Show Or Tell

Based on research by  Shiva Sivaramakrishnan, Praveen Kumar, Nisan Langberg and Jacob Oded

• When their share prices are undervalued, firms have a choice of buying back stocks or disclosing critical information.
• These choices represent a tradeoff between the interests of short-term investors and long-term investors.
• Given that marketplace information is largely incomplete, most firms have an incentive not to provide positive information about themselves, especially when they want to reward long-term shareholders.

When you have good news, it can be hard not to shout it from the mountaintop. But it’s often wiser to hold your tongue for a while – and use the element of surprise to your advantage. 

Let’s say you’re an executive who knows your company’s stock prices are undervalued. You have two choices: You can publicly disclose information that reveals why investors should buy shares, or you can keep quiet, take advantage of the bargain pricing and buy back the undervalued stock yourself. 

In the wake of recent tax cuts, companies such as Apple, Cisco, Boeing and Merck are opting for the second choice – they’re reinvesting in themselves through share repurchases. Using this method, companies can buy back their stock either directly from the marketplace or by offering shareholders the option of selling shares at a fixed price. Of course, announcing a share repurchase essentially signals to investors that you’re confident the company will increase in value.

Given how often firms either pursue share repurchases or release disclosures about their true value, there is surprisingly little research on which strategy is the more effective. Rice Business Professor Shiva Sivaramakrishnan and colleagues Praveen Kumar and Nisan Langberg of the University of Houston and Jacob Oded of Tel Aviv University set out to find an answer by modeling both options.

At its core, the debate boils down to whether companies want to reward short-term or long-term shareholders. On the one hand, stock repurchases benefit long-term shareholders at the expense of the short-term shareholders who sell their shares at a discount. On the other hand, direct disclosure disadvantages long-term investors by revealing the stock’s true value to the general public, taking away their opportunity to buy back cheap stocks.   

Of course, there are limits in place that prevent major windfalls – or major losses – for both short- and long-term investors. In the U.S., certain stock repurchases are not permitted until after a firm provides some form of disclosure – for example, its earnings reports. 

So which strategy should managers pursue: disclose, buy back or both? It depends on two key variables, the researchers say: what the firm is really worth and the degree to which short-term versus long-term interests are at stake.  

If a firm’s value is relatively low compared to its share prices – and especially compared to the value of competing companies – it’s better off doing nothing, neither disclosing nor buying back. After all, the researchers point out, investors aren’t going to purchase stock if they know a competitor can offer a better deal. 

If a firm is neither highly undervalued nor highly overvalued, managers may disclose information but not pursue a stock repurchase. Since in that case the disclosure information is unlikely to affect stock prices one way or another, there is no disincentive to do so. The researchers emphasize that even disclosing good news doesn’t necessarily lead to more investment, since investors rely more heavily on information that comes from outside analysts rather than from the company itself. 

If a firm’s stock is extremely undervalued, however, Sivaramakrishnan and his colleagues say, the best bet is to err on the side of the long-term investors, which means withholding that information from the public. Long-term investors will reap the greatest reward if managers induce as much undervaluation as possible by not releasing positive news. Once the market is convinced that the shares are worth less and less, then the firm can swoop in and buy them back at a discount. 

In other words: Don’t shout your good news from the mountaintop until you’ve reached the top of the mountain – and brought your investors along with you. 

Shiva Sivaramakrishnan is the Henry Gardiner Symonds Professor of Accounting at Jones Graduate School of Business at Rice University. 

To learn more, please see: Kumar, P., Langberg, N., Oded, J., & Sivaramakrishnan, S. (2017). Voluntary disclosure and strategic stock repurchases. Journal of Accounting and Economics, 63(2), 207–230.