Do Islamic Banks Optimally Balance the Trade-Off in Capital Structure Mix? A Comparison Approach

What the paper says

This paper extends prior corporate stock buy back studies by evaluating the effect of stock buybacks on and non-growth industries. Regression results indicate that firms categorized in above average industries contain a higher degree of information content over firms categorized in below average industries, and there appears to be a stronger earnings response among non-buyback firms in the above average industries. When assessing the effects of percent change in stock price correlated with long term investment, results indicate that investors perceive earnings associated with non-buyback firms to be informative and good indicators of stock prices and have a strong correlation with long term investment. However, findings indicate that investors perceive earnings associated with buyback firms to be noisy and unclear indicators of stock prices or possessing a strong correlation with long term investment. Introduction Stock buybacks are typically as straightforward as they sound, with the company buying its own shares on the open market with the help of an institution that specializes in such purchases. Alternatively, a company can tender an offer to existing shareholders to buy some of their shares back. There are several reasons why a company would engage in a stock repurchase program. The most common are: 1) Tax efficiency--In theory, rational investors prefer lower taxes. With that in mind, a company may decide to repurchase its own stock (effect a buyback) rather than pay out cash dividends to shareholders. Dividends are taxed as ordinary income, causing an immediate tax liability. Stock buybacks are not taxable because the shareholder does not receive a distribution (Dittmar 2000). What makes them superior to dividends is the fact that if there are capital gains on the repurchase, the rate at which those gains are taxed is lower than the rate on which dividends are taxed. 2) Management flexibility--Once a firm commits to paying a dividend, it tends to continue doing so since ceasing to pay a dividend sends a negative signal to shareholders (Miller and Modigliani 1961). With buybacks, a firm can announce one and never fulfill or take longer to do so than originally planned without the same negative reaction as cutting or eliminating a dividend. 3) Undervalued stock--What better way to communicate to the market that management thinks their stock is undervalued than by using shareholder money to buy back the stock? This approach has the potential of raising the mid- to long-term price of the stock (Boudry, Kallberg and Lin 2009). 4) Investment--If the company lacks positive net present value investment opportunities, rather than reinvesting the retained earnings into existing businesses, management may be inclined to buy back stock instead (Bayar, Chemmanur and Liu 2015). 5) The earnings game--Companies want to reflect earnings per share (EPS) from one year to the next, but what if they did not actually increase their earnings? Buying back stock reduces the number of shares outstanding, thus making each investor's stake worth a little bit more. If a company can't grow their EPS, they can reduce the denominator (shares outstanding) and get the same effect, which is earnings growth (Ferreira and Rezende 2007). All in all, stock repurchase programs can be considered part of a company's broad policy on distributing retained earnings to shareholders. In general, the market usually favors buybacks as a positive signal sending stock prices higher. That said, there are many reasons for companies to repurchase stock. As long as the motivation to repurchase stock is in line with shareholders' best interests, investors tend to favor them. Over the past three decades U.S. businesses, with the authorization of their boards of directors and encouragement from the Securities and Exchange Commission (SEC), have allocated trillions of dollars to buying back their companies' own stock (Kranish 2015). …