Bondholder

THE JOURNAL OF FINANCE VOL. LVIII, NO.
2 APRIL 2003
The Wealth E¡ects of Repurchases on Bondholders
WILLIAM F. MAXWELL and CLIFFORD P. STEPHENS n
ABSTRACT
Prior research has documented positive abnormal stock returns around the
announcements of repurchase programs; several explanations of these re-
turns have been suggested, including signaling, free cash £ow, and wealth re-
distributions. This study analyzes abnormal stock, bond, and ¢rm returns
around repurchase announcements to examine these hypotheses. We ¢nd
evidence consistent with both signaling and wealth redistribution. The loss
to bondholders is a function of the size of the repurchase, and the risk of the
¢rm’s debt.We also ¢nd that bond ratings are twice as likely to be downgraded
as upgraded after the announcement of the repurchase program.
IN THIS PAPER, WE EXAMINE the impact of open market share repurchase announce-
ments on both stock and bond prices. Positive stock price reactions to the an-
nouncement of an open market repurchase program are well documented in the
empirical ¢nance literature.1 Several potential explanations of the positive stock
returns have been posited in the literature, including signaling, free cash £ow,
and bondholder wealth expropriation. However, only the signaling and wealth
transfer or wealth expropriation hypotheses have implications for the impact of
a repurchase program on both stock and bond returns. The signaling hypothesis
suggests that bond and stock returns should be positively correlated; the signal
provides information regarding the ¢rm as a whole and, consequently, bond and
stock prices will move in the same direction depending on the signal.2 Alterna-
tively, the wealth transfer hypothesis suggests that bond and stock value changes
should be negatively correlated. Ignoring any dead-weight losses (transactions
costs), a wealth transfer is a zero-sum game; any gains to shareholders must come
at the expense of bondholders and vice versa.
n
Maxwell is with the Eller College of Business and Public Administration, University of
Arizona. Stephens is with E. J. Ourso College of Business, Louisiana State University. We
thank Phil English, Martin Fridson, Rick Green (the editor), Ro Gutierrez, Scott Hein, Dave
Mauer, Shirley Peterson, Je¡ Ponti¡, Mark Shenkman, Doug Witte, and a particularly helpful
anonymous referee, as well as seminar participants at the University of Kansas and the Uni-
versity of Missouri for their constructive comments. All remaining errors are ours.
1
See Dann (1981), Vermaelen (1981), Comment and Jarrell (1991), Ikenberry, Lakonishok, and
Vermaelan (1995), and Stephens and Weisbach (1998).
2
It is plausible that the signal provides only information relevant to stock pricesFthat is,
the stock is currently undervaluedFand no information regarding bond prices. However, it is
considerably less plausible that a signal could be viewed as positive for stockholders and
negative for bondholders or vice versa.
895
896 The Journal of Finance
Share repurchases, particularly open market share repurchases, are becoming

an increasingly common method of distributing cash £ows to shareholders. Ac-
cording to Jagannathan, Stephens, and Weisbach (2000), the number and dollar
value of open market share repurchases grew by 650 percent and 750 percent,
respectively, between 1985 and 1996. In fact, Grullon and Ikenberry (2000) report
that in 1998, the value of share repurchases by industrial ¢rms actually exceeded
the value of dividends paid. Similarly, Grullon and Michaely (2002) ¢nd that
share repurchases have grown at an average annual rate of about 28 percent,
while dividends have grown at an average rate of only about 7.5 percent; the per-
centage of earnings paid out to shareholders has remained relatively constant
between 26 and 28 percent, but the proportion of that payout from share re-
purchases has been steadily increasing.
Investors appear to view the announcement of an open market repurchase pro-
gram favorably; positive abnormal returns associated with the announcement of
an open market share repurchase program are well documented in the empirical
¢nance literature. The abnormal returns observed around the announcement of
an open market repurchase program average about two to three percent depend-
ing on the length of the event window used. However, we do not know the impact
of the share repurchase programs on holders of the ¢rm’s more senior securities.
Corporate ¢nance theory suggests there are potential agency con£icts between
di¡erent classes of stakeholders in a ¢rm, particularly bondholders and share-
holders, and that some actions taken by management will bene¢t one class of
stakeholders at the expense of another. Share repurchases are a classic example
of such a decision. Share repurchases, like dividends and other payout mechan-
isms, reduce the cash and other assets available to meet the ¢rm’s other obliga-
tions, including principal and interest payments on debt. If this reduction in
cash £ow is signi¢cant, the probability of default on the bonds will increase and
a loss to bondholders will occur. Moreover, since a stock repurchase is a leverage-
increasing event, the ¢rm’s potentially greater ¢nancial risk may also result in a
decrease in bond prices, and can be viewed as a contributing factor in the wealth
transfer.
Previous studies have examined the wealth transfer versus signaling hypoth-
eses of both repurchases and dividend announcements.The evidence for dividend
announcements is mixed. Studies by Woolridge (1983) and Handjinicolaou and
Kalay (1984) ¢nd support for the signaling hypothesis. In contrast, Dhillon and
Johnson (1994) ¢nd evidence supporting the wealth transfer hypothesis for large
dividend changes. Dann (1981) examines possible wealth transfers around tender
o¡er repurchases and ¢nds no evidence of a wealth transfer. However, the ability
to generalize Dann’s results is limited by the small sample of straight debt issues
in the study (41 bonds from 30 ¢rms) and the use of exchange bond pricing (the
only bond pricing information available at that time).3 In this study, we examine
the signaling and wealth transfer hypotheses around open-market repurchase
announcements using a large sample of ¢rms with both publicly traded debt
3
The bond market is a dealer market; the exchange pricing information is typically smaller
odd-lot transactions for large ¢rms (Warga and Welch, 1993).
TheWealth E¡ects of Repurchases on Bondholders 897
and equity and institutional bond pricing information from the Lehman Brothers
Bond Database.
Since we know from prior research that, on average, stock prices increase
around the announcement of a share repurchase program, the signaling hypoth-
esis predicts that, on average, bond prices will also increase; conversely, the
wealth transfer hypothesis predicts that changes in equity and debt (bond) values
will be negatively correlated. However, these two hypotheses are not mutually
exclusive; thus, any observed changes in stock or bond prices are the net reaction
to the repurchase announcement. A repurchase announcement where both stock
and bond abnormal returns are negative is not necessarily a wealth transfer, and
a repurchase announcement where both bond and stock returns are positive
does not necessarily preclude a wealth transfer.To demonstrate the non-mutually
exclusive nature of the hypotheses, we report our empirical predictions regard-
ing the signs of the stock, bond, and ¢rm returns as well as the predicted correla-
tions between changes in the total values of the ¢rm’s stock and bonds
outstanding in Table I. In some combinations of wealth transfer and signaling
e¡ects, the suggested sign or correlation is ambiguous. We examine stock, bond,
and ¢rm returns as well as correlations to the possible outcomes to better di¡er-
entiate the hypotheses, and then segment the sample by important di¡erentiat-
ing characteristics to better understand the relative strength of the signal and
wealth transfer.
Prior research ¢nds that larger repurchases are associated with larger abnor-
mal stock returns, and suggests that the larger gains to stockholders are a func-
tion of increased strength of the signal as the size of the repurchase increases.4
However, since large repurchases are associated with larger changes in the li-
quidity and leverage of the ¢rm, increased stockholder gains from a large re-
purchase could be a function of a larger wealth transfer.
The ¢rm’s risk level and outstanding debt level may in£uence any wealth trans-
fer among claimants. A shift in the probability of default for an AA-rated bond
will likely have less e¡ect than the same shift in probability of default for a BB-
rated bond. For a ¢rm rated AA, a shift to an A has a modest impact on the value
of the bond, while a shift from BB to B has a signi¢cant impact.To illustrate, the
average spread between the Lehman Brothers long-term bond indexes of AA- and
A-rated bonds over the 1987 to 1998 time period was 19.8 basis points, whereas the
spread between the BB- and B-rated bonds during this time period was 201.5
basis points. To examine whether the risk of the debt in£uences stock and bond
returns around a repurchase announcement, we segment the data into invest-
ment- and noninvestment-grade bonds.
In addition, we control for the timing of the repurchase by segmenting the sam-
ple at 1987. The Tax Reform Act of 1986 reduced overall tax rates and decreased
the di¡erence between capital gains tax rates and the highest marginal tax rates;
these new tax rates were phased in over a period of four years with the majority of
the change occurring in the ¢rst two years. Lie and Lie (1999) ¢nd that tax rate
changes in£uence ¢rms’ repurchase decisions, and Stephens (1998) reports that
4
See Ikenberry et al. (1995) and Stephens and Weisbach (1998).
Table I
Predicted Returns for Repurchases with Both Signaling and Wealth
Transfer E¡ects
The possible outcome space is mapped for repurchases with both signaling and wealth transfer
e¡ects with positive and negative signs. Given that signaling and a wealth transfer have di¡er-
ent e¡ects in particular outcome spaces, we represent the uncertainty of the outcome with
a 1/ .
Correlation
between
Predicted Predicted Predicted Changes in
Abnormal Abnormal Firm Stock and
Bond returns Stock returns Returns Bond Values
Pure wealth transfer 1 0
Positive signal and no wealth transfer 1 1 1 1
Negative signal and no wealth transfer 1
Positive signal and wealth transfer 1/ 1 1 1/
Negative signal and wealth transfer 1/ 1/
the abnormal returns observed around the announcement of an open market re-
purchase program declined as a result of the decrease in overall tax rates and the
capital gains tax preference.5 After the change in the tax law, the use of open
market share repurchases increased dramatically; prior to 1987, open market
share repurchases were relatively rare. Hence, early repurchase announcements
could have greater information content, with the result that both bond and stock
prices would be expected to have larger reactions.We control for this time period
e¡ect on stock returns and any potential secondary e¡ect on bond returns in our
multivariate analysis.
Consistent with prior research, we ¢nd a positive abnormal stock price reac-
tion to the announcement of an open market repurchase program. As predicted
by the wealth transfer hypothesis, we ¢nd a negative abnormal bond price reac-
tion to these announcements. Further, we ¢nd that bond prices react more nega-
tively (and stock prices more positively) to larger repurchase programs. We also
¢nd that bonds of ¢rms with noninvestment-grade debt react more negatively
than bonds of ¢rms with investment-grade debt. Moreover, following the an-
nouncement of a repurchase program, bond ratings are more frequently down-
graded than upgraded. Although our evidence is consistent with the wealth
transfer hypothesis, it does not exclude signaling. In fact, we ¢nd that the total
¢rm value increases following a repurchase announcement, which suggests that
open market repurchase announcements are still viewed as positive signals and
not simply as wealth transfers.
5
Changes in the taxation of share repurchases directly in£uence investors’ reservation
prices and, consequently, the observed abnormal stock returns. Although we have no predic-
tion of a direct impact on the observed bond returns, there may be an indirect e¡ect resulting
from the increased or decreased cost to repurchase shares.
The remainder of this paper is organized as follows: Section I describes the

sample of open market repurchase programs, Section II details the empirical
method utilized, Section III reports our empirical results, and Section IV is our
conclusion.
I. Sample Selection
In this section, we discuss the identi¢cation of the sample of repurchases, the
derivation of the ¢nal sample, and the descriptive statistics for the sample.
A. Sample Selection
We utilize two sources to identify the announcement of an open market re-
purchase program. Our primary source of repurchase announcements is the Se-
curities Data Company (SDC) mergers and acquisitions database. SDC records
announcements from a variety of sources, including the Wall Street Journal and
wire service announcements, and provides the most comprehensive sample of
open market share repurchase announcements of which we are aware. SDC’s da-
tabase, however, includes only open market repurchase announcements from
1985 forward; accordingly, we augment our sample with the open market repurch-
ase announcements used by Stephens and Weisbach (1998). The Stephens and
Weisbach sample includes all open market repurchase announcements reported
in the Wall Street Journal Index from 1980 through 1990. Combining these two
sources, the initial sample contains 8,691 open market repurchase announce-
ments made from 1980 through 1997.
In addition to the announcement date, we also collect information on the
size of the repurchase program from SDC. Program size is generally reported
either in dollar amount or number of shares sought and is occasionally
reported as a percentage of shares outstanding. We convert program size, re-
ported as a dollar amount or as a number of shares, to the percentage of shares
outstanding, by dividing by either the market value of equity or the number of
shares outstanding, respectively. Approximately 20 percent of ¢rms do not an-
nounce the size of the open market repurchase program. All other necessary ¢-
nancial statement data are extracted from Standard and Poor’s COMPUSTAT
database, and the necessary market and return data are taken from the Center
for Research in Securities Prices (CRSP) database. A small number of ¢rms in
our sample are not listed on both CRSP and COMPUSTAT, and they were ex-
cluded from this analysis.We are left with a sample of 6,541 repurchase announce-
ments by ¢rms listed on CRSP and COMPUSTAT where we also know the size of
the repurchase program.
Finally, since the purpose of this paper is to examine the impact of repurchase
announcements on bondholders, we then screen the repurchase sample for avail-
ability of bond return data. The bond data are from the Lehman Brothers Bond
Database (LBBD). The LBBD reports institutional pricing for Treasury and
corporate bonds over the 1973 to 1997 time period and is considered to be more
accurate than exchange pricing (Warga and Welch (1993)).6 Although the di⁄-
culty with ¢nding accurate bond data is well known, Elton et al. (2001) analyze
bond pricing information in the LBBD and conclude that the LBBD is compar-
able in accuracy to CRSP data. As in Elton et al., we eliminate all putable bonds
as well as all bonds for which the bond price is matrix priced. From the sample of
6,541 open market repurchases, we ¢nd bond data for 945 announcements (17 per-
cent of the sample) covering 2,817 bonds outstanding. Of the 945 announcements
with stock and bond returns, 467 (49 percent) are announcements of ¢rst repurch-
ase programs, 207 (22 percent) represent second repurchase programs, and 271
(29 percent) represent third or subsequent repurchase programs.7 We ¢nd that
after accounting for the di¡erences in the size of the repurchase announcements,
there is no statistically signi¢cant di¡erence in bond or stock returns based upon
whether the ¢rm has announced prior repurchase programs.8
B. Sample Characteristics
Table II presents the descriptive statistics for our sample of open market re-
purchase programs. Since the sample covers a period of 18 years, market capita-
lization, sales, total assets, and net income are each reported in 1997 dollars to
avoid complications or false inferences due to in£ation.9 Column 1 contains the
descriptive statistics for the 5,596 observations in our sample of open market re-
purchases without bond data, but where returns and ¢nancial statement infor-
mation are available. Column 2 presents the descriptive statistics for our sample
of 945 open market repurchases where we also have bond returns available from
the LBBD. Not surprisingly, the most striking di¡erence between the two sam-
ples is that the ¢rms with publicly traded debt are substantially larger than the
¢rms without publicly traded debt. In fact, the ¢rms with bond data are, on aver-
age, 7.5 times the size of the ¢rms without publicly traded bonds (the di¡erence in
the medians is almost 20 times). The mean market capitalization for the observa-
tions without bond data is $745 million (median of $118 million), whereas the
mean market capitalization for ¢rms with publicly traded debt is $5.66 billion
(median of $2.32 billion). The di¡erences in sales, total assets, and net income
are all of similar magnitudes. The relative size of the repurchase programs and
market-to-book ratios do not di¡er statistically across the two samples.
The remaining six columns of Table II further segment ¢rms with both stock
and bond returns. Columns 3 and 4 compare large repurchases to smaller
6
See Hong and Warga (2000) for a discussion of the Lehman Brothers Bond Database. The
LBBD is used in previous studies by Flannery and Sorescu (1996), Blume, Lim, and Mackinlay
(1998), and Elton et al. (2001).
7
The frequency of repurchase program announcements is similar to that reported in Jagan-
nathan and Stephens (2001), who also report that the mean time between the ¢rst and second
repurchase announcement is approximately 676 days and the mean time between the second
and subsequent repurchase announcements is 370 days.
8
In the sample of ¢rms with stock and bond returns, we ¢nd the average size of the re-
purchase program for ¢rst time announcements is 7.70 percent, 6.72 percent for second time,
and 6.02 percent for third or more.
9
CPI information is obtained from COMPUSTAT.
Table II
Descriptive Statistics for Sample Companies
This table provides descriptive statistics about the companies in the sample. The announced repurchase percentage is the announced number of
shares to be repurchased divided by the number of shares outstanding. The market capitalization is from CRSP and is from the month preceding
the event.The COMPUSTAT data are the previous year-end data.The market-to-book ratio represents the market price of the stock divided by the
book value per share of the common equity. Given the time span of the study, values are adjusted by the CPI to re£ect 1997 dollars.
TheWealth E¡ects of Repurchases on Bondholders

Firm Characteristics Segmented by
Firms with Firms with Large Small Senior Debt Senior Debt Repurchases Repurchases
Stock Returns Stock & Repurchases Repurchases Rating: Rating: during or after
Only Bond Returns 45.2% r5.2% Investment Grade Noninvestment Grade before 1987 1987
Financial information: CRSP & COMPUSTAT

Number of companies 5,596 945 470 475 791 154 158 787
Announced repurchase %
Mean 7.17% 7.02% 11.06% 3.01% 6.48% 9.73% 8.85% 6.62%
Median 5.17% 5.20% 9.00% 3.00% 5.00% 6.80% 6.70% 5.10%
Market capitalization (MM) in 1997 dollars
Mean 745.16 5,661.19 4,555.86 6,531.84 6,478.28 839.13 3,604.15 5,940.19
Median 118.23 2,321.24 2,001.38 2,820.97 2,945.49 358.42 1,135.73 2,620.46
Long-term debt (MM) in 1997 dollars
Mean n.a. 4,775.53 4,395.53 5,163.45 5,532.17 907.62 1,724.79 5,228.65
Median n.a. 902.67 1,113.46 716.51 1,182.56 302.29 460.16 1,050.85
Market-to-book ratio
Mean 2.99 2.49 2.32 2.62 2.47 2.49 1.88 2.57
Median 1.67 1.91 1.89 2.00 1.94 1.71 1.49 1.99
Sales (MM) in 1997 dollars
Mean 649.42 5,820.16 4,868.31 5,416.47 5,864.04 1,580.47 4,254.46 5,291.75
Median 142.93 2,691.80 2,343.57 2,987.85 3,232.12 713.54 2,266.21 2,783.09
Total assets (MM) in 1997 dollars
Mean 1,348.52 14,862.20 13,254.05 14,930.06 16,342.60 2,982.97 6,081.39 15,424.66
Median 231.40 4,530.54 3,599.21 5,912.34 5,902.55 845.51 2,208.78 5,244.59
Net income (MM) in 1997 dollars
Mean 45.09 353.88 300.65 363.95 387.60 57.47 222.54 350.72
Median 8.36 160.96 145.26 190.70 205.45 23.97 87.18 172.69
901
repurchases; the sample is bisected at the median size of the announced repurch-
ase programs, 5.2 percent of total shares outstanding.The average size of the lar-
ger repurchase programs is 11.06 percent (median of 9.0 percent) of shares
outstanding, and the average size of the smaller repurchase programs is 3.01 per-
cent (median of 3.0 percent). Predictably, ¢rms that repurchase a smaller percen-
tage of their shares are larger; the mean market capitalization of the ¢rms
making large repurchases is $4.55 billion (median of $2.0 billion), whereas the
mean market capitalization of the ¢rms making small repurchases is $6.53 bil-
lion (median of $2.82 billion). However, the amount of long-term debt outstanding
is relatively similar between the two groups.
Columns 5 and 6 compare ¢rms with investment-grade debt to those with non-
investment-grade debt.The most signi¢cant di¡erence between these two groups
is that ¢rms with investment-grade debt are much larger. In terms of market ca-
pitalization, total assets and net income, ¢rms with investment-grade debt are
seven to eight times the size of those with noninvestment-grade debt.
Finally, columns 7 and 8 compare repurchases during or before 1987 to those
after 1987. Prior to 1988, fewer ¢rms repurchased shares, but the repurchases
were generally larger. Prior to 1988, the average open market repurchase pro-
gram targeted 8.85 percent of the shares outstanding. Beginning in 1988, more
¢rms announced repurchase programs, but the average size of the repurchase
programs is smaller, only 6.62 percent of the shares outstanding. Additionally,
consistent with the ¢ndings of Jagannathan et al. (2000), it appears that, prior
to 1988, repurchases were made predominantly by smaller ¢rms, while, after
1987, larger ¢rms began to use open market repurchases as well. In constant dol-
lar terms, the market capitalization, total assets, and net income of ¢rms an-
nouncing repurchase programs are 1.5 to 2 times larger in the post-1988 period
compared to the pre-1987 period.10
The following section describes the empirical method used to analyze excess
stock and bond returns around and following open market repurchase announce-
ments.
II. Empirical Method

We use standard event study methodologies to calculate abnormal bond and
stock returns around the repurchase announcement. Given the relation between
the signs of the bond and stock returns, we then examine whether a wealth trans-
fer may occur upon the repurchase announcement.The total abnormal change in
10
Although there were 681 open market repurchase announcements in the fourth quarter of
1987 following the stock market crash, very few of these observations made it into our ¢nal
sample. The vast majority of these announcements did not include the size of the repurchase
program and were, consequently, excluded from our analysis. Therefore, we avoid potential
problems caused by clustering of announcements following the crash. Netter and Mitchell
(1989) examine the repurchase programs announced following the crash of 1987 and conclude
that very few of the ¢rms actually followed through with their announced intention to re-
purchase stock. To further check for any bias, we eliminated all announcements in the fourth
quarter of 1987 and ¢nd little change in our results.
the market value of the equity and debt is also calculated to determine the overall
e¡ect of repurchase announcements on ¢rm value.
A. Abnormal Bond Returns

To calculate abnormal bond returns, we use a mean-adjusted return model ac-
counting for changes in the term structure. The LBBD database, our source of
bond returns data, contains only monthly data; consequently, our test of the an-
nouncement impact on bondholder wealth is restricted to the month of the re-
purchase announcement. While it would be preferable to use daily returns, the
lack of daily bond price data precludes us from using daily returns in our investi-
gation. The use of monthly bond returns biases our study against ¢nding signi¢-
cant e¡ects (Brown and Warner, 1980).
Monthly bond returns in the LBBD are de¢ned as the change in the £at price
plus accrued interest. To account for changes in bond returns related to shifts in
the term structure, we calculate a bond’s premium monthly holding period return
(PBR) for bond i during month t as the bond’s monthly return (BR), minus the
return on a matched Treasury security (TR):11
PBRi ¼ BRi TRi : ð1Þ
The mean expected excess return (EBR) for bond i in the announcement month is
equal to the average PBR for the previous y months (the estimation period):
!
Xy
1
EBRi ¼ PBRi;t : ð2Þ
t¼1
y
After calculating the expected return, the abnormal bond return (ABR) for bond
i is calculated as:
ABRi ¼ PBRi EBRi : ð3Þ
Although the majority of ¢rms in the sample have a single bond outstanding, a
number of ¢rms have multiple bonds. There are two methods to deal with this
issue.12 First, we can treat each bond as a separate observation (referred to as
the‘‘all-bond’’sample). However, given the likely high correlation between returns
of bonds issued by the same ¢rm, this approach would in£ate the t-statistics and
more heavily weight ¢rms with multiple issues in the sample. Second, we can
treat each ¢rm as a separate observation (referred to as the ‘‘weighted-average’’
sample). Using this approach, ¢rm bondholder returns are measured as a
weighted average (based upon market values) of the abnormal returns to the dif-
ferent bond issues. Since a ¢rm’s bond returns are not perfectly correlated, this
11
The methodology to account for term-structure changes is developed by Handjinicolaou
and Kalay (1984). To take into account both time to maturity and coupon, corporate bonds are
matched to Treasury securities with the closest duration.
12
Eberhart and Siddique (2002) discuss the problems associated with using each bond as a
separate observation or calculating a ¢rm-level bond return for companies with multiple bond
issues as a separate observation.
approach overestimates the standard error and biases the t-statistics downward.
We report both the all-bond and the weighted-average results in the tables.
The weighted-average abnormal bond return for ¢rm k in the announcement
month is calculated as:
XJ
ABRk ¼ ABRi wi ; ð4Þ
i¼1
where J is the number of bonds outstanding for ¢rm k, and w is the relative
market value weight of bond i to the total market value of bonds outstanding
for ¢rm k.
B. Test Statistics forAbnormal Bond Returns

We examine the signi¢cance of the abnormal bond returns using both para-
metric and nonparametric test statistics. Assuming that the excess bond returns
are normally distributed with a mean of 0 and Y-2 degrees of freedom, we can test
if abnormal excess bond returns are statistically di¡erent than zero in the follow-
ing manner.We calculate the standard deviation of ¢rm k’s premium bond return
over the estimation period:
" !#1=2
1 X
y
2
sk ¼ ðPBRk;t EBRk Þ ; ð5Þ
y 2 t¼1
where
X
J X
J
EBRk ¼ EBRi wi and PBRk ¼ PBRi wi :
i¼1 i¼1
To create a standardized excess return for ¢rm k, we standardize the abnormal

bond return by the standard deviation in the estimation period as follows:
ABRk
SERk ¼ : ð6Þ
sk
An equally weighted portfolio of the ¢rms is formed for the event month by com-
bining standardized excess bond returns. The mean portfolio standardized bond
return for the announcement period is
PN
SERk
k¼1
SMER ¼ ; ð7Þ
N
where N is the number of ¢rms in the sample.
The test statistic is then given by
SMER
t ¼ pffiffiffiffiffi : ð8Þ
N
To check the robustness of our ¢ndings, we also examine the statistical signi¢-
cance of the abnormal bond returns using nonparametric test statistics. These
methods make no assumption about the underlying distribution of excess bond
returns.We report the Wilcoxon signed rank test and the Sign test results.
A concern with using a mean-adjusted model is that events in the estimation

period, 1 to y months relative to the announcement month, can lead to a
biased expected return. By focusing on a short window to estimate mean ex-
pected returns, there is a greater probability that expected returns would not
be biased by other events. Additionally, the use of longer time horizons to esti-
mate mean expected returns could lead to incorrect estimation of a bond’s
current expected return as the credit spread changes over time. We use a
three-month time period to estimate expected bond returns. To check our
¢ndings for any potential biases, we also estimate mean expected returns over
longer time periods (four, ¢ve, and six months). Though not reported, our results
are qualitatively invariant to the time period used to estimate the mean expected
returns. Additionally, in Table III, we report the mean raw premium above
Treasuries for the sample as a check on the reasonableness of our method.
C. Abnormal Stock Returns

Abnormal stock returns are calculated using the market model with the CRSP
equally weighted index as the market portfolio on both a daily and monthly ba-
sis.13 The estimation period for the daily market model coe⁄cients is 255 trading
days, ending 30 days before the announcement date.The estimation period for the
monthly market model is 60 months, ending one month before the event. For daily
data, we report cumulative abnormal returns (CAR) over a three-day announce-
ment period ( 1,1).14 For monthly data, we report the announcement return for
the announcement month, similar to the manner in which we handled bonds.
D. Abnormal Firm Returns

In addition to examining abnormal bond and stock announcement returns, we
also analyze the e¡ect of repurchase announcements on the value of the entire
¢rm (V).15 If wealth gains to stockholders are roughly equal to the wealth loss
to bondholders, then repurchases are arguably pure wealth-transferring events
13
To con¢rm our ¢ndings, we also run the results using a value-weighted index. We ¢nd
little di¡erence in the results.
14
The abnormal stock returns are statistically signi¢cant in day 1, 0, and 1. The ¢rst day
of statistical signi¢cance seems to be a function of the reporting source. For events collected
in the early 1980s using the Wall Street Journal Index, we ¢nd signi¢cance in day 1. For
events collected using SDC, we ¢nd no statistical signi¢cance in day 1.
15
We focus only on publicly traded securities. Consequently, our measure of aggregate re-
turns on publicly traded debt and equity is only an approximation of aggregate ¢rm returns.
While it is possible to calculate aggregate ¢rm returns by assuming that nontraded securities
in a given security type (e.g., long-term debt) exhibit returns similar to publicly traded secu-
rities of the same general type, this may not be appropriate. For example, most ¢rms have
nontraded long-term debt that includes secured debt (mortgage loans, real estate liens, con-
struction loans, equipment notes, etc.), capitalized lease obligations, and revolving credit
agreements. The change in underlying price of these securities is probably limited given the
nature of these contracts and, therefore, could bias the results if they are assumed to react
similarly to traded debt securities. We rely on a measure of total long-term debt; when utiliz-
ing only publicly traded debt, our results are qualitatively similar, but the change in total
¢rm value is approximately one half the magnitude reported here.
Table III
Bond and Stock Returns on the Announcement of a Repurchase
This table documents the abnormal stock and bonds returns as well as the estimated percen-
tage change in total value. The abnormal bond returns (ABR) are calculated using a mean-ad-
justed model. To account for changes in the term structure, the expected return for the bond is
calculated as the premium over a Treasury bond with a similar duration. The abnormal stock
returns (ASR) are calculated using a market model (CRSP Equally Weighted Index). The
change in a ¢rm’s total value is calculated as ((ABRi.t DTi,t 1)1(ASRi,t MKTCAPi,t 1))/
(DTi,t 11MKTCAPi,t 1) with DT equal to the market value of interest bearing debt. All re-
turns are expressed in percentages and p-values are in parentheses. For the mean bond and
stock excess returns, the probabilities are calculated after standardizing the excess returns
by their estimation period standard deviation. For the change in the total ¢rm value, the prob-
abilities are calculated using the event period variance. The probabilities under the median ex-
cess returns are calculated using the Wilcoxon sign rank statistic. The probabilities under the
percentage of positive and negative returns are calculated using the sign test. The 99 percent
and 90 percent con¢dence levels are denoted by a and c, respectively.
Mean Mean Median Excess Returns

Raw Excess Excess % Positive:
Return Return Return % Negative
Bond Returns
Weighted-average premium bond return 0.108 0.185a 0.051a 45% : 55%a
(n 5 945) (0.000) (0.000) (0.001)
All-bond premium bond return 0.062 0.127a 0.017a 48% : 52%c
(n 5 2,817) (0.000) (0.002) (0.057)
Stock returns (n 5 945)
Monthly-equal weight market model 1.910 1.265a 1.176 57% : 43%a
(0.000) (0.000) (0.000)
Daily CAR ( 1,1) equal weight market model 1.500 1.490a 1.110a 65% : 35%a
(0.000) (0.000) (0.000)
Change in total ¢rm value (n 5 923) 0.966a 0.900a 57% : 43%a
(0.000) (0.000) (0.000)
with no wealth creation. On the other hand, if wealth gains to stockholders are
larger than the loss to creditors, then the wealth transfer hypothesis provides
only a partial explanation for the abnormal returns to stockholders. If wealth
gains to equity holders were smaller than the losses to creditors, then perhaps
the potential wealth transfer gains from bondholders are mitigated by other costs
engendered by the repurchase.To examine announcement impact on overall ¢rm
value, we calculate the abnormal change in the value (DV ) of ¢rm k during the
announcement month as:
DV k ¼ ððASRk Ek;t1 Þ þ ðABRk Dk;t1 ÞÞ=ðEk;t1 þ Dk;t1 Þ ð9Þ
The abnormal change in the value of the equity for ¢rm k is the abnormal stock
return (ASRk) multiplied by the ¢rm’s previous month’s market equity capitaliza-
tion (Ek,t 1).16 Next, we quantify the abnormal change in the market value of the
interest bearing debt for ¢rm k as the product of the abnormal bond return
16
To match the periodicity of the bond data, the monthly abnormal stock return is used in
the calculation.
(ABRk) and the previous month’s debt capitalization (Dk,t 1).The market value of
the ¢rm’s debt is obtained from the LBBD database.
To examine the statistical signi¢cance of the change in ¢rm value, we rely on
both nonparametric test statistics and a parametric student t-statistic based
upon the variance in the event period.17 Given the necessary assumption that
both bond and stock returns are normally distributed, and the fact that we rely
on the event period variance to calculate the student t-statistic, we rely on the
nonparametric tests, but also report the t-statistic calculated using the event per-
iod variance in our analysis.
III. Empirical Results

In this section, we ¢rst examine the e¡ects of open market repurchases on
bondholders, stockholders, and the total value of the ¢rm.We then explore factors
that determine di¡erences in returns using univariate analysis based upon the
size of the repurchase and the risk of the ¢rm’s debt. To con¢rm the results, we
examine changes in bond ratings after repurchase announcements. Finally, gi-
ven the possible correlation of variables between the univariate samples, pooled
time-series cross-sectional analyses are used to further examine the results.
A. Full Sample
Table III presents abnormal stock returns, abnormal bond returns, and abnor-
mal ¢rm returns for our full sample of repurchase announcements made by ¢rms
with available bond data.We report monthly bond and stock returns for both the
month of the repurchase announcement and the three-day event window, from
the day prior to the announcement through the day after the announcement. We
report both raw returns and excess returns calculated as described in the pre-
vious section. Finally, we report bond returns treating each bond as a separate
observation, and treating each repurchase announcement as a separate observa-
tion, using the weighted-average change in each of the ¢rm’s outstanding bonds.
Consistent with previous studies by Dann (1981), Vermaelen (1981), Comment
and Jarrell (1991), Ikenberry et al. (1995), and Stephens and Weisbach (1998),
among others, we ¢nd that the stock market greets announcements of open mar-
ket repurchase programs favorably. The mean three-day stock return around the
17
It would be preferable to use the estimation period to determine the standard error and,
hence, calculate the t-statistics. However, estimating the standard error of the ¢rm over the
estimation period is problematic. If the excess returns for both the stocks and bonds are nor-
mally distributed, then the change in ¢rm value should also be normally distributed. Assum-
ing that both are normally distributed allows us to calculate standard deviation of the ¢rm
over the estimation period as
rffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffi
E D ED
sv ¼ s2E þ s2D þ 2 r sE sV :
V V V V E;V
The problems with using this method are signi¢cant. Di¡erent estimation periods as well as
methods are used in calculating the variance of the excess bond and stock returns.
announcement of the repurchase program is 1.50 percent and the excess return is
1.49 percent, which is statistically signi¢cant at the one percent level. The stock
return in the month of announcement is similar, with a 1.27 percent excess re-
turn, which is also statistically signi¢cant. Our three-day excess stock returns
are lower than previous studies, but given the average size of ¢rms in our sample,
the results are consistent with the ¢nding by Ikenberry et al. (1995) that larger
¢rms experience smaller abnormal stock returns around open market re-
purchases. Though not reported in the tables, we ¢nd the three-day mean abnor-
mal stock returns for the full sample to be 2.58 percent with a median of 1.72
percent, which is closer in magnitude to the results reported in previous studies.
The bond market does not have such a favorable view of repurchase programs.
For the weighted-average sample, the raw bond return is negative 11 basis points,
and the average excess bond return is a negative 18.5 basis points, which is statis-
tically signi¢cant at the one percent level. For the all-bond sample, the excess
bond return is negative 12.7 basis points, which is again statistically signi¢cant
at the one percent level.The nonparametric statistics con¢rm the ¢ndings for both
the weighted-average and all-bond samples. The less negative excess bond return
for the all-bond sample is reasonable given that larger ¢rms have a tendency to
have more bond issues. Large ¢rms are more likely to be investment grade and to
initiate smaller repurchases, which we ¢nd later to lower bond losses.
Although the bond returns are negative, the average increase in total ¢rm va-
lue is about 0.97 percent, which is also statistically signi¢cant at the one percent
level. The nonparametric tests con¢rm these results. The signi¢cantly positive
¢rm return suggests that the positive stock returns observed are not solely a re-
sult of expropriating wealth from bondholders.
One potential problem with using a mean-adjusted model to calculate abnor-
mal bond returns is that it does not correct for changes in credit spreads due to
macroeconomic factors. This should present no bias in our results unless ¢rms
are more likely to announce repurchases during months when credit spreads
widen. Though not reported, we examine whether clustering during months
when credit spreads widen could be driving our results.18 First, we analyze if
there is a relation between changes in the credit spread between Treasuries and
BBB bonds and the number of observations in a month and ¢nd a symmetrical
distribution. As a further check, we examine our results in calendar time.
Though of smaller magnitude, the calendar-time results are consistent with the
event-time results. Hence, we conclude that clustering is not driving our results.
The positive abnormal stock and negative bond returns are consistent with a
wealth transfer among claimants at the time of repurchase announcement. How-
ever, given the overall increase in ¢rm value, the wealth transfer hypothesis is
only a partial explanation of the gain to stockholders, and there is additional va-
lue associated with the signal from the repurchase announcement. To better dif-
ferentiate the competing hypotheses, we also examine the correlation between
changes in stock and bond values and ¢nd a negative but statistically insigni¢-
cant relation. Overall, the results are consistent with a wealth transfer among
18
Results are available from the authors upon request.
claimants as well as a positive signal; given the ambiguous nature of the relation
between bond and stock returns neither the positive signal nor the wealth trans-
fer dominates.
B. Bond and Stock Returns Segmented byAnnouncements Associated with Positive

or Negative Signals (Firm Returns)
To further di¡erentiate the signaling and wealth transfer hypotheses, we seg-
ment our analysis based on whether the signal associated with the repurchase
announcement is viewed positively or negatively. Assuming no wealth transfer,
a repurchase announcement viewed as a positive signal will result in an increase
in ¢rm value, and a repurchase viewed as a negative signal will result in a de-
crease in ¢rm value.19 A pure wealth transfer, on the other hand, is a zero sum
game; absent any signal, the announcement of a repurchase program should have
no impact on ¢rm value. The change in total ¢rm value can be viewed as an indi-
cator of the information content of the repurchase announcement; consequently,
we use the abnormal ¢rm returns to proxy for the information content of the re-
purchase announcement. The results of our analysis segmented by announce-
ments associated with positive and negative abnormal ¢rm returns are
reported in Table IV. Though not reported, the results are qualitatively similar if
we segment the data based on abnormal stock returns.
In Table III, we report that 57 percent of the repurchase announcements in our
sample are greeted favorably by the market (have positive abnormal ¢rm re-
turns), and the other 43 percent of the announcements are greeted with skepti-
cism (have negative abnormal ¢rm returns). Not surprisingly, repurchase
announcements with positive abnormal stock returns are associated with abnor-
mal increases in ¢rm value, and announcements with negative abnormal stock
returns are associated with abnormal decreases in ¢rm value. On average, the
announcements associated with a positive signal (positive abnormal ¢rm re-
turns) result in a 2.42 percent increase in stock price, while the announcements
with negative abnormal ¢rm returns result in only a 0.456 percent increase in
stock price. Although both values are statistically positive, the di¡erence of 1.97
percent is statistically signi¢cant at the one percent level.
If the repurchase is associated with both a signal (usually positive) and a
wealth transfer, then we would expect that the bond returns will be more nega-
tive for announcements with negative stock returns; in other words, if the
repurchase is bad news to shareholders, it is very bad news to bondholders. Con-
sistent with our predictions summarized in Table I, repurchase announcements
viewed as negative signals (negative abnormal ¢rm returns) are associated with
negative abnormal bond returns. On average, repurchase announcements
greeted negatively by the market are associated with a statistically signi¢cant
71 basis point decrease in bond prices. On the other hand, repurchase
19
The predicted information content of a repurchase announcement is ambiguous. The
¢rm’s willingness to repurchase shares, thereby investing in itself, could be viewed as a posi-
tive signal; however, the ¢rm’s willingness to repurchase its shares could signal that the ¢rm
has no positive NPV projects and could be viewed negatively.
Table IV
Di¡erences in Abnormal Stock and Firm Returns Segmented by Positive
or Negative Firm Returns
This table documents the abnormal bond and ¢rm returns segmented by the overall change in
¢rm value. A positive change in ¢rm value is considered to be a positive signal and a negative
change in ¢rm value is a negative signal. All returns are expressed in percent and the p-values
are in parentheses. We report the mean and then the median. The 99 percent and 95 percent
con¢dence levels are denoted by a and b, respectively. (n 5 number of ¢rms in the sample.)
Abnormal Bond Abnormal Bond Abnormal

ReturnFAll-Bond ReturnFWeighted Stock Return
Description Sample Average by Firm (CAR 1,1)
Firms with positive changes in ¢rm value (n 5 526)
Mean 0.152a 0.290a 2.422a
(0.000) (0.001) (0.000)
Median 0.034a 0.028b 1.650a
(0.001) (0.032) (0.000)
Firms with negative changes in ¢rm value (n 5 397)
Mean 0.424a 0.713a 0.456a
(0.000) (0.000) (0.000)
Median 0.072a 0.134a 0.346a
(0.000) (0.000) (0.006)
Firms with positive minus ¢rms with negative changes in ¢rm value
Mean 0.576a 1.003a 1.966a
(0.000) (0.000) (0.000)
Median 0.106a 0.162a 1.304a
(0.000) (0.000) (0.000)
announcements greeted positively by the market (positive abnormal ¢rm re-

turns) are associated with a statistically signi¢cant 29 basis point increase in
bond prices, suggesting that the signal dominates the wealth transfer for these
repurchases.The 100 basis point di¡erence in returns for these two groups is sta-
tistically signi¢cant at the one percent level.
To further understand the dynamics of returns observed around repurchase
announcements, we also examine the correlation between changes in the value
of stock and bonds. For the positive signal sample, there is a statistically signi¢-
cant, at the one percent level, negative correlation between bond and stock abnor-
mal value changes, which is consistent with a wealth transfer. However, given the
signi¢cantly positive bond returns for this sample, it suggests that the signal
dominates the wealth transfer for this subgroup. For the negative signal sample,
there is a negative relation, though not statistically signi¢cant, between the ab-
normal value changes.20 The negative ¢rm return and the insigni¢cant relation
20
To examine if other factors are driving the correlations between the change in the stock
and bond values, we also ran cross-sectional tests with the change in the stock value as the
dependent variable. We included the control variables found in our cross-sectional tests in
Table VII as well as the change in the bond value. We ¢nd results consistent with the correla-
tion analysis. There is a negative relation (p 5 0.002) between changes in the stock and bond
values for the positive signal group and a negative relation (p 5 0.245), though not signi¢cant,
for the negative signal group.
between the bond and stock returns suggests that the negative signal dominates
any wealth transfer for this group.
In general, it appears that the abnormal bond and ¢rm returns are driven by
the information content of the repurchase; however, the abnormal stock returns
are signi¢cantly positive even when the repurchase announcement is viewed as a
negative signal, which is consistent with the hypothesis that some of the gain is
associated with a wealth transfer from bondholders.
C. Sample Segmented by Size of the Repurchase

We next segment the data to examine and test for di¡erences in stock, bond,
and ¢rm returns based on univariate designations. In TableV, we report the mean
values and use the unequal variance t-test to examine di¡erences between sam-
ples. Though not reported, we ¢nd consistent results using medians and testing
for signi¢cance using the nonparametric Mann^Whitney test statistic.
We segment the sample by relative size of announced repurchase programs at
the median size of announced repurchase programs for the entire sample, 5.2 per-
cent of the shares outstanding. As expected, the stock returns are signi¢cantly
greater for the larger repurchases. The three-day abnormal announcement stock
returns are statistically signi¢cant at the one percent level for both samples, but
for larger repurchases the average is 2.01 percent, while those for smaller re-
purchases are 0.98 percent.The di¡erence (1.03 percent) in stock returns is statis-
tically signi¢cant at the one percent level. The opposite is true for the bond
returns. Larger repurchases are associated with larger losses to bondholders.
For larger repurchases, excess bond returns average negative 32 basis points
using the weighted-average method of calculating excess bond returns (23 basis
points using the all-bond method) and are signi¢cant at the one percent level.The
negative excess returns for the smaller repurchases average only about 6 basis
points and 3 basis points for the weighted-average and all-bond samples, respec-
tively, which is only marginally signi¢cant for the all-bond sample and statisti-
cally insigni¢cant for the weighted-average sample.We ¢nd that, for the all-bond
sample, the larger losses to bondholders in large repurchases are statistically sig-
ni¢cant at the one percent level. For both small and large repurchases, there is an
increase in the total value of the ¢rm. In contrast, we ¢nd a larger change in ¢rm
value, a di¡erence of 0.75 percent, for large repurchases, which is signi¢cant at
the 10 percent level.
These results are consistent with the idea that larger repurchases result in
greater wealth transfers from bondholders to shareholders. In both cases, how-
ever, overall ¢rm value increases, and the increase in total ¢rm value is signi¢-
cantly greater for the larger repurchases. This is again consistent with the
signaling theory.
D. Sample Segmented by Risk

Table V also reports the returns observed around repurchase announcements
for ¢rms with investment-grade debt versus ¢rms with noninvestment-grade
debt. For the all-bond sample, bonds are segmented into investment and non-
912
TableV
Di¡erences in Abnormal Stock, Bond and Firm Returns
This table documents the abnormal bond, stock, and ¢rm returns segmented by the size of the repurchase and the level of the risk associated with
the ¢rm’s debt. The di¡erences in segment returns are then tested. The sample is segmented into ¢rms at or below the median repurchase of 5.2
percent and those above the median repurchase of 5.2 percent and by ¢rms with a senior debt rating of investment and noninvestment grade. All
returns are expressed in percentages and p-values are in parentheses.The 99 percent, 95 percent, and 90 percent con¢dence levels are denoted by
a, b, and c, respectively. (n 5 number of ¢rms in the sample.)
Abnormal Bond Abnormal Bond Abnormal Abnormal

ReturnFAll-Bond ReturnFWeighted Stock Firm
The Journal of Finance

Description Sample Average by Firm Return ( 1,1) Return
Large repurchases (n 5 470) 0.225a 0.316a 2.009a 1.342a
(0.000) (0.000) (0.000) (0.000)
Small repurchases (n 5 475) 0.028c 0.057 0.975a 0.592b
(0.092) (0.137) (0.000) (0.043)
Large repurchases (n 5 470) minus small 0.197a 0.259 1.034a 0.750c
repurchases (n 5 475) (0.008) (0.129) (0.001) (0.082)
Repurchases by ¢rms with investment-grade 0.064a 0.065a 1.258a 1.091a
debt (n 5 791) (0.000) (0.003 (0.000) (0.000)
Repurchases by ¢rms with noninvestment-grade 0.738a 0.803a 2.682a 0.282
debt (n 5 154) (0.000) (0.000) (0.000) (0.702
Repurchases by ¢rms with noninvestment-grade debt (n 5 154) 0.671a 0.738a 1.424b 0.809
minus repurchases by ¢rms with investment-grade debt (n 5 791) (0.000) (0.001) (0.029) (0.292)
Large repurchase with a noninvestment-grade rating (n 5 98) 0.815a 1.413a 0.924c 0.771
minus large repurchase with an investment-grade rating (n 5 372) (0.000) (0.002) (0.097) (0.320)
Small repurchases with a noninvestment-grade rating (n 5 56) 0.370b 0.016 1.818a 0.768
minus small repurchases with an investment-grade rating (n 5 419) (0.017) (0.946) (0.003) (0.170)
investment categories based on the individual bond’s rating. For the weighted-
average sample, we rely on the senior rating category of the ¢rm to designate
the company as either investment or noninvestment grade.21
The negative excess bond returns for ¢rms with investment-grade debt are
about 6 basis points for both the weighted-average and all-bond samples. The ne-
gative excess returns for ¢rms with noninvestment-grade debt are about 80 basis
points (74 basis points for the all-bond sample). The di¡erence in bond returns is
statistically signi¢cant at the one percent level for both the weighted-average and
all-bond samples. Similarly, the excess stock returns for ¢rms with investment-
grade debt are considerably less, about half the magnitude, than the returns for
¢rms with noninvestment-grade debt, and the di¡erence is statistically signi¢-
cant at the ¢ve percent level.The increase in total ¢rm value for ¢rms with invest-
ment-grade debt is 1.09 percent, which is statistically signi¢cant. The mean total
change in ¢rm value for the ¢rms with noninvestment-grade debt is 0.28 percent,
which is statistically insigni¢cant. Compared to investment-grade ¢rms, the lar-
ger gains to stockholders, larger losses to bondholders, and lower gains in ¢rm
value for noninvestment-grade ¢rms are consistent with a greater wealth trans-
fer for ¢rms with the riskier (noninvestment-grade) debt and a lower information
content.
E. Further Segmentation within Large and Small Repurchases

Our ¢ndings suggest that bondholders in ¢rms undertaking large repurchases
with noninvestment-grade debt su¡er large losses. However, while only 16 percent
of our sample has noninvestment-grade debt, 21 percent of large repurchasers
have noninvestment-grade debt. This suggests the variables may be correlated,
and therefore, we further segment the data.
In TableV, large and small repurchases are further segmented into investment-
and noninvestment-grade categories. When compared to the results for invest-
ment-grade ¢rms, large repurchases by ¢rms with noninvestment-grade debt
show a statistically signi¢cant additional loss of 1.41 percent for the weighted-
average sample and 0.82 percent for the all-bond sample. We also ¢nd some evi-
dence of larger gains to the stockholders, though statistically signi¢cant at only
the 10 percent con¢dence level. There is no statistically signi¢cant di¡erence in
¢rm value. In the small repurchase category, we ¢nd similar results for nonin-
vestment-grade ¢rms as compared to investment-grade ¢rms. Bondholders su¡er
larger losses, though the di¡erence is only statistically signi¢cant for the all-
bond sample, and stockholders receive a signi¢cantly larger gain. Again, the
change in the value of the ¢rm is not statistically di¡erent from zero.
When controlling for di¡erences in the size of repurchases, we still ¢nd larger
losses to bondholders of noninvestment-grade debt, larger gains to stockholders,
and no di¡erence in the total ¢rm returns. While there is no additional value
gain to the whole ¢rm, the larger gain to stockholders and the loss to bondholders
21
There are two ¢rms in the sample with both investment- and noninvestment-grade bonds.
Our designation of ¢rms or bonds into investment or noninvestment, based upon senior rating
or bond rating, has no impact on our results.
suggest a larger wealth transfer for ¢rms with senior debt rated as noninvest-
ment grade.
F. Changes in Bond Ratings after Repurchase Announcements

Although excess returns to bondholders following open market repurchase an-
nouncements are negative, if there is truly a wealth transfer from bondholders to
shareholders, it must be due to an increased probability of default on the bonds,
suggesting that we should subsequently observe more bond downgrades than
bond upgrades.22 Table VI presents the changes in ¢rms’ bond ratings as tracked
by Standard and Poor’s three months following the announcements of repurch-
ase programs. As a frame of reference, we report in Panel A changes in the senior
debt rating for all ¢rms over the 1980 to 1997 time period.23 Panel B reports
changes in bond ratings for the ¢rm’s senior debt, and Panel C reports the
changes in bond ratings for all outstanding bonds.
For the full sample in Panel A, we ¢nd close to a symmetrical distribution of
upgrades and downgrades. In comparing the repurchase sample in Panel B to the
full sample, we ¢nd more downgrades and upgrades for the repurchase sample.
This result seems to be consistent with both the wealth transfer hypothesis (sug-
gesting more downgrades) and the signaling hypothesis (suggesting more up-
grades).
When comparing the percentage of upgrades to downgrades, we observe more
than twice as many downgrades as upgrades over the entire sample in both Pa-
nels B and C. Consistent with our observations of bond returns, ¢rms announ-
cing large repurchases have more downgrades (Panel B, 9.1 percent and Panel C,
10.1 percent) than upgrades (Panel B, 3.0 percent and Panel C, 2.7 percent). In con-
trast, small repurchases have only slightly more downgrades than upgrades. Con-
trary to our ¢ndings on bond returns, ¢rms with investment-grade debt are more
likely to have downgrades (Panel B, 7.1 percent and Panel C, 7.5 percent) than
¢rms with noninvestment-grade debt (Panel B, 5.2 percent and Panel C, 4.6 per-
cent). However, care should be taken not to read too much into this result as this
may simply be a function of the limits of the bond ratings; ¢rms with the lowest
bond ratings cannot be downgraded, and ¢rms with the highest bond ratings can-
not be upgraded.
G. Pooled Cross-sectional Tests

Based on the descriptive statistics, it is obvious that some of the variables in
the univariate analyses are correlated. To segment these e¡ects on bond, stock,
and ¢rm returns, pooled time-series and cross-sectional analyses are used. The
results are reported in Table VII.
22
Lie (2002) ¢nds that ¢rms undertaking self-tender o¡ers are more likely to be down-
graded than upgraded.
23
Further analyses of bond rating changes for the full sample indicate that the probability
of upgrades versus downgrades changes over time and by bond rating (available from the
authors upon request). Hence, the ability to estimate the statistical signi¢cance of a change
in a ¢rm’s senior bond rating is problematic.
TableVI
Standard and Poor’s Rating Changes after the Announcement of a Re-
purchase by Senior Bond Rating and for All Bonds Outstanding
This table shows the change in debt rating of the ¢rm’s most senior debt and for all bonds after
the announcement of a repurchase. To examine rating changes, we track Standard and Poor’s
rating, or Moody’s if Standard and Poor’s is unavailable, from the month prior to the announce-
ment to three months after the announcement. A rating change is de¢ned as a change in the
minor debt rating of the bond. For example, a rating change includes a bond rated AA at the
time of the announcement and AA three months after the announcement.We eliminate ¢rms
from the sample if a rating is unavailable three months after the announcement or the ¢rm is
categorized as not rated before or after the announcement (this represents 16 ¢rms in the sam-
ple). To examine S&P senior debt rating changes for all ¢rms covered in the LBBD, we track
Standard and Poor’s rating changes over a three-month period from 1980 to 1997. There were
276,758 observations.
% Rating Change
Upgraded No Change Downgraded
Panel A: Standard & Poor’s Senior Bond Rating Changes During Any Three Month Period From
1980-1997Âll Firms
All ¢rms 1.2% 97.5% 1.3%
Panel B: Standard & Poor’s Senior Bond Rating Changes after Three MonthsFRepurchasing
Firms
Full sample 3.0% 90.2% 6.8%
Segmented by announced repurchase %
Small repurchases (o5.2%) 2.9% 92.5% 4.5%
Large repurchases (Z5.2%) 3.0% 87.8% 9.1%
Segmented by risk category
Investment-grade ¢rms 2.0% 90.9% 7.1%
Noninvestment-grade ¢rms 8.1% 86.7% 5.2%
Panel C: Standard & Poor’s All-Bond Rating Changes after Three Months
Full sample 3.4% 89.3% 7.3%
Segmented by announced repurchase %
Small repurchases (o5.2%) 4.1% 91.3% 4.6%
Large repurchases (Z5.2%) 2.7% 87.2% 10.1%
Segmented by risk category
Investment-grade ¢rms 2.4% 90.0% 7.5%
Noninvestment-grade ¢rms 14.2% 81.1% 4.6%
We examine the relation between abnormal bond, stock, and ¢rm returns and a
number of independent variables found to in£uence abnormal returns.To control
for any size e¡ect, we include a continuous size variable calculated as the natural
log of a ¢rm’s market capitalization (adjusted for in£ation).We use a discrete (0,1)
variable to indicate if the repurchase announcement was made in 1987 and be-
fore, or 1988 and after. The size of the repurchase is measured in three ways: (1)
as the log of the percentage of shares repurchased, (2) as the value of repurchase
relative to the amount of debt outstanding, and (3) as an indicator variable cate-
gorizing the repurchase as large (segmented at the median repurchase program
size of 5.2 percent of the shares outstanding).We utilize two di¡erent measures of
the risk to bondholders. The ¢rst is an indicator variable de¢ned as zero if the
¢rm’s senior debt is rated as investment grade and one if the ¢rm’s senior debt is
TableVII
916
Pooled Cross-sectional Regression Analysis of Bond, Stock, and Firm Returns
Abnormal stock, bond, and ¢rm returns are estimated for 945 ¢rms with announced repurchase programs made from 1980 to 1997.The ¢rms in the
sample have both bond and stock return information. This table examines the relation between abnormal stock, bond, and ¢rm returns and a
number of independent variables. The size of the ¢rm is calculated as the natural log of the ¢rm’s market capitalization (in 1997 dollars). An in-
dicator variable indicates if the repurchase announcement is in 1987 or before and after 1987.The size of the repurchase is measured in three ways:
(1) as the log of the percentage of shares repurchased, (2) as the value of repurchase relative to the amount of debt outstanding, and (3) as an
indicator variable categorizing the repurchase as large (greater than 5.2 percent). The measure of the risk to bondholders is measured using an
indicator variable representing the senior debt rating of the ¢rm at the time of the announcement is noninvestment grade and by the debt-to-capital
ratio. p-values are in parentheses. The 99 percent, 95 percent, and 90 percent con¢dence levels are denoted by a, b, and c, respectively.
Panel of Dependent Variables
Abnormal Bond Abnormal Stock Abnormal Firms
The Journal of Finance

Returns during the Returns during the 3 -day Returns During the
Announcement Month Announcement Period Announcement Month
Independent Variables Model 1 Model 2 Model 3 Model 4 Model 5 Model 6 Model 7
Intercept 0.149 0.272 0.139 0.724a 3.149b 0.432b 4.414a

(0.235) (0.233) (0.366) (0.001) (0.036) (0.041) (0.002)
Firm sizeFlog of market capitalization 0.132 0.042 0.273b
(0.102) (0.767) (0.044)
Indicator variable for announcements prior to 1988 0.906a 0.964a 1.018a 0.746c 0.642 0.420 0.063
(0.000) (0.000) (0.000) (0.063) (0.129) (0.268) (0.874)
Size of repurchase program:
As the log of the percentage of stock outstanding 0.456a 0.081
(0.008) (0.615)
Value of the repurchase relative to the value of debt 0.092 0.088
(0.335) (0.355)
Indicator variable for a large repurchase program (45.2%) 0.153 0.885a 0.298
(0.366) (0.003) (0.299)
Measures of risk to bondholders
Indicator variable for noninvestment-grade debt 0.660a 0.791a 1.235a 1.276a 1.125a 0.902c
(0.004) (0.005) (0.002) (0.010) (0.005) (0.057)
Debt-to-capital ratio 1.127b 1.037 0.529 2.838a
(0.049) (0.108) (0.530) (0.000)
Model speci¢cations
Global F-value 9.27a 7.50a 7.05a 8.49a 4.83a 3.17b 4.29a
(0.000) (0.000) (0.000) (0.000) (0.000) (0.024) (0.001
Adjusted R-square 0.026 0.020 0.027 0.023 0.020 0.007 0.018
rated as noninvestment grade. The second measure, debt-to-capital ratio, is used

to control for any leverage e¡ects.
All the models are statistically signi¢cant at a minimum ¢ve percent level.
However, the models do not explain a large percentage of the cross-sectional var-
iance in returns, as evidenced by the low adjusted R2 values. Firm size is gener-
ally not signi¢cant in the models, but this e¡ect is not surprising given the
correlation between ¢rm size, the investment/noninvestment-grade indicator
variable, and the size of the repurchase program.
When examining the model of abnormal bond returns, we ¢nd results consis-
tent with the univariate observations discussed in the prior sections. Abnormal
bond returns are more negative and statistically signi¢cant for riskier bonds,
whether measured using an indicator variable for noninvestment-grade debt or
using the debt-to-capital ratio.We also ¢nd more negative abnormal bond returns
for ¢rms with repurchase announcements before 1988.The intercept is not signif-
icantly di¡erent than zero, suggesting that for ¢rms with investment-grade debt
making small repurchases after 1987, there is no statistically signi¢cant wealth
transfer or loss to bondholders.
Similar to the univariate results, stock returns are more positive and statisti-
cally signi¢cant for large repurchases and for ¢rms with noninvestment-grade
debt. There is some evidence of larger abnormal returns for repurchases taking
place before 1988. The intercept in each of the models is positive and statistically
signi¢cant. Contrary to the results for bonds, ¢rms with investment-grade debt
making small repurchases after 1987 still produce statistically signi¢cant wealth
gains to stockholders.
Finally, changes in ¢rm value for the month of the repurchase announcement
are greater for ¢rms with investment-grade debt and lower leverage ratios; the
coe⁄cients on both the noninvestment-grade debt indicator variable and the
debt-to-equity ratio are both negative and statistically signi¢cant. This suggests
that for ¢rms with high leverage ratios and noninvestment-grade debt, the wealth
transfer dominates the signal associated with the repurchase. The intercept is
also statistically signi¢cant. Given the signi¢cant positive intercepts for the
stock and ¢rm returns and the positive and signi¢cant intercept for the bond
returns, our results suggest that for ¢rms with an investment-grade rating under-
taking small repurchases after 1987, there is a wealth gain. Hence, while there is
a wealth transfer, there is still a signi¢cant signal in stock repurchases.
IV. Conclusions
Corporate ¢nance theory suggests there are potential agency con£icts between
di¡erent classes of stakeholders in a ¢rm, particularly bondholders and share-
holders, and that some, if not many, actions taken by management will bene¢t
one class of stakeholders at the expense of another. Share repurchases are a clas-
sic example of such a decision. Share repurchases distribute cash to share-
holders, thereby reducing the cash £ow available to cover interest and principal
payments to bondholders. If this reduction in cash £ow is su⁄ciently signi¢cant,
there will be a greater probability of default on the bonds and a wealth transfer
from bondholders to shareholders.
We examine a large sample of repurchase announcements made by ¢rms with
publicly traded debt for which bond price information is available in the Lehman
Brothers Bond Database. During the announcement period, we ¢nd abnormal
positive stock returns, negative bond returns, and positive ¢rm returns, as well
as an insigni¢cant correlation between stock and bond returns. Given the posi-
tive ¢rm returns, we can reject the pure wealth transfer hypothesis.
To further understand the relation between the signaling and wealth transfer
hypotheses, we segment the sample into positive and negative signal ¢rms. For
the positive signal ¢rms, we ¢nd statistically signi¢cant positive stock and bond
abnormal returns, as well as a negative correlation between changes in stock and
bond values. These results are consistent with both the signaling and wealth
transfer hypotheses. For the negative signal ¢rms, we ¢nd statistically signi¢-
cant positive stock and negative bond abnormal returns as well as a negative cor-
relation, though not statistically signi¢cant, between the changes in stock and
bond values. This suggests that, for this group, the signal dominates any wealth
transfer. Overall, we ¢nd evidence suggesting the gain to stockholders around
open market repurchase announcements is a function of both a signal and
wealth transfer and that, depending upon the signal, either one can dominate
the other.
In explaining the returns, the bond returns are more negative and stock re-
turns more positive for large repurchase programs, for repurchase programs an-
nounced before 1988, and for repurchase announcements by ¢rms with
noninvestment-grade debt. Similarly, following a repurchase announcement
bond ratings are more likely to be downgraded than upgraded; downgrades are
also more likely for ¢rms announcing large repurchase programs.
This wealth transfer has implications for empirical studies examining the ab-
normal stock returns and motives associated with share repurchases (see studies
by Jagannathan and Stephens (2001), Grullon and Michaely (2002), among
others). The cross-sectional di¡erences in bondholdings and potential wealth
transfers must be accounted for in making inferences about the sources of the
gains associated with repurchase announcements.
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THE JOURNAL OF FINANCE VOL. LVIII, NO.

The Wealth E¡ects of Repurchases on Bondholders

WILLIAM F. MAXWELL and CLIFFORD P. STEPHENS n

Share repurchases, particularly open market share repurchases, are becoming

The remainder of this paper is organized as follows: Section I describes the

TheWealth E¡ects of Repurchases on Bondholders

Financial information: CRSP & COMPUSTAT

II. Empirical Method

A. Abnormal Bond Returns

B. Test Statistics forAbnormal Bond Returns

To create a standardized excess return for ¢rm k, we standardize the abnormal

A concern with using a mean-adjusted model is that events in the estimation

C. Abnormal Stock Returns

D. Abnormal Firm Returns

Mean Mean Median Excess Returns

III. Empirical Results

B. Bond and Stock Returns Segmented byAnnouncements Associated with Positive

Abnormal Bond Abnormal Bond Abnormal

announcements greeted positively by the market (positive abnormal ¢rm re-

C. Sample Segmented by Size of the Repurchase

D. Sample Segmented by Risk

Abnormal Bond Abnormal Bond Abnormal Abnormal

The Journal of Finance

E. Further Segmentation within Large and Small Repurchases

F. Changes in Bond Ratings after Repurchase Announcements

G. Pooled Cross-sectional Tests

Panel of Dependent Variables

Abnormal Bond Abnormal Stock Abnormal Firms

The Journal of Finance

Independent Variables Model 1 Model 2 Model 3 Model 4 Model 5 Model 6 Model 7

Intercept 0.149 0.272 0.139 0.724a 3.149b 0.432b 4.414a

rated as noninvestment grade. The second measure, debt-to-capital ratio, is used

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