The cost of financial flexibility: Evidence from share repurchases

- Repurchases are more popular than dividends, in part due to their flexibility.
- We document a significant cost to payout flexibility.
- The average firm could improve repurchase timing by smoothing repurchases.
- The cost of payout flexibility is correlated governance and agency concerns.

Over the last two decades, share repurchases have emerged as the dominant payout channel, offering a more flexible means of returning excess cash to investors. However, little is known about the costs associated with payout-related financial flexibility. Using a unique identification strategy, we document a significant cost. We find that actual repurchase investments underperform hypothetical investments that mechanically smooth repurchase dollars through time by approximately two percentage points per year on average. This cost of financial flexibility is correlated with earnings management, managerial entrenchment, and less institutional monitoring.