The aim of the research project is to examine the relationship between share repurchase and taxation in the UK companies.
Project Objectives To examine the motivations of share repurchase in the United Kingdom. To analyze the recent trend in share repurchases over last 20 decades among UK companies. To explore the relationship between shares repurchase with taxation in the UK companies. To explore the impacts of taxation on share repurchase activity for UK companies
Context For decades, most of the corporations are preferred to pay out cash in the form of dividends rather than share repurchases, despite the relative tax advantage of capital gains over ordinary income. In some countries, such as U.S. and UK, companies can buy back their own shares in the stock market, also known as a share repurchase. In the last 20 decades, share buybacks become extremely popular in the United States. According to aggregate data from Compustat, companies announced share repurchases increased from 4.8 percent in 1980 to 41.8 percent in 2000, while dividends only grew at an average annual rate of 6.8 percent (Grullon & Ikenberry, 2002). Researchers also found that during 1985 to 1999, corporations in the U.S. announced intentions to repurchase about $750 billion of stock (Vermaelen & Rau, 2002). Moreover, studies show that from 1999 to 2000, industrial firms spent more money on share repurchases than on dividend pay out, and that is the first in history, share repurchases programs have become more popular than dividends (Grullon & Ikenberry, 2002). What are the reasons for the companies buy back their own shares. Jensen (1986) pointed that firms repurchase stock to distribute excess cash flow. A share repurchase distributes cash to existing shareholders in exchange for a fraction of the firmâ€™s outstanding equity. This hypothesis has been supported by Stephens and Weisbachâ€™s (1998) study. They found share buy backs have a positive relationship with the level of corporation cash flow. Moreover, they also found a negative relationship between share repurchase and prior stock returns, which means, firm repurchase when their share prices are undervalued in stock market. This theory has been supported by Vermaelenâ€™s (1981) study. He found that firms repurchase stock when they are undervalued and have the excess cash to distribution. In later studies, researchers pointed that firms may repurchase stock to increase their leverage ratio (Opler and Titman, 1996). For the tax perspectives, researchers pointed that tax changes have a major impact on share repurchase. In the UK, companies are sensitive to tax environmental changes. For example, studies shows that in 1994, there were significant increase in the number of open-market stock repurchase programs. This cause by the introduction of tax favored agency share repurchases programs (Vermaelen & Rau, 2002). But in 1996, when the tax credit given to tax exempt pension funds in agency buybacks was abolished, the number of the companies announced share repurchase fell significantly. However, in 1997, when all tax credits were abolished, share repurchase became popular again. As some evidence showing above, share repurchase become more popular than any time in the history. Researchers stated that the majority of companies start to use cash payouts to shareholders through share buybacks rather than cash dividend (Grullon & Michaely, 2002). Therefore, it is important to better understand the motivation behind the recent surge in share repurchase activity. Although, share buy backs growing popularity, most of the established studies focus on the U.S. firms. Whether the share buybacks in UK as popular as in the U.S., because the different of tax and regulation systems between this two countries. The aim of the research will not only enhance our understanding of corporation pay out policy but also examine the share repurchases programs under UK taxation system and how this impacts effect on UK companiesâ€™ payout strategies. Moreover, the reason for me to focus on the UK companies rather than other EU companies because there have lacks of share repurchase activities in Europe countries. According to the Securities Data Corporation (SDC) reports shows that during 1980 to 1998, there were only 489 stock buybacks announcements made by European companies. And nearly 60% of those announcements were made by the UK companies. There have various reasons for the lack of share buy back activities in EU companies. Firstly, share repurchase is still illegal in some European countries, such as France and Germany. Secondly, some countries proposed specific tax provisions to discourage share buy backs. For example, in Netherland have the high taxes on dividends and low taxes on capital gains. Thirdly, the share repurchase do not fit European company culture. Traditionally, most European companies focus on maximizing stakeholdersâ€™ value rather than shareholdersâ€™ value (Vermaelen & Rau, 2002). Moreover, in European countries the stakeholders (such as managers, banks) prefer to maximize the size of the companies rather than focus on stock prices. They are not interested in share repurchase. Finally, there are little relative studies examine the relationship between share repurchase and taxation with UK companies.
4.1 Introduction This search focuses on share repurchase and taxation among UK companies. Bibliographic database used were Business Source Premier (EBSCO), Econo Lit with Full Text (EBSCO), JSTOR Business, Psyc ARTICLES (CSA), Science Direct and Swets Wise. The details of these and full text database were searched in Table 1. The total numbers of retrieved articles were 30. Keywords used were dividend, share repurchase, buybacks, payout policy, dividend policy, taxation and regulation with limited to academic journals and non-academic articles on the last 20 years. Table 1 Database Number of retrieved articles Business Scource Premier (EBSCO) 7 ConoLit with Full Text (EBSCO) 6 JSTOR Business 6 Psyc ARTICLES (CSA) 3 Science Direct 5 Swets Wise 3
4.2 Motivations of share buy backs There are number of reasons a firm repurchase stock. First, Share repurchase could improve the retained profits. Because when companies purchase their own shares, the remaining number of shares left in the public will lower. The reduction of shares in the public means the earning per share will increase even the profits remain the same. So when companyâ€™s share price undervalued, repurchasing shares may still result in a strong return on investment. Secondly, firms may use share repurchase announcements to signal the market that their shares are undervalued and the positive stock price reaction at the announcement of share repurchase should correct the misevaluations (Dann, 1981; Vermaelen, 1981). However, Ikenberry, Lakonishok, and Vermaelen (1995) argued that this increase may not be sufficient to correct the misevaluations, particularly in the open market share repurchase- programs. According to Stephens and Weisbachâ€™s (1998) study, they investigated on 450 open-market share repurchase programs in the U.S. between 1981 and 1990. They found that between 74% and 82% of the shares targeted at the time of announcement are later repurchased and this actual share buybacks are negatively related to stock price performance after the stock repurchase. Thirdly, share repurchase may increase the leverage ratio. The leverage ratio will increase when a firm distributes its capital. Therefore, assuming that an optimal leverage ratio exists, a firm may more likely to buy back their own shares when their leverage ration is below the target ratios (Bagwell & Shoven, 1988). Fourthly, companies where there are few opportunities for growth, share repurchase may the possible way to improve the earning per share in order to meet executives or managersâ€™ targets. Thus, companies structures may affect their decisions to buy back own shares. Finally, share repurchase make a takeover more expensive. Because share buybacks avoid the accumulated amount of cash in the firm, when a firm with a strong cash position but needs limited spending on capital will accumulate cash on balance sheet, therefore, it make the firm more attractive for takeover. However, recent studies shown share repurchases are only benefit shareholdersâ€™ wealth in the short term, but do not add any long term value to the company (Guay and Harford, 2000). Eberhart and Siddique (2003) did a survey based on 7,079 share repurchase programs between 1981 and 1995. The results showed that after the share buybacks, there were a slightly increase in the number of share outstanding. Often the share purchases in the share buybacks programs are used for employee stock options and stock grants. As one article suggested, share repurchases in general are just â€œbackdoor compensationâ€? for company employees (Henry, 2006:74).
4.3 Taxation with share repurchases Tax changes have a major impact on share repurchase. Study shows that in 1994, there were significant increases in the number of open-market stock repurchasing programs cause by the introduction of tax-favored agency share repurchase programs (Vermaelen & Rau, 2002). Grullon and Michaely (2000) also find that the differential tax between capital gains and dividends is a significant determinant of the market reaction to share repurchase announcement. Grullon and Michaely (2002) pointed that in the U.S., corporations start to substitute share repurchases for dividends because capital gains are taxed at more favorable rates than ordinary income. They found that even in 1986, the Tax Reform Act greatly reduced the relative tax advantage of capital gains, but there was still a significant positive difference between the marginal rate on ordinary income and the marginal rate on capital gains. Raghavendra and Vermaelen (2002) studied on the relationship between taxation and share buybacks among the UK companies. In their studies, the result showed that buyback activity increased significantly when the agency buybacks introduced during 1990 to 1998 in the UK. This consistent with the hypothesis that taxation has a significant effect on share buybacks. Moreover, they also pointed that the ability of pension fund to recover dividend credits has a major impact on the buyback activity in the UK (Raghavendra and Vermaelen, 2002). However, some researchers have argued that taxes alone do not explain the extent of repurchases activity in the U.S. Brav at al (2005) stated that managers view tax considerations as of second important factor in the choice if disbursement mechanism. Ikenberry et al (2004) suggested that since the tax changed in 2003 in the U.S., the dividend had increased significantly. He also pointed that although dividends in the U.S. remain slightly tax disadvantages, that due to the delay of the capital gains by the investors. However, based on the results from research conducted in the U.S., the extent to whether the taxation dominant the managersâ€™ decisions announce share repurchase rather than dividends is still an unresolved issue.
4.4 Regulation framework in the UK In order to better understanding the effect between taxation and share repurchase among the UK. It is important to develop our knowledge in the legal and tax frameworks governing U.K. share buybacks, moreover, to recognize the difference between these frameworks and those in the U.S. In The UK, share buybacks allow the company to manipulate its stock price. In order to avoid the share repurchase reduce creditorsâ€™ benefits, the Companies Act states that only distributable profits or the proceeds of fresh issue of share can be used to finance the purchase. Moreover, the companies are not allowed to announce share repurchase programs during the period when directors are not allowed to trade in their companyâ€™s shares. This means that in the UK, share repurchases are not allowed in the 2 month period preceding the publication of annual earnings. Finally, compare with the U.S., in the UK, share repurchase are much less flexible tool for capital management. All the firmâ€™s buy-backed shares may ask to cancelled, because the UK regulators more concerned about the preemption rights of shareholders (Vermaelen & Rau, 2002). Not like in the U.S., the regulators more concern about the â€œtreasury stockâ€?, such as repurchased shares can be re-issued without shareholder approval (Vermaelen & Rau, 2002).
Conclusion There are various reasons for firms to announced share repurchase, although share buyback activity become extremely popular in the U.S., but the UK repurchase scene is different from the U.S. scene in many respects. Although the UK is the European country where buybacks are most popular, but it is still relatively small numbers of share repurchase programs announced compare with the U.S., where about 100 U.S. firms announce open-market share buybacks each month. However, the UK taxation system may make share repurchase less attractive than they are in the United Stated. What the impact of taxation system on share repurchase announcement among UK companies? How these impacts affect UK companies in last 20 years? Which industry is more likely to announce share repurchase program? The proposed research will review the potential relationship between taxation and share repurchase among UK companies.
5 Research Method
5.1 Desk Based Research The desk based research used to my study. Because desk based research is very useful to get a broad understanding of the topics and is relatively easy to use (Bryman and Bell, 2003). The data usually used in desk based research is referred to as secondary and includes collecting information from third party sources such as company website, magazine articles, books, journals, published statistics and marketing research reports (Collis & Hussey, 2003). There are many advantages to using secondary research. This includes the relative ease of access to many sources of secondary data with little or no cost to acquire. The use of secondary research may help researcher to clarify the research question and help align the focus of large scale primary research. However, there are also some disadvantages of using secondary research. Sometimes, secondary data may not presented in a form that exactly meets the researcherâ€™s need and the research may not get the full details of the research to gain the full value of the study. Moreover, with companies competing in fast moving industries, the secondary research may out of date have little or no relevance to the current market situation.
5.2 Reasons of using Desk Based Research There are several reasons for me use desk based research. First, there is a tremendous amount of literature available, but limited studies focus on the taxation and share repurchase among UK companies. Therefore, the desk based research may help me to limit the articles to focus on my research topics. Second, the desk based research may possible to obtain companiesâ€™ annual report and account from companiesâ€™ websites. Because the UK Companies Act (2006) requires all quoted companies to publish their annual reports available on their website. (CA S430). Finally, in order to explore the relationship between taxation and share repurchase among UK over 20 years. The specific data need to be obtained, such as market-to-book ratio, return in capital employed, equity to debt ratio, market value. All of that information could obtain through on-line data base, such as Data Stream, which can be used in Aston Universityâ€™s library. However, some of the information may out of date or the results may not be directly related to UK companiesâ€™ situation. And the amounts of information available may be very limited. Also, due to the lack of study on relationship between taxation and share buybacks under UK taxation system, it is difficult to find sufficient sources from limited useful information.
5.3 Sample Section and Analysis Method The company shares repurchase announcement information been collected between 1 January 1999 and 31 December 2009. The information obtained from various ways, including London Stock Exchange (LSE) online service, UK-wire Company Announcement service, news articles from the Financial Times. The independent variables of stock returns and data have been provided by DataStream. Moreover, the data and sample had to satisfy the following criteria: The repurchase must exclusively be ordinary shares The firms is listed in the UK Repurchases announced during the last quarter of 2001 are excluded to dampen the volatility effects of 11 September 2001. Only the first announcement of share repurchase programme is included. The sample includes all open market share repurchases, private repurchases Descriptive statistics of the repurchases and independent variables used in this study to summarize and organize the companies repurchase data. Then, the main tax regimes divided into four equal periods during the sample period. The repurchases announcement data will be analyzed into the four tax periods. The correlation matrix on the variables will be needed to analyze whether there is the correlation between companyâ€™s stock returns and share repurchase. Finally, the result will be interpreted and presented.
Ethical issues The following ethical issues will be conducted with this research: Recode the data and results accurately Follow the Aston University rules on plagiarism Describe and discuss the research result objectively
Solutions Obtain journals and literatures about firmsâ€™ dividend policies, share repurchase and taxation Tremendous amount of literature need to reviewed Limit search to articles that study on share repurchase within UK companies Obtain the information about the firms announced share repurchase programs within the UK for last 20 years Relatively small data need collect from numerous information Limit the research to companies announced share buybacks listed by data stream between 1989 and 2009 in the UK Create a list of relative UK companies Which company should include The company announced share repurchase over million Obtain the information about taxation and regulation changes over last 20 years in the UK A lot literatures need to reviewed Limit search to articles about taxation and regulation changes in last 20 years Find the impact of taxation change for share repurchases activity A limit studies/result on this area, especially for UK companies. Analyze the data on my own, use the statistical methods to explore the relationship between taxation and firmsâ€™ payout policies. Write up report Easy to exceed 15000 word limit Work with supervisor to only include the most relevant information Review the dissertation before the submit it Easy to make some grammar, spelling mistakes. Ask my friend read it, see whether the dissertation make sense for them. Help me to find the grammar mistake.
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