Disclosures and Share Repurchase: Did SEC Rules Curb Opportunistic Buybacks?

Share repurchases have been a controversial way to return cash to shareholders for decades. Prior to the SEC enactment of Rule 10b-18 in 1982, which provided a “safe harbor,” open market share repurchases were judged to be a form of market manipulation due to their ability to increase stock price and were deemed to be illegal. Since Rule 10b-18 was enacted, repurchases have surged, surpassing dividends paid annually. Nonetheless, many critics argue that repurchases are still used to opportunistically manipulate earnings, and prior research has shown that when firms engage in opportunistic repurchases, this leads to negative consequences such as reduced employment and investment. In 2002, the Securities and Exchange Commission (SEC) proposed an amendment to Rule 10b-18 which required firms to increase their disclosures about repurchases. In our paper, “Mandatory Disclosures and Opportunism: Evidence from Repurchases,” we study whether the disclosures required by the SEC improved the detectability of opportunistic repurchases, reduced the frequency of opportunistic repurchases, and mitigated the negative consequences that accompanied opportunistic repurchases.

The amendment to Rule 10b-18 became effective in December 2003 (hereafter the 2003 amendment). Before this amendment, firms were not required to disclose details about the actual repurchases they made each quarter, which made it difficult for investors to identify how many shares were repurchased and what effect repurchases had on reported earnings per share (hereafter, EPS). Brav, Graham, Harvey, and Michaely (2005) interviewed executives and found that while liquidity, undervaluation, and tax efficiency were cited as reasons for conducting repurchases, firms also engaged in repurchases to increase EPS. Hribar, Jenkins, and Johnson (2006) showed that firms strategically bought back shares to increase EPS when they would otherwise miss analysts’ earnings expectations. Almeida, Fos, and Kronlund (2016) further demonstrated that when firms engaged in this type of opportunistic repurchase behavior, it came at a cost to the firm, diverting cash from other productive investments such as employment, capital expenditures, and research and development.

The 2003 amendment was effective for periods ending on or after March 15, 2004, and it required that firms disclose actual monthly repurchase details in their 10-Qs and 10-Ks. After the 2003 amendment became effective, many firms disclosed these details in their earnings announcement as well or filed their 10-Qs and 10-Ks on the same day as their earnings announcement. This made it much easier for investors to detect whether opportunistic purchases had occurred, and whether these repurchases boosted reported earnings, after the 2003 amendment.

We compare the four years before the 2003 amendment (1998-2001) to the four years after the amendment (2004-2007), excluding the transition period when the amendment was proposed and enacted (2002-2003). We follow prior research to define opportunistic repurchases based on whether repurchases increased reported EPS and whether the firms would have narrowly missed EPS benchmarks without repurchases.

We find several significant effects on corporate repurchasing behavior. First, investors began to discount the reported earnings of firms with opportunistic repurchases after the 2003 amendment, especially when firms voluntarily disclosed their repurchase details or filed a 10-Q or 10-K on the same day as their earnings announcement. Second, we find that opportunistic repurchases aimed at meeting or beating EPS benchmarks declined after the 2003 amendment, suggesting that managers were less willing to engage in them since investors would be able to detect and scrutinize this behavior. Finally, we find that the negative real effects found by prior literature to be linked to opportunistic repurchases (reduced capital expenditures, employment, and R&D expenditures) were attenuated or eliminated after the 2003 amendment. The changes in real effects occurred not only because opportunistic repurchases declined, but also because opportunistic repurchases were less likely to be conducted by financially constrained firms after the 2003 amendment.

The 2003 amendment occurred around the same time as other significant macroeconomic events, so we perform additional tests to rule out these events as alternative explanations. The first is the Sarbanes Oxley (SOX) Act of 2002. Prior research shows that some firms changed their earnings management behavior after SOX. The second is the Dotcom crash, which began in 2000. We examine whether these events were influential by using alternative pre- and post-periods that avoid overlap between these events and enactment of the SEC amendment. These alternative tests confirm that the SEC amendment, rather than SOX or the Dotcom crash, is the driving event affecting firms’ change in repurchase behavior.

Finally, we perform some robustness tests to confirm our inferences. In one important test, we hand-collect the information disclosed by firms about their repurchases in earnings announcements. In 2001, the last year of our pre-period, we find that less than 35% of firms with repurchases that increased earnings per share provide sufficient information at earnings announcements for investors to precisely determine whether a firm had opportunistic repurchases during the earnings period. In contrast, during our post-period in 2004-2007, we find that 83% of the firms in our hand-collected sample provided this information, either voluntarily in the earnings announcement press release or by filing their 10-Q or 10-K with the required repurchase disclosure information on the same day as their earnings announcement. This additional test confirms that the ability for investors to detect and discount opportunistic repurchases was substantially higher in the post-amendment period.

Overall, our findings suggest that mandatory disclosure can be a powerful tool for curbing corporate opportunism. By simply mandating timely disclosure of repurchase details, the 2003 SEC amendment increased the transparency of opportunistic share repurchases. This increased transparency enabled investors to detect and discount such repurchases, leading managers to scale back this opportunistic behavior. Political debate about the desirability of repurchases has continued, however, even recently. In 2022, the Inflation Reduction Act imposed an excise tax on repurchases, and in 2023, House Democrats re-introduced the Reward Work Act (originally introduced in 2019) aimed at banning repurchases altogether. Rather than banning activities that may be opportunistic, our research shows that well-crafted disclosure rules may strike the right balance—allowing firms to return capital efficiently and flexibly while still ensuring that repurchases are not used to manipulate financial results.