Derivative Strategies for Share Repurchases

The scale of share repurchases in the last decade generated a significant body of research looking for its causes. Several hypotheses have been advanced to explain the surge in the volume of repurchase transactions. The free cash-flow hypothesis claims that managers return excess cash to mitigate agency problems. The dividend substitution hypothesis seeks to elucidate the relations between the two forms of corporate cash payouts to the shareholders, including the examination of the impact of their tax treatments. The signaling hypothesis postulates that shares are bought back by managers who want to signal their undervaluation to investors. More recently, option-funding theory emphasizes the role played by employee stock option (ESO) grants in repurchase behavior. Another common explanation posits that managers are buying back shares to manage the EPS figures.