Fighting Fire with Fire: the Value of Informed Buybacks

Abstract

This paper studies buybacks in a setting with two informed parties: a manager implementing buybacks and an outside speculator. Contrary to conventional wisdom, uninformed buybacks reduce liquidity and lower shareholder welfare in this setting. Buybacks introduce two opposing economic forces. They intensify the competition for trading profits, making informed trading less profitable. They also make the per-share value of the firm higher (lower) when its shares are undervalued (overvalued); the increased dispersion makes informed trading more profitable. Less informative buybacks weaken the first effect while strengthening the second. Managerial incentives to inflate the current stock price constrain the informativeness of buybacks. The model generates novel predictions linking managerial compensation, buybacks, and trading outcomes.

Keywords: share repurchases, stock buyback, liquidity, informed trading, payout policy, multi-trader Kyle model

JEL Classification: D82, G14, G30, G35