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Related Topics
- Share Repurchase Programs
Description
Companies typically use Stock Buybacks to reduce dilution of their earnings. When a company buys back its own shares, it reduces the amount of stock in circulation. Future profits then are spread across fewer shares, potentially increasing a company?s earnings per share and the value of its stock. Firms implementing a Stock Buyback program repurchase, on average, 5% of outstanding shares through several avenues. While open market trades account for 90% of repurchases, occasionally a company sees benefits in using alternative methods. Private trades allow a firm to buy out unwanted shareholders, self-tenders provide a method for repurchasing larger amounts of stock, and accelerated purchases allow a firm to immediately recognize the financial impact of the program. If successful, Stock Buybacks provide a more taxefficient method of profit distribution to shareholders, as capital gains are often taxed at lower rates than dividend income. Additionally, Buybacks are less binding to a company in the long run?they do not require SEC disclosure and can be scaled back under much less analyst scrutiny than a dividend reduction.
Methodology
In order to execute a Stock Buyback, a manager must:
- Assess whether funds should be returned to shareholders. Typical reasons for Buybacks include the existence of excess profits, a lack of other attractive investment options, a favorable cost of capital or the desire to signal that the stock is undervalued.
- Determine that a Buyback is the correct method to return funds. The advantages of Buybacks versus dividends include tax advantages for long-term shareholders and less analyst scrutiny.
- Carry out the transaction in the most suitable manner. Possibilities include an open market trade, a private trade, self-tender or an accelerated purchase.
- Manage shareholder and investor opinions. Companies executing Buybacks should take care to develop a coherent rationale that convinces interested parties in the merit of the Buyback program.
Common Uses
Companies use Stock Buybacks to:
- Build investor confidence and shareholder loyalty;
- Increase earnings per share and return on equity;
- Obtain company assets at bargain values;
- Boost share price by signaling that the stock is undervalued;
- Increase the company?s debt-equity ratio through shifts in financing structure;
- Offset dilution effects that are caused by the exercising of employee stock options.
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Selected References
Badrinath, Swaminathan, Nikhil Varaiya, and Rhona Ferling. "Share Repurchase: To Buy or Not to Buy." Financial Executives International, May 2001.
Grippo, Theodore, and Matthew Hafter. Corporate Stock Repurchases and Going Private. Bureau of National Affairs, 2001.
Hutchison, Dave. "Stock Repurchase Programs: Economic Principles." Institutional Investor, Winter 1999.
Kahle, Kathleen M. "When a buyback isn?t a buyback: Open market repurchases and employee options." Journal of Financial Economics, June 2001.
Kracher, Beverly, and Robert Johnson. "Repurchase announcements, lies and false signals." Journal of Business Ethics, November 1997.
Oliver, Joseph, and Moffeit, Katherine. "Corporate Share Buyback." The CPA Journal, August 2000. Pettit, Justin. "Is a Share Buyback Right for Your Company?" Harvard Business Review, April 2001.
Repurn, James, and Jackson, Sharon. "Enhancing Performance Through Stock Buybacks." Bank Accounting & Finance, Winter 2001.
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