Share repurchase

Share repurchase

In some countries, including the United States and the United Kingdom, corporations can buy back their own stock in a share repurchase, also known as a stock repurchase or share buyback. There has been a meteoric rise in the use of share repurchases in the U.S. in the past twenty years, from $5b in 1980 to $349b in 2005. [For evidence of the increased use of share repurchases, see "Bagwell, Laurie Simon and John Shoven", "Cash Distributions to Shareholders" 1989, Journal of Economic Perspectives, Vol. 3 No. 3, Summer, 129-140.] A share repurchase distributes cash to existing shareholders in exchange for a fraction of the firm's outstanding equity. That is, cash is exchanged for a reduction in the number of shares outstanding. The firm either retires the shares or keeps them as treasury stock, available for re-issuance. Under U.S. corporate law there are five primary methods of stock repurchase: open market, private negotiations, repurchase put rights, and two variants of self-tender repurchase, a fixed price tender offer and a Dutch auction.

Motivations for share repurchases

Companies making profits typically have two uses for those profits. Firstly, some part of profits are usually repaid to shareholders in the form of dividends. The remainder, termed retained earnings, are kept inside the company and used for investing in the future of the company. If companies can reinvest most of their retained earnings profitably, then they may do so. However, sometimes companies may find that some or all of their retained earnings cannot be reinvested to produce acceptable returns.

Share repurchases are one possible use of leftover retained profits. When a company repurchases its own shares, it reduces the number of shares held by the public so, even if profits were to remain the same, this would have the effect of increasing earnings per share. So, repurchasing shares, particularly when a company's share price is undervalued or depressed, can provide a competitive return on investment.

One reason why companies may prefer to keep a substantial portion of earnings rather than distribute them to shareholders, even if they aren't able to reinvest them all profitably, is that it is considered very embarrassing for companies to be forced to cut dividends. So, rather than pay out larger dividends during periods of excess profitability then have to reduce them during less good times, companies prefer to pay out a conservative portion of their earnings, perhaps half, with the aim of maintaining an acceptable level of "dividend cover".

Another reason why executives, in particular, may prefer share buybacks is that Executive compensation is often tied to executives' ability to meet earnings per share targets. In companies where there are few opportunities for organic growth, share repurchases may represent one of the few ways of improving earnings per share in order to meet targets.

Open market share repurchases

The most common share repurchase method in the United States is the open-market stock repurchase, representing almost 95% of all repurchases. A firm may or may not announce that it will repurchase some shares in the open market from time to time as market conditions dictate and maintains the option of deciding whether, when, and how much to repurchase. Open market repurchases can span months or even years. There are, however, daily buy-back limits which restrict the amount of stock that can be bought over a particular time interval.

Fixed price tender offer repurchases

Prior to 1981, all tender offer repurchases were executed using a fixed price tender offer. This offer specifies in advance a single purchase price, the number of shares sought, and the duration of the offer, with public disclosure required. The offer may be made conditional upon receiving tenders of a minimum number of shares, and it may permit withdrawal of tendered shares prior to the offer's expiration date. Shareholders decide whether or not to participate, and if so, the number of shares to tender to the firm at the specified price. Frequently, officers and directors are precluded from participating in the tender offer. If the number of shares tendered exceeds the number sought, then the company purchases less than all shares tendered at the purchase price on a basis to all who tendered at the purchase price. If the number of shares tendered is below the number sought, the company may choose to extend the offer’s expiration date.

Dutch auction share repurchases

The introduction of the Dutch auction share repurchase in 1981 allows an alternative form of tender offer. The first firm to utilize the Dutch auction was Todd Shipyards. ["Bagwell, Laurie Simon", "Dutch Auction Repurchases: An Analysis of Shareholder Heterogeneity" 1992, Journal of Finance, Vol. 47, No. 1, page 73.] . A Dutch auction offer specifies a price range within which the shares will ultimately be purchased. Shareholders are invited to tender their stock, if they desire, at any price within the stated range. The firm then compiles these responses, creating a demand curve for the stock. [To understand the Dutch auction bidding and outcome from actual shareholder tendering responses, see "Bagwell, Laurie Simon", "Dutch Auction Repurchases: An Analysis of Shareholder Heterogeneity" 1992, Journal of Finance, Vol. 47, No. 1, 71-105.] The purchase price is the lowest price that allows the firm to buy the number of shares sought in the offer, and the firm pays that price to all investors who tendered at or below that price. If the number of shares tendered exceeds the number sought, then the company purchases less than all shares tendered at or below the purchase price on a pro rata basis to all who tendered at or below the purchase price. If too few shares are tendered, then the firm either cancels the offer (provided it had been made conditional on a minimum acceptance), or it buys back all tendered shares at the maximum price.

Types of buy-backs

Equal access buy-backs

The most straightforward form of share buy-back is an equal access buy-back. All ordinary shareholders are offered a reasonable opportunity to consider the offer, which is to buy back the same percentage of their ordinary shares. An equal access scheme can include only marginal differences between offers, relating to, for example, differing accrued dividend entitlements or the calculation of odd lots. An equal access buy-back allows companies to devise their own timetable to suit their particular circumstances (within limits), if no shareholders are unfairly disadvantaged.

Selective buy-backs

In broad terms, a selective buy-back is one in which identical offers are not made to every shareholder, for example, if offers are made to only some of the shareholders in the company. The scheme must first be approved by all shareholders, or by a special resolution (requiring a 75% majority) of the members in which no vote is cast by selling shareholders or their associates. Selling shareholders may not vote in favour of a special resolution to approve a selective buy-back. The notice to shareholders convening the meeting to vote on a selective buy-back must include a statement setting out all material information that is relevant to the proposal, although it is not necessary for the company to provide information already disclosed to the shareholders, if that would be unreasonable.

Other types of buy-backs

A company may also buy back shares held by or for employees or salaried directors of the company or a related company. This type of buy-back, referred to as an employee share scheme buy-back, requires an ordinary resolution.

A listed company may also buy back its shares in on-market trading on the stock exchange, following the passing of an ordinary resolution if over the 10/12 limit [ The 10/12 limit refers to ASIC's requirement that companies buy back no more than 10% of the voting rights in the company within 12 months - [ Share Buy-backs] ] . The stock exchange’s rules apply to on-market buy-backs.

A listed company may also buy unmarketable parcels of shares from shareholders (called a minimum holding buy-back). This does not require a resolution but the purchased shares must still be cancelled.


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