Stock repurchase effect with loan or idle fund
Abstract
Purpose
The purpose of this paper is to integrate Modigliani-Miller (MM) theory and stock repurchases strategy to procure a practical concept for capital decision.
Design/methodology/approach
No-arbitrage proof model deduction was used in this study. The authors consider corporate tax and funding sources as two crucial factors drawn in the model. The paper derives some propositions by trichotomy property and keeps the key assumptions of MM Capital Structure Theory.
Findings
There are two different effects on firm's value through stock repurchases. The positive effect occurs on firm's value through stock repurchases with loan fund. And the negative impact exists on firm's value through stock repurchases with idle fund.
Research limitations/implications
Notably, in the real world there are three limitations with such an arbitrage transaction (Stulz, 2000). The first one is the default risk, and the second one is transaction costs and the last one is the perfect credit market assumption. In the near future, the authors suggest it would be interesting to involve the interest rate factor and contingent tax variable into our model.
Originality/value
On the basis of no arbitrage opportunity, this paper considers both trichotomy property and MM theory. It proves the share repurchase strategy should be financed by borrowing fund. In contrast, share repurchase should not be executed with idle fund because of opportunity cost.
Keywords
Acknowledgements
The authors sincerely thank the anonymous reviewers, Dr Shuenn Ren Chen at Cheng Shiu University, Dr Juei Chao Chen at Fu Jen Catholic University and Dr Junzo Watada at Waseda University, for their insightful comments and suggestions.
Citation
Chieh Liang, W., Chun Tsao, Y., Kuei Chen, W., Chau Tseng, H. and Jian Yu, K. (2014), "Stock repurchase effect with loan or idle fund", Management Decision, Vol. 52 No. 7, pp. 1236-1244. https://doi.org/10.1108/MD-11-2012-0790
Publisher
:Emerald Group Publishing Limited
Copyright © 2014, Emerald Group Publishing Limited