Abstract: We estimate the cross-sectional relationship between open market
repurchases and accounting data for a large sample of dividend-
paying and non-dividend paying firms over a twelve year period
(1984-95). Consistent with the hypothesis that firms use open
market repurchases to reduce the agency costs of free cash flow,
we find that repurchases are positively related to proxies for
free cash flow and negatively related to proxies for marginal
financing costs. We also examine the extent to which management
stock options influence the choice between open market
repurchases and dividend payments. Because the value of
management stock options--like any call option--is negatively
related to expected future dividend payments, management can
increase the value of its stock options by substituting share
repurchases for dividend growth. We find evidence that such
substitution occurs: for dividend-paying firms, share
repurchases are positively related and dividend increases are
negatively related to a proxy for management stock options,
whereas for non-dividend-paying firms, the relationship between
repurchases and options is weak and statistically insignificant.
Keywords: Share repurchases, free cash flow, stock options, dividend increases
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