Value: The Four Cornerstones of Corporate Finance

by Tim Koller

Theory says that share repurchases and dividend increases send signals from the managers of a company to investors, and this will drive a change in the company's share price. For share repurchases, there are three potential signals, two with positive implications for the company's value and one with negative implications. The negative signal of a repurchase is that the company has run out of investment opportunities and can find nothing better to do with its cash than return it to shareholders. This assumes that stock market investors didn't already know that the company was generating more cash flow than it could reinvest. We've never seen a situation in which the stock market was surprised that the company couldn't reinvest its cash flow. Typically, investors are anticipating share repurchases long before managers make that decision, because there aren't many alternatives.