilitates capital formation. The efficiency with which the capital formation is carried out depends on the efficiency of the capital markets and financial institutions. A capital market is said to be efficient with respect to corporate event announcement (stock split, buyback, right issue, bonus announcement, merger & acquisition, dividend etc) contained information’s and its disseminations. How quickly and correctly the security prices reflect these event contained information’s show the efficiency of stock markets. Present study is an attempt to test the efficiency of Indian stock market with respect to stock split announcement by IT companies. Research Methodology Objectives of the study The objectives of the present study are as follows 1) To examine the information content of stock split announcement made by the Information Technology (IT) companies 2) To test the speed with which the stock split announcement information are impounded in the share prices of IT companies. 3) To suggest investment strategies for the investors, fund managers and analysts.
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An Empirical Study on the Signaling Effect in Stock Markets
Hypothesis of the study The following hypotheses are to be tested in this study 1) Stock split announcement contained information‘s are not relevant for the valuation of stocks. 2) Stock split announcement has no significantly influence in the stock prices of IT companies. 3) The Indian stock market is informational not efficient where the stock split announcement contained information’s are not impounded instantaneously and rightly in the stock prices of IT companies Findings of the research paper This study has empirically examined the informational efficiency of Indian stock market with regards to stock split announcement released by the information technology companies. The result of the study showed the fact that the security prices reacted to the announcement of stock splits. The reaction took place for a very few days surrounding day 0, remaining days it was extended up to +15. Thus one can conclude from the forgoing discussion that the Indian stock markets in respect of IT companies in general are efficient, but not perfectly efficient to the announcement of stock split. This can be used by investors for making abnormal returns at any point of the announcement period.
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An Empirical Study on the Signaling Effect in Stock Markets
THE EFFECTS ON EARNINGS FROM ANNOUNCEMENT OF OPEN MARKET MALAYSIAN CORPORATE SHARE BUYBACK
PREPARED BY Santhirasegaran Nadarajan Faculty of Business & Finance,University Tunku Abdul Rahman Zamri Ahmad School of Management University Science Malaysia Sitraselvi Chandren Faculty of Business & Finance,University Tunku Abdul Rahman Published March 2004 Abstract of the research paper This conceptual paper briefly examined the share buyback announcement effects on earnings within the jurisdiction of Malaysian Stock Market (Bursa Malaysia). A central tenet of share buyback announcement presented in the literature, is that the announcement has an impact on earnings before and after thereby improving the earnings. There are however a number of studies on share buyback announcement effects on share price but hardly nothing on earnings improvement. Therefore this paper adapt an information relating to three earning metrics: earnings per share (EPS), dividend payout (DP) and cash flow (CF) and how these metrics were influenced by the announcement of share buyback. Research Methodology
CF EPS
buyback Targets Cash Flow (CF) - Share buyback increase firm value since potential cash payouts signal managerial confidence about future financial performance and cash flow (Bartov ,1991; Comment & Jarrell ,1991). Earnings per Share (EPS) - had more credibility with investors as a measure of financial performance (Jennings, Battalio and Hatch, 1997)
DP
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An Empirical Study on the Signaling Effect in Stock Markets Dividend Payout (DP) - According to Fama and French (2001) noted on cash dividend payout ratio observe that buybacks were increased at an increasing rate by larger , profitable firms that were, in turn decreasing the use of cash dividend payments. The existing literature suggests the motivation for repurchases could be affected by the following theories: signaling, earnings management, asymmetrical information, agency, cash flow and efficient markets. The literature also suggests that open-market share buyback may be affected by more than one theory, and the same time, since different firms may repurchase shares for entirely different reasons (Nohel & Tarhan, 1998). Thus some firms may announce a repurchase as signal of expected future financial performance while other firms may announce a repurchase as a method to distribute cash. The signaling theory and earnings management theory are the core theory for this study and it is analyzed within the context of the asymmetrical information model, the cash flow theory and the efficient markets hypothesis. The generally positive investor reaction to a repurchase announcement suggests support for the signaling hypothesis, in addition to communicating unique financial characteristics of the firm that suggest support for the asymmetrical information model. If a firm’s intention in announcing a share repurchase is to signal to outsiders of the firm that the company’s prospects are improving, then, the signal suggests a tangible improvement in financial operating performance following the announcement (Nohel & Tarhan, 1998). Most repurchases are substantially completed within three years of the announcement date (Stephens & Weisbach ,1998). Findings of the Research paper In conclusion, the purpose of this paper is to provide a thought model for examining and understand the relationship among earnings and proportion of shares targeted due to announcement of share buyback in Malaysia. This proposed conceptual model will serve as the catalyst for future research. Further research should be conducted using multivariate analysis to test and validate the model. Hopefully the model could advance the study in this area and provide a channel for both practitioners and academicians to understand better of the effects on earnings due to share buyback announcement. Findings of this study is important because the buyback has the implication of affordability when firms announce plans to complete the repurchase with internal funds, suggesting that earnings are not expected to be negatively affected by the repurchase, regardless of the proportion of shares targeted for repurchase. Thus, this could lead to the reduction or elimination of other distributions to owners, such as dividends on the various classes of stock issued by the firm. Hopefully this effort will spark further interest among researchers, fund managers and retail investors to start looking into the investment behavioural and contribute to the body of investment knowledge.
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An Empirical Study on the Signaling Effect in Stock Markets
BONUS ISSUE
A bonus share is a free share of stock given to current shareholders in a company, based upon the number of shares that the shareholder already owns. While the issue of bonus shares increases the total number of shares issued and owned, it does not increase the value of the company. Although the total number of issued shares increases, the ratio of number of shares held by each shareholder remains constant. An issue of bonus shares is referred to as a bonus issue. Depending upon the constitutional documents of the company, only certain classes of shares may be entitled to bonus issues, or may be entitled to bonus issues in preference to other classes. Unlike a rights issue, a bonus issue does not risk diluting the investment. Although the earnings per share of the stock will drop in proportion to the new issue, this is compensated by the fact that investors will own more shares. Therefore the value of the investment should remain the same although the price will adjust accordingly. The whole idea behind the issue of Bonus shares is to bring the Nominal Share Capital into line with the true excess of assets over liabilities. Bonus issue has following major effects. ? ? ? ? ? ? Share Capital gets increased according to the bonus issue ratio. Liquidity in the stock increases. Effective EPS, book value and other per share values stand reduced. Markets take the action usually as a favorable act. Market price gets adjusted on the issue of bonus shares. Accumulated profits get reduced.
Whether Bonus Shares are miraculous? Few things match the sheer joy of getting a fat bonus at work. That is what shareholders of a good company feel when their company decides to throw a few shares (free of cost) in their direction. Here’s explaining what bonus shares are all about and why investors like investing in such companies. Free shares are given to you and are called bonus shares. Make money with shares. They are additional shares issues given without any cost to existing shareholders. These shares are issued in a certain proportion to the existing holding. So, a 2 for 1 bonus would mean you get two additional shares -- free of cost -- for the one share you hold in the company. Bonus shares are issued by cashing in on the free reserves of the company. The assets of a company also consist of cash reserves. A company builds up its reserves by retaining part of its profit over the years (the part that is not paid out as dividend). After a while, these free reserves increase, and the company wanting to issue bonus shares converts part of the reserves into capital. What is the biggest benefit in issuing bonus shares is that its adds to the total number of shares in the market. Now the earnings of the company will have to be divided by that many more shares. Since the profits remain the same but the number of shares has
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An Empirical Study on the Signaling Effect in Stock Markets increased, the EPS will decline. Theoretically, the stock price should also decrease proportionately to the number of new shares. But, in reality, it may not happen. A bonus issue is a signal that the company is in a position to service its larger equity. What it means is that the management would not have given these shares if it were not confident of being able to increase its profits and distribute dividends on all these shares in the future. A bonus issue is taken as a sign of the good health of the company. When a bonus issue is announced, the company also announces a record date for the issue. The record date is the date on which the bonus takes effect, and shareholders on that date are entitled to the bonus. After the announcement of the bonus but before the record date, the shares are referred to as cum-bonus. After the record date, when the bonus has been given effect, the shares become ex-bonus. Issue of Bonus Shares Bonus shares are issued by converting the reserves of the company into share capital. It is nothing but capitalization of the reserves of the company. There are some conditions, which need to be satisfied before issuing Bonus shares: ? Bonus shares can be issued by a company only if the Articles of Association of the company authorizes a bonus issue. Where there is no provision in this regard in the articles, they must be amended by passing special resolution act at the general meeting of the company. It must be sanctioned by shareholders in general meeting on recommendations of BOD of company. Guidelines issue by SEBI must be complied with. Care must be taken that issue of bonus shares does not lead to total share capital in excess of the authorized share capital. Otherwise, the authorized capital must be increased by amending the capital clause of the Memorandum of association.
? ?
If the company has availed of any loan from the financial institutions, prior permission is to be obtained from the institutions for issue of bonus shares. If the company is listed on the stock exchange, the stock exchange must be informed of the decision of the board to issue bonus shares immediately after the board meeting. Where the bonus shares are to be issued to the non-resident members, prior consent of the Reserve Bank should be obtained. Only fully paid up bonus share can be issued. Partly paid up bonus shares cannot be issued since the shareholders become liable to pay the uncalled amount on those shares. It is important to note that Issue of bonus shares does not entail release of company’s assets. When bonus shares are issued/credited as fully paid up out of capitalized accumulated profits, there is distribution of capitalized accumulated profits but such distribution does not entail release of assets of the company.
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An Empirical Study on the Signaling Effect in Stock Markets
RESULTS AND ANALYSIS
Company details: 10 companies namely Pidilite Industries, Shree Renuka Sugars, Jai Prakash Associates, Reliance industries, Indian Oil Corporation, Jindal Steel, TCS, L & T, Reliance Power and NMDC where considered w.r.t. the study on the issue of bonus shares. The hypothesis: H1: There is no positive signaling in Share price behaviour around the announcement of bonus shares. H1alternate: There is a positive signalling in Share price behaviour around the announcement of bonus shares. Average Abnormal Returns: The AAR is calculated for the listed companies (refer appendix) for a period of 4 days before and after the date of announcement of bonus shares.
Day -4 -3 -2 -1 0 1 2 3 4 AAR -0.010413438 -0.008146959 0.011442464 0.002758818 0.017458485 -0.003901036 -0.000266229 -0.007472247 0.005873349
T-Test for comparison of AAR before and after date of announcement
t-Test: Two-Sample Assuming Equal Variances Variable 1 Mean Variance Observations Pooled Variance Hypothesized Mean Difference df t Stat P(T
This is a report about empirical study on signaling effect with respect to bonus issues, stock splits, dividend announcements and buyback shares.
With respect to: Bonus Issues, Stock Splits, Dividend Announcements and Buyback of Shares
Corporate Finance 2 Final Project Report
Group 6 Aakriti Kakkar Aditi Bindlish Ankita Maheshwari Gourab Kundu H. Sanchay Grover Neha Kasturia 91001 91003 91007 91020 91021 91037
Trimester 3 FORE School of Management
An Empirical Study on the Signaling Effect in Stock Markets
ACKNOWLEDGEMENT
W
e would like to express our earnest gratitude towards Dr. Himanshu Joshi for the stupendous guidance and support that he provided to us during the execution of the project on the imprints of the Signalling effect with respect to the stock markets and the practical influence that it has on the all of us. His role in providing a vivid insight into the dynamics of Corporate Finance, the various determinants and the present day scenario that goes beyond the realms of any text-book; have really motivated us to work that bit harder to come out with this report. We’d also like to acknowledge the unending help that we received from our fellow classmates whilst the execution of this project report. Their help and concern goes on to reiterate the kind of bonhomie that exists at FORE School of Management.
Thanking You,
Aakriti Kakkar Aditi Bindlish Ankita Maheshwari Gourab Kundu H. Sanchay Grover Neha Kasturia
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An Empirical Study on the Signaling Effect in Stock Markets
PREFACE
S
tock market, being a vital institution, facilitates economic development. It is true that so many parties are interested in knowing the efficiency of the stock market. The small and medium investors can be motivated to save and invest in the stock market only if their securities in the market are appropriately priced. The information content of events and its dissemination determine the efficiency of the stock market. That is how quickly and correctly security prices reflect these information show the efficiency of the stock market. The companies may buy-back shares from the existing shareholders on a proportionate basis either through tender offer; or from the open market either by inviting tenders or by the book building process; or odd lot shares; or the shares issued to employees pursuant to a scheme of stock option or sweat equity. As a part of laid out procedure the management is required to inform the shareholders the necessity for the share buyback, basis of the offer price, sources of funds, and the management discussion on the likely impact of the buyback on the company in the offer document. Most of the Indian companies in their offer document have claimed that the share buyback programme is expected to contribute to the overall enhancement of the shareholder value. However, no supportive analysis has been provided in the discussion. In the India and elsewhere around the globe, many research studies have been conducted to test the efficiency of the stock market with respect to information content of events. Whereas in India, very few studies have been conducted to test the efficiency of the stock market with respect to stock split announcements, even after these studies have been conducted with different industries with different period. Hence the present study on the corporate finance project is an attempt to test the efficiency of the Indian stock market with respect to information content of stock split announcements, bonus issues, dividends and buyback of shares.
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An Empirical Study on the Signaling Effect in Stock Markets
TABLE OF CONTENTS
INTRODUCTION 5
RESEARCH METHODOLOGY Sources of Collection of Data The hypotheses of the study Tools used for the Analysis
7
REVIEW OF LITERATURE Share price behaviour around buy back and Dividend announcements in India Impact of dividend changes on the Indian Corporate bond market: signaling effects Testing the semi-strong form efficiency of Indian stock market with respect to information Content of stock split announcement – a study in it industry The effects on earnings from announcement Of open market Malaysian corporate share buyback
10
BONUS ISSUE STOCK SPLIT DIVIDEND ANNOUNCEMENT BUYBACK OF SHARES
21 26 31 38
LIMITATIONS OF THE STUDY CONCLUSION
44 45
APPENDIX BIBLIOGRAPHY
46 62
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An Empirical Study on the Signaling Effect in Stock Markets
INTRODUCTION
P
ayout policy of a firm is one of the most important areas in corporate finance. Managers have to decide about the amount and type of the payout repeatedly and regularly. Though a number of theoretical explanations have been proposed in the literature to explain the payout policy, the empirical support is scanty. The changes in corporate laws permitted share repurchase in the Indian market, however cash dividend continues to be the most prominent form of payout to the owners of the firm. The limited work on corporate dividend decisions in the Indian market have mainly focused on the valuation effects and determinants of firms’ dividend payout. Most of these studies have documented the behaviour of share prices and profitability/earnings measures around dividend changes. Corporate debt market has remained highly underdeveloped segment of Indian financial markets. On one hand bond issues from corporates are very low, with most of the corporate borrowing still made up of institutional and bank loans, on the other hand, most of the retail investors perceive corporate bonds nearly as risky as equity and do not show significant inclination in investing in corporate bonds. During 19962001, due to bearish trend in equity market companies sought to approach debt market but showed preference for private placements over public issues. Efforts by regulators to discourage private placement market have improved the number of listed bonds and market capitalisation in 2003-04; however we are yet to experience vibrancy in corporate bond market. In nineties, primary market for financial institutional issues is fairly developed, with ICICI and IDBI repeatedly approaching the market and successively raising significant amounts. Despite this secondary market lacks both width and depth, evidenced by thin trading and a few investors. Though corporate debt market is still immature, its significance cannot be undermined. Policy makers have realized importance of development of bond market and are making all-out efforts to achieve the same. This further makes it imperative to add to little available literature on fixed income market. The capital market plays a pivotal role in the allocation of economic resources into productive activities of the economy, which are possible only if the securities traded in the markets are priced appropriately. A capital market in which stock prices fully reflect all available information can be termed as efficient. The market efficiency can be classified into the following three categories depending on the information set that is fully reflected in the security prices. a. Weak - Form of Efficiency, popularly known as Random Walk Theory states that the current stock prices reflect all the information that is contained in the historical sequence of prices.
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An Empirical Study on the Signaling Effect in Stock Markets b. Semi - Strong Form of Efficiency, which states that current market prices not only reflect all information content of historical prices but also reflect all the information, which are publicly available about the companies being studied. c. Strong - Form of Efficiency, which states that current market prices reflect all information whether it is publicly available or private information (insiders information). SIGNALING EFFECT Dividend Declaration A model developed by Merton Miller and Kevin Rock in 1985 suggests that dividend announcements convey information to investors regarding the firm's future prospects. Many earlier studies had shown that stock prices tend to increase when an increase in dividends is announced and tend to decrease when a decrease or omission is announced. Miller and Rock pointed out that this is likely due to the information content of dividends. When investors have incomplete information about the firm (perhaps due to opaque accounting practices) they will look for other information that may provide a clue as to the firm's future prospects. Managers have more information than investors about the firm, and such information may inform their dividend decisions. When managers lack confidence in the firm's ability to generate cash flows in the future they may keep dividends constant, or possibly even reduce the amount of dividends paid out. Conversely, managers that have access to information that indicates very good future prospects for the firm (eg. a full order book) are more likely to increase dividends. Investors can use this knowledge about managers' behaviour to inform their decision to buy or sell the firm's stock, bidding the price up in the case of a positive dividend surprise, or selling it down when dividends do not meet expectations. This, in turn, may influence the dividend decision as managers know that stock holders closely watch dividend announcements looking for good or bad news. As managers tend to avoid sending a negative signal to the market about the future prospects of their firm, this also tends to lead to a dividend policy of a steady, gradually increasing payment.
Share Buyback Stock repurchases may have a signaling effect. For example, a positive signal might be sent to the market if management believed the stock were undervalued and they were constrained not to tender shares they owned individually. In this context, the premium in repurchase price over existing market price would reflect management’s belief about the degree of undervaluation.
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An Empirical Study on the Signaling Effect in Stock Markets
RESEARCH METHODOLOGY
O
ver the past few years, many firms have announced significant number of stock repurchases. The overwhelming reason given for stock repurchase announcements has been to reverse a trend of declining stock prices. Share buy backs have become an important area in financial research considering its strong implications for corporate policy. Indian companies have been permitted to buy back shares after the provisions of the Companies Act 1956 were suitably amended in 1999. Several studies have provided conclusive proof of signalling effect of stock repurchase and dividends announcements. In our project paper we attempt to analyse signalling of dividend announcements, stock splits, buyback, and issue of bonus shares. Sources of Collection of Data ? The data relating to announcement dates of buyback, dividend, stock splits and issue of bonus shares were obtained from moneycontrol.com. ? The share prices of the respective securities and closing market index was obtained from the BSE Website. The hypotheses of the study The objectives of the project are fourfold. First, we analyse if the market recognizes bonus issues as an instrument of change in sentiment and if it reacts favourably to the firms’ announcements. This leads to the hypothesis: H1: There is no positive signaling in Share price behaviour around bonus issues. H1alternate: There is a positive signalling in Share price behaviour around bonus issues. Second, we analyse if the market recognizes stock splits as an instrument of change in sentiment and if it reacts favourably to the firms’ announcements. This leads to the hypothesis: H2: There is no positive signaling in Share price behaviour around stock splits. H2alternate: There is a positive signalling in Share price behaviour around stock splits.
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An Empirical Study on the Signaling Effect in Stock Markets Third, we analyse if the market recognizes the announcement of dividend as an instrument of change in sentiment and if it reacts favourably to the firms’ announcements. This leads to the hypothesis: H3: There is no positive signaling in Share price behaviour around the announcement of dividend. H3alternate: There is a positive signalling in Share price behaviour around the announcement of dividend. Fourth, we analyse if the market recognizes the buyback of shares as an instrument of change in sentiment and if it reacts favourably to the firms’ announcements. This leads to the hypothesis: H4: There is no positive signaling in Share price behaviour around the buyback of shares. H4alternate: There is a positive signalling in Share price behaviour around the buyback of shares. Tools used for the Analysis: a. Daily returns The daily returns were calculated for both individual securities as well as Market Index using the following equation
Where, R i, t = Returns on Security i on time t. Pt = Price of the security at time t Pt-1 = Price of the security at time t-1
b. Abnormal Returns Abnormal Returns (AR) under market-adjusted abnormal returns is calculated using by the equation as below;
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An Empirical Study on the Signaling Effect in Stock Markets Abnormal Returns for each day (day -4 to +4) was computed by horizontal summation of abnormal returns on day t for all companies, divided by the number of companies. Where, ARi,t = Abnormal returns on security i at time t Ri,t = Actual returns on security i at time t Ri,m = Actual returns on market index, which is proxied by BSE Sensex, at time t. Thus daily actual returns over the announcement period (8 days) were adjusted against their corresponding market returns.
c. Average Abnormal Returns The Average Abnormal Returns is calculated by the equation given below:
Where, AARt = Average Abnormal Returns on day t ARi,t = Abnormal Returns on security i at time t which is calculated by using the equation. d. T-Test In order to ascertain whether the various announcements or events had a significant impact on the abnormal returns, a t-test (t-test: two sample assuming equal variances) was conducted. e. Cumulative Abnormal Returns (i) CAR before and after announcement was computed for each company (for every parameter considered), and a graph depicting the same was plotted. (ii) In order to study, whether the impact was felt more around the announcement dates, CAR for each company for each trading window was then computed (e.g. one day trading window is -1 to +1 days). Then, a mean value for each trading window was computed. A graph of the same was plotted.
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An Empirical Study on the Signaling Effect in Stock Markets
REVIEW OF LITERATURE
SHARE PRICE BEHAVIOUR AROUND BUY BACK AND DIVIDEND ANNOUNCEMENTS IN INDIA
Prepared by: Dr. P. Thirumalvalavan – Reader, Bharathiar School of Management and Entrepreneur, Development, Bharathiar University K. Sunitha – Research Scholar, Bharathiar School of Management and Entrepreneur Development, Bharathiar University Published August 2005 Abstract of the research paper Over the past few years, many firms have announced significant number of stock repurchases. The overwhelming reason given for stock repurchase announcements has been to reverse a trend of declining stock prices. Share buy backs have become an important area in financial research considering its strong implications for corporate policy. Indian companies have been permitted to buy back shares after the provisions of the Companies Act 1956 were suitably amended in 1999. Several studies have provided conclusive proof of signaling effect of stock repurchase and dividends announcements. This paper investigates and tests the following: 1) Signaling effect of a share buy - back and dividend announcements 2) The market reaction and share price behaviour to announcements of stock repurchases and dividends 3) Abnormal Returns across various repurchase levels. The analysis uses data of 22 firms in the BSE 500 index, which has announced stock repurchase option and dividends during the period 2002 –2004. An examination of share price behaviour around stock repurchases and dividends prove the signaling effect of these announcements. Stock repurchase programs recorded a high cumulative abnormal return of 3.2 percent within two days of the event whereas dividend announcement recorded a high cumulative abnormal return of 2.1 percent within one day of the event. There is no significant difference in abnormal returns as result of various repurchase levels. These results imply the strong signaling power of stock repurchases announcements and that the market reacts more favourably to repurchases compared to dividend announcements.
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An Empirical Study on the Signaling Effect in Stock Markets
This study is one of the work examining the impact of stock repurchase program and dividend nnouncements on share price behaviour and their relative signaling power with reference to Indian firms. The research methodology used: Hypotheses: The objectives of the research paper are twofold. Firstly, if the market recognizes any differences between stock repurchases and dividends and if it reacts more favourably to firms’ announcements of one of the payout instruments. This leads to the hypothesis: H1: There is no positive signaling in Share price behaviour around buybacks. H2: There is no positive signaling in Share price behaviour around dividend announcement. H3: There exist no significant difference between the cumulative abnormal returns of stock repurchases and dividend announcements. Secondly, as the market is assumed to be efficient, the expectation is that stock prices should reflect the level of stock repurchases, given that an abnormal return is evident upon the announcement. This leads to the fourth hypothesis: H4: Stock prices in the post announcement period will reflect the level of stock repurchases. Alternatively, if the market reaction to the repurchase announcement is in response to a signal of under pricing, then stock prices may not adjust to reflect the extent of actual stock repurchases. To test the hypothesis, market adjusted cumulative abnormal returns (the BSE 500 index was used as the market reference) was calculated for each stock for a 5-day period, starting on the announcement date. Next, the average cumulative abnormal returns are calculated and the means of abnormal returns for various level of repurchase are compared for statistical significance. Short-term Abnormal Returns The first step in the analysis of the impact of actual stock repurchase on the level of abnormal returns requires computing the market adjusted cumulative abnormal returns (CAR) for the sample of 22 firms over a five-day trading period starting on the announcement date. By examining this shorter interval, the analysis investigates whether the abnormal returns just after the announcement ultimately impact the
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An Empirical Study on the Signaling Effect in Stock Markets subsequent levels of repurchases. (The announcement date was included since the publication date would be normally a trading date and investors have the opportunity to respond to such announcements on the same date.) Standard event-study procedures as used by Comment and Jarrell (1991) and Stephens and Weisbach (1998) were used to calculate the abnormal returns. The abnormal return in any given period is the market model residual, which is the difference between the stock’ s actual return and the predicted return based on the market return for that period. Hence the market adjusted abnormal returns were calculated as: AR i, j = RT i, j - R m Where, AR i, j is the abnormal return for firm j on day i. RT i, j is the actual return for firm j on day i. The total percentage return to shareholders (RTt ) on day t is given by the expression: (RT t ) = [(P t - P t-1) + Dt ]/P t-1 And RMi is the return on the BSE 500 Index on day i. The market adjusted abnormal returns are calculated as above. The five-day cumulative abnormal returns for each firm is calculated as: 5-Day CARij = ?AR i, j, for days i = 0, 1, 2, 3, 4 where the announcement day is day 0. Cumulative abnormal returns are then averaged over the five-day period starting on the announcement date to obtain the five-day cumulative average abnormal returns as: 5-Day CAR = (?CARj)/n for all firms j = 1,2,…..n The average cumulative abnormal returns are then compared for statistical difference between the means in each quintile. Statistical significance in the difference in the means would indicate that abnormal return is related to the level of repurchases undertaken during the five-day period.
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An Empirical Study on the Signaling Effect in Stock Markets Findings of the research paper: The study indicates that stock repurchases and dividend announcements primarily serve as a signalling mechanism of management’s view that their firm’s stock is undervalued. Stock repurchases and dividend announcements have also been shown to result in positive and statistically significant abnormal returns around the announcement date. For stock repurchase and dividend announcements the markets immediately signalled an upward swing in the share price movement. But this positive signaling existed only for a day after the announcements, after which the extent of positivity of shares started decreasing. A possible explanation is that the market reaction in the Indian market to events or announcements such as stock repurchases and dividends was complete within a day or two. Hence, if management perceives that the announcement has worked to their advantage in contributing to the rise in price of the shares, they would have accomplished their main objective of enhancing shareholder value. At the same time, the nature of open market repurchase programs allows firms to take advantage of changes in stock price and provides flexibility to firms that face uncertain cash flows during the repurchase period. The findings contained in this paper have significant implications. The short-term effects of the announcements are consistent with earlier works with positive abnormal returns. More importantly, this study provides new insights over stock price performance, which is shown to be independent of the level of repurchase transactions, the implication is that firms will not reap additional stock price benefits from following through on repurchasing stock after announcing a plan to do so, and the repurchase announcement is sufficient to obtain abnormal returns. Alternatively, if the market reaction to the repurchase announcement is in response to a signal of underpricing, then stock prices may not adjust to reflect the extent of actual stock repurchases.
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An Empirical Study on the Signaling Effect in Stock Markets
IMPACT OF DIVIDEND CHANGES ON THE INDIAN CORPORATE BOND MARKET: SIGNALING EFFECTS
Prepared by: Prof. Varadraj B. Bapat Vice-Principal, S. K. Somaiya College of Arts, Science and Commerce, Vidyavihar, Mumbai Published 2004 Abstract of the research paper Corporate bond market is an important segment of financial market in terms of funds raised as well as potential for future growth though is sparsely researched. One of the two propositions on impact of dividend changes is signaling hypothesis (Bhattacharya, 1979) which suggests a positive effect on bond prices, on an announcement of dividend increase; whereas the other one is wealth transfer hypothesis (Handjinicolaou and Kalay, 1984) which proposes a negative impact on bond prices due to extortion of wealth from bond holders. By studying the impact of dividend policy decisions on Indian corporate bond prices, the paper examines these hypotheses and contributes to the literature on payout policy. Dividend increase and decrease announcements of 5% or more during a period of 5 years from year 1997-98 to 2001-02 have been identified and abnormal returns for bonds and stocks are computed. The analysis shows that abnormal bond and stock returns are positive and are statistically significant in the event month in case of dividend increase. It is concluded that signaling hypothesis is found to hold in Indian corporate bond market. Research Methodology used Sample Identification & Selection The database of daily bond prices available on the Stock Exchange, Mumbai (BSE) website is used. The data on percentage of dividend as made available in the capitaline 2000 database is utilized. The study relates to a 5-year time period viz. from financial year 1997-98 to financial year 2001-02. Although bond prices are reported on daily basis, the available series contain a number of missing values due to non-trading. Further, the daily return calculated from this series may lead to erroneous conclusions due to scanty trading of debt instrument. Therefore, closing month-end prices have been used for analysis. For the companies, which have issued more than one debt instrument in the market the debt security, which is most frequently traded on the exchange has been selected.
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An Empirical Study on the Signaling Effect in Stock Markets For the purpose of study, abnormal bond returns and abnormal stock returns have been calculated around the dividend distribution announcement. A. Calculation of Abnormal Bond return Monthly return for bond is calculated using Equation BR i, t = (P i, t – P i, t-1)/ P i, t-1 BR i, t is defined as the returns on bond i for the month t P i, t: Price of bond i at the end of month t P i, t-1: Price of bond i at the end of earlier month (t-1) Monthly return for I Bex is calculated using Equation RIBext = (I Bext-I Bext-1)/I Bexi, t I Bext: I Bex at the end of month t I Bext-1: I Bex at the month of t-1 I Bex is the bond index developed by ICICI. Abnormal bond returns are calculated using mean adjusted return model to account for changes in the term structure [methodology developed by Handjinicolaou and Kalay, 1984]. Bond prices are available on BSE as the principle plus accrued interest. Hence to account for changes in the bond returns related to shifts in term structure, IBEX (Total Return Index) developed by ICICI, is used as the benchmark bond index. We have calculated Premium Monthly Bond Return (PBR) for bond i; during month t as bond’ s monthly return (BRi) minus return on the IBEX in the same month. PBRi, t = BRi, t –RIBext The mean Expected Bond Return (EBR) for a bond; in the announcement month is equal to the average PBR for the previous 3 months. EBR i, t = ?PBR i, t /3 After calculating the expected return, the Abnormal Bond Return (ABR) for bond i in month t (event month) is calculated as follows. ABR i, t = PBR i, t - EBR i, t Similarly, Abnormal Bond Return (ABR) in the month t+1 is also calculated as follows. ABR i, t+1 = PBR i, t+1 – EBR i, t Mean, median and ‘ t-value’ of abnormal bond returns for all the events in each case viz. dividend increase, decrease and no change is calculated using standard formulae.
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An Empirical Study on the Signaling Effect in Stock Markets B. Calculation of Abnormal stock return The standard market-adjusted model for the calculation of abnormal stock return has been used. The abnormal return is defined as the return of the stock for the month less the return of the BSE Sensex for the corresponding month. AR i, t = R i, t – R m, t AR i, t = Abnormal return on security of firm i for the period t R i, t = return on security of firm i for the period t R m, t = return on BSE Sensex for the period t The statistical significance is arrived at using t-statistic calculated on the basis of the cross-sectional standard error. The proportion of firms with positive abnormal returns is reported additionally to verify whether the results are driven by outliers. Findings of the Research Paper It is found that investors in bond market react positively in the event of increase in dividend. This is characterized by a positive abnormal return in the month of dividend increase. Whenever there is a decrease in dividend or the dividends remain constant, abnormal bond returns in the month is not statistically different from zero. Further by analyzing the equity valuations for this sample, it is observed that the share price reaction to dividend changes as reported in literature holds. Though it is reported in some of the studies that the reaction to dividend decreases is significant, the present analysis shows that it not statistically significant. However, the market has reacted positively to dividend increases. Therefore, investor behaviour in Indian bond market is consistent with the signaling hypothesis. One of the limitations of the study is small sample size due to the nonavailability of traded bond prices. The power of the analysis may be poor, as scanty trading of the bonds has led us to carry out the analysis with monthly prices.
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An Empirical Study on the Signaling Effect in Stock Markets
TESTING THE SEMI-STRONG FORM EFFICIENCY OF INDIAN STOCK MARKET WITH RESPECT TO INFORMATION CONTENT OF STOCK SPLIT ANNOUNCEMENT – A STUDY IN IT INDUSTRY
Prepared by M.Raja Faculty in Finance, School of Management, Karunya University, Coimbatore J.Clement Sudhahar Professor & Head, School of Management, Karunya University, Coimbatore M.Selvam Reader & Head, Department of Commerce & Financial Studies, Bharathidasan University, Tiruchirappalli Published 2001 Abstract of the Research Paper An efficient market as a market in which price fully reflect all information. This means that no possibility exists of making sustainable excess returns and the prices follow a random walk. An efficient and integrated capital market is an important infrastructure that facilitates capital formation. The efficiency with which the capital formation is carried out depends on the efficiency of the capital markets and financial institutions. A capital market is said to be efficient with respect to corporate event announcement (stock split, buyback, right issue, bonus announcement, merger & acquisition, dividend etc) contained information’s and its disseminations. How quickly and correctly the security prices reflect these event contained information’s show the efficiency of stock markets. Present study is an attempt to test the efficiency of Indian stock market with respect to stock split announcement by IT companies. Research Methodology Objectives of the study The objectives of the present study are as follows 1) To examine the information content of stock split announcement made by the Information Technology (IT) companies 2) To test the speed with which the stock split announcement information are impounded in the share prices of IT companies. 3) To suggest investment strategies for the investors, fund managers and analysts.
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An Empirical Study on the Signaling Effect in Stock Markets
Hypothesis of the study The following hypotheses are to be tested in this study 1) Stock split announcement contained information‘s are not relevant for the valuation of stocks. 2) Stock split announcement has no significantly influence in the stock prices of IT companies. 3) The Indian stock market is informational not efficient where the stock split announcement contained information’s are not impounded instantaneously and rightly in the stock prices of IT companies Findings of the research paper This study has empirically examined the informational efficiency of Indian stock market with regards to stock split announcement released by the information technology companies. The result of the study showed the fact that the security prices reacted to the announcement of stock splits. The reaction took place for a very few days surrounding day 0, remaining days it was extended up to +15. Thus one can conclude from the forgoing discussion that the Indian stock markets in respect of IT companies in general are efficient, but not perfectly efficient to the announcement of stock split. This can be used by investors for making abnormal returns at any point of the announcement period.
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An Empirical Study on the Signaling Effect in Stock Markets
THE EFFECTS ON EARNINGS FROM ANNOUNCEMENT OF OPEN MARKET MALAYSIAN CORPORATE SHARE BUYBACK
PREPARED BY Santhirasegaran Nadarajan Faculty of Business & Finance,University Tunku Abdul Rahman Zamri Ahmad School of Management University Science Malaysia Sitraselvi Chandren Faculty of Business & Finance,University Tunku Abdul Rahman Published March 2004 Abstract of the research paper This conceptual paper briefly examined the share buyback announcement effects on earnings within the jurisdiction of Malaysian Stock Market (Bursa Malaysia). A central tenet of share buyback announcement presented in the literature, is that the announcement has an impact on earnings before and after thereby improving the earnings. There are however a number of studies on share buyback announcement effects on share price but hardly nothing on earnings improvement. Therefore this paper adapt an information relating to three earning metrics: earnings per share (EPS), dividend payout (DP) and cash flow (CF) and how these metrics were influenced by the announcement of share buyback. Research Methodology
CF EPS
buyback Targets Cash Flow (CF) - Share buyback increase firm value since potential cash payouts signal managerial confidence about future financial performance and cash flow (Bartov ,1991; Comment & Jarrell ,1991). Earnings per Share (EPS) - had more credibility with investors as a measure of financial performance (Jennings, Battalio and Hatch, 1997)
DP
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An Empirical Study on the Signaling Effect in Stock Markets Dividend Payout (DP) - According to Fama and French (2001) noted on cash dividend payout ratio observe that buybacks were increased at an increasing rate by larger , profitable firms that were, in turn decreasing the use of cash dividend payments. The existing literature suggests the motivation for repurchases could be affected by the following theories: signaling, earnings management, asymmetrical information, agency, cash flow and efficient markets. The literature also suggests that open-market share buyback may be affected by more than one theory, and the same time, since different firms may repurchase shares for entirely different reasons (Nohel & Tarhan, 1998). Thus some firms may announce a repurchase as signal of expected future financial performance while other firms may announce a repurchase as a method to distribute cash. The signaling theory and earnings management theory are the core theory for this study and it is analyzed within the context of the asymmetrical information model, the cash flow theory and the efficient markets hypothesis. The generally positive investor reaction to a repurchase announcement suggests support for the signaling hypothesis, in addition to communicating unique financial characteristics of the firm that suggest support for the asymmetrical information model. If a firm’s intention in announcing a share repurchase is to signal to outsiders of the firm that the company’s prospects are improving, then, the signal suggests a tangible improvement in financial operating performance following the announcement (Nohel & Tarhan, 1998). Most repurchases are substantially completed within three years of the announcement date (Stephens & Weisbach ,1998). Findings of the Research paper In conclusion, the purpose of this paper is to provide a thought model for examining and understand the relationship among earnings and proportion of shares targeted due to announcement of share buyback in Malaysia. This proposed conceptual model will serve as the catalyst for future research. Further research should be conducted using multivariate analysis to test and validate the model. Hopefully the model could advance the study in this area and provide a channel for both practitioners and academicians to understand better of the effects on earnings due to share buyback announcement. Findings of this study is important because the buyback has the implication of affordability when firms announce plans to complete the repurchase with internal funds, suggesting that earnings are not expected to be negatively affected by the repurchase, regardless of the proportion of shares targeted for repurchase. Thus, this could lead to the reduction or elimination of other distributions to owners, such as dividends on the various classes of stock issued by the firm. Hopefully this effort will spark further interest among researchers, fund managers and retail investors to start looking into the investment behavioural and contribute to the body of investment knowledge.
Group 6 Corporate Finance 2 Final Project Report
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An Empirical Study on the Signaling Effect in Stock Markets
BONUS ISSUE
A bonus share is a free share of stock given to current shareholders in a company, based upon the number of shares that the shareholder already owns. While the issue of bonus shares increases the total number of shares issued and owned, it does not increase the value of the company. Although the total number of issued shares increases, the ratio of number of shares held by each shareholder remains constant. An issue of bonus shares is referred to as a bonus issue. Depending upon the constitutional documents of the company, only certain classes of shares may be entitled to bonus issues, or may be entitled to bonus issues in preference to other classes. Unlike a rights issue, a bonus issue does not risk diluting the investment. Although the earnings per share of the stock will drop in proportion to the new issue, this is compensated by the fact that investors will own more shares. Therefore the value of the investment should remain the same although the price will adjust accordingly. The whole idea behind the issue of Bonus shares is to bring the Nominal Share Capital into line with the true excess of assets over liabilities. Bonus issue has following major effects. ? ? ? ? ? ? Share Capital gets increased according to the bonus issue ratio. Liquidity in the stock increases. Effective EPS, book value and other per share values stand reduced. Markets take the action usually as a favorable act. Market price gets adjusted on the issue of bonus shares. Accumulated profits get reduced.
Whether Bonus Shares are miraculous? Few things match the sheer joy of getting a fat bonus at work. That is what shareholders of a good company feel when their company decides to throw a few shares (free of cost) in their direction. Here’s explaining what bonus shares are all about and why investors like investing in such companies. Free shares are given to you and are called bonus shares. Make money with shares. They are additional shares issues given without any cost to existing shareholders. These shares are issued in a certain proportion to the existing holding. So, a 2 for 1 bonus would mean you get two additional shares -- free of cost -- for the one share you hold in the company. Bonus shares are issued by cashing in on the free reserves of the company. The assets of a company also consist of cash reserves. A company builds up its reserves by retaining part of its profit over the years (the part that is not paid out as dividend). After a while, these free reserves increase, and the company wanting to issue bonus shares converts part of the reserves into capital. What is the biggest benefit in issuing bonus shares is that its adds to the total number of shares in the market. Now the earnings of the company will have to be divided by that many more shares. Since the profits remain the same but the number of shares has
Group 6 Corporate Finance 2 Final Project Report
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An Empirical Study on the Signaling Effect in Stock Markets increased, the EPS will decline. Theoretically, the stock price should also decrease proportionately to the number of new shares. But, in reality, it may not happen. A bonus issue is a signal that the company is in a position to service its larger equity. What it means is that the management would not have given these shares if it were not confident of being able to increase its profits and distribute dividends on all these shares in the future. A bonus issue is taken as a sign of the good health of the company. When a bonus issue is announced, the company also announces a record date for the issue. The record date is the date on which the bonus takes effect, and shareholders on that date are entitled to the bonus. After the announcement of the bonus but before the record date, the shares are referred to as cum-bonus. After the record date, when the bonus has been given effect, the shares become ex-bonus. Issue of Bonus Shares Bonus shares are issued by converting the reserves of the company into share capital. It is nothing but capitalization of the reserves of the company. There are some conditions, which need to be satisfied before issuing Bonus shares: ? Bonus shares can be issued by a company only if the Articles of Association of the company authorizes a bonus issue. Where there is no provision in this regard in the articles, they must be amended by passing special resolution act at the general meeting of the company. It must be sanctioned by shareholders in general meeting on recommendations of BOD of company. Guidelines issue by SEBI must be complied with. Care must be taken that issue of bonus shares does not lead to total share capital in excess of the authorized share capital. Otherwise, the authorized capital must be increased by amending the capital clause of the Memorandum of association.
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If the company has availed of any loan from the financial institutions, prior permission is to be obtained from the institutions for issue of bonus shares. If the company is listed on the stock exchange, the stock exchange must be informed of the decision of the board to issue bonus shares immediately after the board meeting. Where the bonus shares are to be issued to the non-resident members, prior consent of the Reserve Bank should be obtained. Only fully paid up bonus share can be issued. Partly paid up bonus shares cannot be issued since the shareholders become liable to pay the uncalled amount on those shares. It is important to note that Issue of bonus shares does not entail release of company’s assets. When bonus shares are issued/credited as fully paid up out of capitalized accumulated profits, there is distribution of capitalized accumulated profits but such distribution does not entail release of assets of the company.
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An Empirical Study on the Signaling Effect in Stock Markets
RESULTS AND ANALYSIS
Company details: 10 companies namely Pidilite Industries, Shree Renuka Sugars, Jai Prakash Associates, Reliance industries, Indian Oil Corporation, Jindal Steel, TCS, L & T, Reliance Power and NMDC where considered w.r.t. the study on the issue of bonus shares. The hypothesis: H1: There is no positive signaling in Share price behaviour around the announcement of bonus shares. H1alternate: There is a positive signalling in Share price behaviour around the announcement of bonus shares. Average Abnormal Returns: The AAR is calculated for the listed companies (refer appendix) for a period of 4 days before and after the date of announcement of bonus shares.
Day -4 -3 -2 -1 0 1 2 3 4 AAR -0.010413438 -0.008146959 0.011442464 0.002758818 0.017458485 -0.003901036 -0.000266229 -0.007472247 0.005873349
T-Test for comparison of AAR before and after date of announcement
t-Test: Two-Sample Assuming Equal Variances Variable 1 Mean Variance Observations Pooled Variance Hypothesized Mean Difference df t Stat P(T