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The Option to Repurchase Stock

Author

Listed:
  • David L. Ikenberry
  • Theo Vermaelen

Abstract

Companies often announce their intention to reacquire share via open market transactions. However, these programs are not firm commitments. By design, they provide managers the flexibility to forego repurchasing stock. Managers concerned with maximizing the wealth of long-term stockholders will tend to buy back share when they view their stock as undervalued and otherwise forego repurchasing shares. We value this inherent flexibility as an exchange option in which the market price of the stock is exchanged for the true value of the stock. Hence, the announcement of a repurchase expands the company's investment opportunity set. In essence, the programs authorize management to use the firm's resources along with their "insider" valuation of the firm to the benefit of long-term shareholders.

Suggested Citation

  • David L. Ikenberry & Theo Vermaelen, 1996. "The Option to Repurchase Stock," Financial Management, Financial Management Association, vol. 25(4), Winter.
  • Handle: RePEc:fma:fmanag:ikenberry96
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