Share buyback announcements excite investors and shareholders as buyback is always at premium and investors are likely to generate profit out of the same. The general rationale is that buyback is a tax-efficient mechanism to return capital to shareholders. Buybacks are also welcomed by investors as the company’s profits are now distributed across a smaller number of shares outstanding. But what actually is the reason for companies doing a buyback. Here is FinanceShed with some inner criteria for why companies go for Share Buyback.
To Reward Shareholders
The common reason why companies go for the buyback is that through Buyback Company can distribute excess cash to shareholders. This practice is commonly used when the company wants to strengthen its position amongst the nervousness among shareholders regarding the business sector or the company. Also, buybacks are sometimes favored against dividends the reason being if the economy slows or falls into recession, the bank might be forced to cut its dividend to preserve cash.
The second reason companies go for the buyback is that feeling amongst the company of the value of shares to be undervalued. A share buyback in such a case is helpful to pump up the share prices which can benefit the company in the long run. The undervaluation can be because of numerous reasons other than performance and some companies try to hide the said truth with investors. If the share prices are undervalued, the issuing company can repurchase some of its shares at this reduced price. After the company has repurchased, then they re-issue them once the market has corrected, thereby increasing its equity capital without issuing any additional shares.
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Other Reasons That Can Be Not So Pleasant
There can be some not so good reasons for buyback other than these reasons. They are often done to manage the dilution from equity compensation plans. Companies buy back the shares when the options are exercised. But this can be expensive and it may happen that the existing shareholders aren’t getting the benefit of reduced share count – they are just paying the executives. Also, the shares bought back can be canceled, or they can be held in treasury for a reissue for this, companies take decision with respect to market conditions. It is possible that sometimes buybacks are wholly at the discretion of the board, which typically delegates to management. It can be possible that management has received incentives for buyback of shares to achieve EPS goals and have window-dressing with accounts.
Effects Of Buyback
Buybacks can be both good as well as bad for the company as well as the economy. Share buybacks give tax arbitrage opportunities to the company where it gives higher values to investors and shareholders compared to the dividend. Though, the buyback can give a slightly positive effect on the economy as the stock prices increase whatsoever being the reason. Thus rising prices benefit the economy on a greater extent and also carries low borrowing costs.