Discuss why firms repurchase their own stock?
STOCK REPURCHASES
Treasury stock or treasury shares are shares a firm has previously issued and later reacquired. Treasury shares do not receive dividends, do not have voting rights, and do not enter the calculation of earnings per share, because corporation laws do not consider them outstanding shares for these purposes.
Reasons for reacquiring outstanding common stock include the following:
1 . To use in option arrangements.
To fulfill commitments to deliver shares to its employees under employee stock option plans, the employer can reacquire shares so that the number of shares outstanding remains approximately constant. Doing so avoids diluting existing shareholders' voting interest and perhaps maintaining earnings per share. The firm would project the expected number of shares needed for the exercise of employee stock options and repurchase that amount of shares in the open market.
2 . To invest excess cash.
Some firms believe that their own shares provide a good investment. Evidence supports the notion that share prices often increase after a firm announces a share repurchase program.
3 . To defend against an unfriendly takeover bid.
Two different motives appear to be at work here:
Share repurchases reduce common shareholders' equity and increase the proportion of debt in the capital structure, making the firm more risky and therefore less attractive to an unfriendly bidder. Some firms even borrow cash to repurchase shares, which affects the debt ratios even more than using already available cash to reacquire shares.
Share repurchases use up available cash and thereby reduce the attractiveness of the company to outsiders who believe that the available cash makes the company an attractive target.
4 . To distribute cash to shareholders in a tax-advantaged way.
Rather than pay dividends to all shareholders, many of whom will owe personal income taxes on the entire dividend amount, the firm can buy back shares from those who wish to receive cash. Some shareholders will have lower tax rates on receipts from sales of shares than on dividend receipts.
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