Equity underpricing and actual stock repurchases: Evidence based on residual income model

We examine whether and how equity misvaluation impacts corporate stock repurchase activities using an ex ante and forward-looking stock mispricing measure. In particular, we obtain our equity mispricing measure 𝑃𝑃/𝑉𝑉 by normalizing prevailing stock price with the firm’s intrinsic value based on Residual Income Model (RIM). We find that the degree of equity undervaluation significantly influences firms’ stock repurchase decision and share buyback activities over our sample period 1981 to 2014. In particular, the undervalued firms tend to repurchase their stock more both in terms of the repurchase percentage of market value of equity and the dollar volume of stock repurchases. Our evidence suggests that equity undervaluation serves as one significant determinant for companies to undertake actual stock repurchases.