Do Share Repurchases Enhance Liquidity? Evidence from UK Closed-End Funds

Abstract

Can companies increase the liquidity of their shares through repurchases? On the one hand, the presence of informed insiders increases adverse selection costs; on the other hand, repurchasing firms increase the demand of shares and therefore improves the liquidity. This paper examines the competing hypotheses on the effects of individual repurchase transactions on the stock liquidity (bid-ask spread and trading volume) in the context of closed-end funds that are much less heterogeneous and more transparent than conventional firms. Based on a sample of 119 closed-end funds listed on the London Stock Exchange between 1998 and 2009, we find that repurchases effectively improve share liquidity, suggesting the role of repurchasing funds as “competing market makers”. In addition, we study the regulatory reform on repurchases and show that the positive effect on liquidity is more pronounced when funds have been allowed to hold repurchased shares in treasury for future reinsurance since 2003. Finally, we explore the property of the liquidity effect and document continuity in the liquidity effect of the repurchase program as a result of the high frequency of fund repurchase transactions.

Keywords: closed-end fund, open-market repurchase, liquidity, UK, Share Repurchases

JEL Classification: G23, G35, G38