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Rev Fin 1994; 7:321-350
© 1994 the Society for Financial Studies

Article

Repurchase premia as a reason for dividends: a dynamic model of corporate payout policies

B Chowdhry1 and V Nanda2,z
1 University of California at Los Angeles, USA
2 School of Business Administration, University of Southern California, Los Angeles, CA 90089, USA
z Corresponding author

Abstract

We propose that it is precisely because firms' repurchases of their own stock through tender offers are associated with large stock-price increases that repurchases are unattractive as a means o distributing cash. As a result, firms distribute some cash in the form of dividends - despite the tax disadvantage - and carry the rest to future periods. However, when their stock is sufficiently undervalued, firms distribute all accumulated cash through stock repurchases. We show that dividends are smoothed and are positively related both to earnings innovations and to previous period's dividends. Also, the stock-price reaction to a repurchase announcement, of a given size, is increasing in the previous period's dividends.


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