Protecting business, employee remuneration, corporate conflicts: Why companies buy their own shares

In many countries, companies increasingly prefer not to pay out money to shareholders as dividends or to invest them in expanding production, but to send them to buy their own shares traded on exchanges.

For example, according to the report of Goldman Sachs, to which Bloomberg refers, in January last year, the largest source of cash in circulation on the stock markets of America were not traders and funds, but companies that bought out their own shares. The volume of such purchases amounted to $ 46 billion per month.

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Today, we’ll talk about what share repurchase is really about and why companies use it.

What it is

In most countries, dividend tax rates are higher than capital gains tax rates. This leads to a situation in which it is unprofitable for the shareholders of the company to pay dividends to them. As an alternative to dividend payments, a stock buyback tactic can be used.

Redemption of shares (in English buyback or share repurchase) is a procedure for redemption from private investors by the company issuing its own securities. Shares can be redeemed both from the stock market and directly from shareholders. By implementing the buy-back procedure, companies can pursue a variety of goals.

Why you need a buyback

There are several main objectives of the stock repurchase transaction.

1. The increase in the value of shares

According to the results of the repurchase, the number of shares freely traded on the stock exchange decreases, which allows increasing the market value of the securities remaining at the auction and increasing the net profit per share indicator (EPS, earnings per share).

Often, the buy-back procedure is also conducted during periods of a decrease in its market price — the company's management may find the drop in quotations unjustified. Undervalued securities may occur in a period of falling market with the release of bad news or the appearance of negative comments from analysts. At such times, an aggressive buying up of own shares may push prices on them, becoming a kind of “bullish factor” and provoking traders and investors to more active buying.

2. Remuneration of key employees

The growth of quotations can also be a positive factor for the top management of the company - often in many organizations trading on the stock exchange one of the key indicators in evaluating work is just the cost of shares. If the targets are met, the management can count on bonuses. By the way, companies are not always profitable and the presence of excess amount of available funds, which simply lie in bank accounts - in such a situation, management may also decide to send part of the funds to repurchase shares.

In addition, it is not uncommon for the shares to be bought back to be transferred as remuneration to company employees in key positions.

3. Increased investor confidence

Often, redemption of own shares of a company is used as a psychological moment - says Richard Zichel, investment director of the Philadelphia Trust Co. By applying this strategy, they demonstrate the confident position of their business, thereby strengthening investor confidence and attracting new investments.

4. Business protection

Often, companies that are at risk of unwanted takeover use stock repurchases as a kind of protective mechanism that can prevent takeovers.

Among other things, the redemption is used in the course of corporate conflicts, when some shareholders seek to reduce the influence of other shareholders on important decisions.

Not so simple

Despite certain advantages of the share buyback procedure, it also has its significant drawbacks. This tool can be used not only for respectable actions, but also, for example, for manipulating stock prices. As you know, the repurchase leads to an increase in earnings per share - this causes financial analysts to increase the company's stated market value. Such growth may not always be supported by real factors and the success of the business itself.

Also, the repurchase may worsen the situation of shareholders who do not sell their shares - as we wrote above, in some cases, this tool can be used by opponents of a particular shareholder.

Buyback in Russia

The practice of share buybacks in the Russian market is not yet as popular as abroad. However, there is a certain interest in this procedure, and during the 2008 crisis, interest in this tool increased. At that time, the purchase of own shares became quite a profitable investment of free funds for a business.

The specified period includes announcements on the repurchase of own shares from four large companies at once - Severstal, Wimm-Bill-Dann, Norilsk Nickel and Sollers.

Conclusion

The difficult economic situation throughout the world leads to the fact that the repurchase of shares is becoming increasingly beneficial for large companies.

According to Bloomberg, companies from the S & P 500 list have free funds of $ 1.75 trillion. They need to do something with this money, and there are not so many adequate investment opportunities in the short term in the short term, analysts are convinced. Therefore, the redemption is one of the best solutions, which has a beneficial effect on the company and beneficial to shareholders.