Repurchases for Price Impact: Evidence from Fragile Stocks
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We highlight an important but overlooked characteristic of financial fragility: “fragile” stocks are more liquid because they are sensitive to non-fundamental liquidity shocks. This makes them less sensitive to corporate actions with price impact and therefore affects firms’ incentives to engage in those actions. We show that fragile firms have lower share repurchases but invest more, the effects stronger for financially constrained firms. We establish causality by relying on exogenous changes in fragility induced by mergers of asset managers with portfolio overlap in the stocks. Our results suggest that financial fragility has direct but unexpected real implications for corporate actions.
Valuation Insight: Stocks that are financially fragile face liquidity risk that is not fundamental. Price fluctuations then are more likely a result of value-neutral events. As a result, corporate actions that are value-relevant are more easily confused with value-neutral events and have less of a market impact. This provides a screen for corporate actions. These may in some cases have a more positive effect on value because of a smaller market response.