Treasury stocks are stocks a company issued and then later bought back from the open market or directly from its shareholders. Several reasons may contribute to a company’s decision to buy back its stock. Common reasons companies repurchase shares of their stock are to prevent a hostile takeover or to give the shares to employees as an incentive. Companies can use several methods to buy back treasury stocks. The Securities and Exchange Commission requires a corporation to announce its plans to buy back shares before making the transaction. Managers must understand the rules regarding repurchasing stocks.
1. Evaluate the company’s stock to choose the best repurchase price. Corporations typically buy back stock when they are undervalued. The SEC limits the price a corporation can pay for stock up to the amount of an independent bid.
2. Obtain authorization from the corporation's board of directors. The board should decide on the amount of money to spend on the repurchase, the volume of stocks to buy back and the reason for the repurchase. The SEC limits the amount of stocks a corporation can repurchase to 25 percent of the average daily trading volume.
3. Select the repurchase date and time. The SEC prohibits companies from repurchasing stocks as the opening trade or 30 minutes before the stock market closes for the day.
4. Announce your decision to buy back the shares through the creation and distribution of a press release. Verify that the corporation is not containing material inside information. The SEC prohibits a corporation from buying back stocks without informing shareholders of important information regarding the company.
5. Repurchase the shares using one of the available methods. Make a tender to shareholders to sell a percentage or all of their stocks or buy the shares on the open market. Most companies use a broker to facilitate the buyback. Obtain an agreement from the broker the he will follow SEC rules regarding the purchase of treasury stocks.
6. Record the repurchase of treasury stocks in the company’s books. Use the cost method or the par value method. The cost method records the amount paid for the shares in the treasury stock account and reports the amount on the balance sheet under shareholders’ equity. The par value method is for stock a company does not plan to sell again after the repurchase.
- Companies are not required to pay taxes on treasury stocks they repurchased.
- Failing to follow the legal requirements surrounding treasury stock can lead to a company receiving penalties from the SEC.
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