When a company decides to use excess cash to purchase its own shares from the market, it is called a buyback or “share repurchase program.”
There are only so many things a company can do with earnings in excess of their projections; among these are issuing a dividend, paying off debts, expanding, acquiring another company, or buying back shares of its own stock. Buybacks are also known as Stock Repurchase Agreements. There may be guidelines in state law or the company’s contracts or buy laws that determine what options they have and how many shares can be repurchased.
There are a few ways buybacks can be accomplished. Among these are purchases in the open market where the company advertises a buyback and shareholders can take advantage of the offer, even if it is at the prevailing market price, and this is the most commonly used method.
Other options include tender offers, privately-negotiated agreements, and structural programs which include accelerated share repurchases. The decreased supply in the marketplace will cause the shares prices to rise for stockholders, who now own a proportionally greater share of the company and will experience a higher earnings per share (EPS). Sometimes buybacks are a more tax-efficient way to distribute capital than dividends. It also signals to the market that the company believes the shares are undervalued, which improves investor sentiment around the company.
Sometimes buybacks are done to counteract the dilutive effects of employee stock option redemptions or M&A (mergers and acquisitions) activity. Tender offers are a public agreement to buy a certain number of shares within a certain price range, and are subject to many reporting requirements. Insider trading laws such as Regulation M are meant to prevent repurchases from being done for the benefit of insiders. If share repurchases cause the number of shareholders to shrink below 300, the company may “go private” and will no longer be listed on an exchange.
Accelerated repurchases are done with the help of an investment bank, who shorts the amount of stocks the company would like to retire, and the company is able to retire a set number of shares almost immediately.