Share repurchases occur when a company feels the price on its stock has fallen below a target level that the company recognizes as an accurate reflection of the company's value. Many companies consider maintaining a stable stock price to be one of their duties to their shareholders. Some companies maintain a regular schedule of share repurchases. Other companies make a decision to repurchase shares when particularly good earnings result in excess cash, or the stock price has declined.
Company & Shareholder Benefits
When the stock price is low in the marketplace, it represents a good investment for a cash-rich company because the repurchase of issued and outstanding stock raises the earnings-per-share of the company and supports the price of the stock Stock trades based on the price-earnings ratio (P/E), and the higher the earnings compared to the stock price, the more investors are attracted to buy the stock, which demand results in a higher market price.
The board of directors is charged with voting whether to repurchase stock, how many shares and at what price range. The announcement of a stock repurchase comes from the board through the company. The repurchase is done either through an investment banking firm operating as agent for the company or directly from the company by its treasurer or cash manager. The repurchase transforms the stock from issued and outstanding to issued but not outstanding stock. This stock resides in the company treasury. Stock repurchases do not affect the number of authorized shares.
Companies like to have treasury stock on hand. It is issued stock that can be used in numerous ways including acquisitions of other companies, employee bonuses, stock dividends or resale to raise money to fund the company. The company does not recognize a profit or loss on the difference between the original issue price of the stock and the price of repurchase, and treasury stock cannot be kept on the books for an unlimited amount of time. In fact, some states require that repurchased stock be retired, increasing the amount of unissued stock.
Cash rich companies are potential hostile take-over targets, so using that cash for a stock repurchase program removes some of the assets that could be used to collateralize a borrowing for a leveraged buy-out. Treasury stock is not an asset, even though it can be reissued and sold to fund the acquisition of assets. It can also be distributed as a stock bonus to employees loyal to the firm, to maintain a control block that would be difficult for a corporate raider to overcome in attempting to gain voting control of the company.
- McGraw-Hill: Share Buybacks
- The University of Melbourne; Do Accelerated Stock Repurchases Deter Takeovers? An Empirical Analysis; Ali C. Akyol
- Federal Reserve Bank of New York; Stock Repurchases and Bank Holding Company Performance; Beverly Hirtle; January 2003
- New York University, Stern School of Business: A Primer on Financial Statements