In search of stock repurchases determinants in listed Indonesian firms during regulatory changes
Introduction
In the last two decades, the increasing number of firms undertaking stock repurchases and the fast-growing intensity of cash used to repurchase shares have been important issues in corporate finance (Weigand and Baker, 2009; Lee and Suh, 2011). The increasing number of firms conducting share buybacks occurred not only in the U.S.A. but also all over the world (Baker et al., 2010). This phenomenon, particularly outside the U.S.A., was induced by regulatory changes in many countries in the 1990s which significantly affected the propensity of public firms to repurchase their own stocks (Manconi et al., 2018). Since the 1990s, several Asia-Pacific countries1have enacted share repurchases regulations to avoid the declining prices of firms’ stocks due to the impact of future unfavorable financial conditions driven by the U.S. capital market crashes in 1987 and 1989 (DeAngelo et al., 2004).
Regulators argue that the regulations aim to reduce agency problems and prevent abusive market practices (Leuz and Wysocki, 2016; Fauver et al., 2017). Therefore, several studies were conducted to test their effects. The findings are inconclusive. On one hand, some studies suggest that the enactment of regulations has positive effects not only for capital market performance but also for the improvement of individual firms (Fauver et al., 2017). On the other hand, the effectiveness and benefits of the regulations on capital markets are still subject to long-standing debate due to further impacts and consequences including the existence of externalities and economy-wide cost (Leuz and Wysocki, 2016).
In this study, we focus our analysis in the context of a single large emerging economy, more specifically, the Indonesian market. First, we investigate the determinants of share repurchases among Indonesian Stock Exchange (IDX) listed firms after the introduction of the first regulatory changes in 1998. Then, we investigate the effect of the second regulatory changes in 2007, as an exogenous shock, on the intensity of share repurchases policies. In addition, we examine the relationship between the firms’ decisions to deviate from their optimal corporate policies, i.e., excess cash holdings, paying excess dividends, and holding lower than optimal leverage and the firms’ share repurchases policies. Finally, we test for an association between share repurchases and firms’ corporate governance mechanisms.
As one of the fastest growing capital markets in Asia, Indonesian listed firms have been extensively carrying out share repurchases programmes since the first regulation in 1998 and particularly after the enactment of the share repurchases regulation in 2007. As for the Indonesian regulators, the primary objectives of these regulations were to: (i) anticipate the declining price of firms’ stocks due to market instability stemming from the impact of the capital market crashes in 1989 and the global financial crisis of 2008; (ii) foster stock market activities through which individual firms can offer premium prices that may attract shareholders selling their stocks; (iii) regain investors’ confidence in the future prospects of firms. Motivated by these regulatory changes concerning share repurchases coupled with the unique characteristics of the Indonesian market,2 we chose to unearth the main determinants of share repurchases in Indonesia and study the impact of the regulations on the firms’ decisions to buy back shares.
Theoretically, several motives have been proposed to justify the firms’ share repurchases decisions.3 These motives are mainly justified from the perspective of developed countries with established economies. However, they do not necessarily hold for emerging countries and they may well vary from one country to another. To provide further evidence, several studies have been conducted using international or emerging country-specific samples. For example, Faccio et al. (2001) study the expropriation effect of outside shareholders by controlling shareholders using a sample of Western European and East Asian firms. To test this effect, they focus on the firms’ dividend policies. They find that East Asian firms distribute lower dividend rates compared to Western European firms, which suggests that firms operating under weak legal shareholder protection are more likely to suffer from expropriation by large shareholders. Furthermore, Byrne and O'Connor (2017) examine how creditors affect dividend payouts in various disclosure regimes. Using a sample of firms from 28 countries, they find that poorly-protected creditors do not restrict the practice by firms in opaque regimes of using large dividend payouts to build reputation capital, and place few restrictions on dividend payouts in transparent regimes. Mulyani et al. (2016) examine the role dividends and leverage in reducing the agency conflict arising from the dominance of family-controlled firms in the Indonesian market. Furthermore, Moin et al. (2019) investigate the association between corporate ownership structure and cash dividends using a sample of Indonesian listed firms. They also confirm the expropriation hypothesis that minority interests are put at risk by large shareholders.
In more related share repurchases literature, Cheng and Hou (2013), on a microstructure level, use the information disclosures of open-market repurchases in Taiwan to test the association between the firm's share repurchases announcements and the market responses to these announcements. They find that the intention ratio, defined as the ratio of the number of shares intended to be repurchased to the number of outstanding shares, leads to a higher market reaction within a two-day announcement effect. Using data from Hong Kong, Firth et al. (2010) find some evidence consistent with the free cash flow and signaling arguments for share repurchases. They also examine directors’ dealing activities around share repurchases periods and find a significant insider trading activity before the share repurchases period. In addition, Manconi et al. (2018) utilize a wide international sample of 31 non-U.S. countries (including Indonesia) to test the link between share repurchases and the firm's short- and long-term excess returns. They find that share repurchases increase the firms’ long- and short-term excess returns. We further extend this literature by focusing our study on a single emerging market context, namely Indonesia. We test several motives behind the firms’ policies to buy back shares and examine the effect of the regulatory changes on these motives and the firms’ intensity to repurchase their shares.
To test our empirical predictions, we use a sample that contains 5386 firm-year observations representing 385 unique Indonesian listed firms spanning from 1998 to 2014. We use four estimation methods to answer our empirical questions. First, a probit regression model and marginal effects are used to analyze the propensity of firms to repurchase shares. Second, robust OLS regression models are used to analyze the intensity of firms’ shares repurchases. Third, to overcome endogeneity issues and sample selection bias, we provide several robustness tests using fixed effects and IV-GMM estimation methods and Heckman two-step procedure. Fourth, the difference-in-differences (DiD) analysis is used to analyze the impact of governmental regulations on the intensity of firms undertaking share repurchases.
Our empirical results provide several findings. Overall, we find that the introduction of the 2007 regulations had a significant impact on the IDX firms to undertake share repurchases. The implementation of the regulations changed the motives behind the firms to buy back their shares. For example, before the regulation introduction in 2007, there was a substitutional relationship between dividends and share repurchases. However, after the regulations, it became a complementary relationship. Furthermore, the excess cash and excess payout policies become significant determinants of the firms’ share repurchases only after the regulatory changes in 2007. This supports the agency cost of free cash flow, whereby shareholders require a larger distribution of firms’ cash rather than it being retained by managers. Conversely, the motive to capital restructuring was significant before the implementation of these regulations and became insignificant after that. Unlike the common perception in Indonesia, we find that shares underpricing has a weak effect on the firms’ decisions to repurchase their stocks. Finally, on a corporate governance level, this study fails to support the hypothesis that firms with a larger independent board member, as a proxy for better corporate governance quality, pay more to repurchase shares. One possible explanation is that corporate governance mechanisms have not been effectively applied by IDX firms.
Another explanation could be driven by the large number of State-Owned Enterprises (SOEs) among IDX firms. Typically, the composition of the board of directors in SOEs is heavily determined by the Indonesian government. This means that the role of the board of directors is weak and the firms’ strategic decisions are under the control of the government. In 1998, the Indonesian government declared its intention to regain its stock ownership from foreign and private shareholders via share buybacks. For example, the Indonesian Government through the Ministry of SOEs spent 4 trillion rupiahs (USD250 million) to repurchase 20% of SOEs stocks during the global financial crisis in 2008.
On the other hand, this study finds evidence that the higher the proportion of stocks held by institutional investors, the larger are the stock repurchases. One explanation for this is that institutional investors, as main shareholders, have strategic long-term plans to increase the percentage of ownership of the firms by increasing the intensity of the repurchases programs. Other minority shareholders who are interested in receiving the repurchases offering will sell their stocks and the proportion of stocks held by institutional investors increases.
The remainder of this study is organized as follows: Section 2 briefly reviews the literature and sets the main testable questions. Section 3 provides an overview of the share repurchases regulations in Indonesia. Section 4 presents the sample selection process. Section 5 presents the research design. Section 6 summarizes and interprets the findings. Section 7 explores several robustness checks. Section 8 tests the effects of regulatory changes on share repurchases decisions. Section 9 concludes.
Section snippets
Literature review and hypotheses development
The theories justifying the use of share repurchases are well developed in the literature. Baker et al. (2010) and Dhanani and Dhanani (2016) summarize the main theories and motivations regarding share repurchases activities according to the following: (i) signaling of undervaluation, (ii) agency cost of free cash flow, (iii) the tax hypothesis, (iv) capital structure, (v) takeover deterrence, and (vi) stock options. Rau and Stouraitis (2011) argue that firms experience five different cycles
Share repurchases regulations in Indonesia
In Indonesia, share repurchases are conducted by using either a tender offer or open capital market transaction.8 In addition, firms are obliged to submit information to the Capital Market Supervisory Board. In a tender offer, a firm announces
Sample selection
Our sample comprises all non-financial firms listed in Indonesia Stock Exchange (IDX), for the period between 1999 and 2014.10
Research design
In order to examine the propensity of firms to repurchase their shares, this study employs probit and marginal effects models with a dummy variable, DUM_REP, which takes the value of 1 for firms that undertake share repurchases, and 0 otherwise.
While the above
Descriptive statistics
Table 3 reports the summary statistics. The average value of share repurchases (Repurchases) is only 0.01% of assets, with a maximum of 1.28% of assets, and a standard deviation of 0.14%. This indicates that the value of share repurchases is very low compared to the value of their assets. By referring to the value of the Indonesian currency (IDR), the maximum Dividend Per Share is IDR12,000 and IDR69.170, on average. Based on the exchange rate at December 2014 quoted at IDR12,000 per USD, the
Fixed-Effects and the IV-GMM estimation methods
The OLS method has been widely criticized as it strictly assumes that all of the explanatory variables are exogenous. Furthermore, this method generates biased coefficients because the time-specific effects are unobservable, and they correlates with other regressors (Antoniou et al., 2008). To overcome the problem, we use fixed effects estimation and IV-GMM to test the robustness of our estimations by treating the main explanatory variables as endogenous.14
The effect of regulatory changes in 2007 on corporate share repurchases policies
In order to address the effect of share repurchases regulatory changes, this study provides empirical evidence on the impact of the regulations on the intensity of IDX firms’ shares repurchasing decisions.15 As a consequence of the implementation of the regulations in
Conclusion
This study examined the factors affecting share repurchases policies of the IDX firms for the period between 1999 and 2014. During this period, Indonesian firms experienced a regulatory change in 2007 concerning share repurchases’ activities. This natural experiment provides an opportunity to investigate the main determinants of share repurchases in Indonesian firms through an exogenous shock on the intensity of firms to buy back shares. In addition, we provide empirical evidence on the impact
Declarations of interest
none
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