Buying High and Selling Low: Stock Repurchases and Persistent Asymmetric Information

We investigate the consequences of allowing for repeated capital market transactions in a model with asymmetric information between a firm and its investors. All firms in the model possess a profitable project that they need to raise cash to undertake. However, equilibria exist in which firms return cash to investors via share repurchases. Consistent with managerial accounts, some firms directly profit from repurchasing their stock. The ultimate source of these profits is that other firms buy “high” in order to improve the terms of subsequent stock issues, which is again consistent with empirical evidence. Only equilibria with repurchases satisfy a mild refinement. Repurchases lower social welfare by reducing the fraction of firms that invest, even though repurchasing itself carries no deadweight cost. Our model generates a number of empirical predictions.

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