A company's repurchase of a portion of its own outstanding shares. The purpose of a buyback may be to acquire a block of stock from an investor who is unfriendly to the target firm's management and is considering taking over the firm. Conversely, a buyback may be an attempt to increase earnings per share by reducing the number of outstanding shares. Regardless of the purpose of a buyback, the result is increased risk for the firm because of reduced equity in the firm's capital structure. Also called stock buyback
, stock repurchase plan
. See also greenmail
, partial redemption
Case Study Corporate stock buybacks generally consist of a company purchasing its shares in the open market or offering shareholders an above-market price for a certain proportion of their holdings. Either method will result in fewer outstanding shares and, hopefully, help support the market price of the firm's stock. In some instances companies sell short put options that commit the companies to buy back shares of their stock at a specified price until a certain date. Companies issuing the puts pocket premiums paid by investors who gain the right to force the company to buy back its own shares. If the stock price remains above the exercise price specified by the puts, option holders choose not to exercise the puts because they have no interest in selling stock at a below-market price. The unexercised options expire, allowing the companies to issue additional puts and pocket additional premiums. In the event puts are exercised, companies purchase shares they intended to purchase in any case. A problem develops when the company's stock price declines dramatically, in which case the company will be forced to repurchase its own shares at a price much higher than the market price. This is exactly what happened to PC maker Dell Computer during the first half of 2001, when the company was forced to repurchase some of its shares for $47 (the exercise price of the puts) at a time the stock was trading on the Nasdaq National Market in the mid-20s. In other words, Dell was being required to pay twice the market price to repurchase its shares because the company had earlier sold put options with strike prices that on the issue date seemed reasonable but later turned out to be substantially higher than the price at which the stock traded in a depressed market. According to an SEC filing, Dell had issued put contracts on 96 million of its own shares at an average exercise price of $44 per share. Unfortunately for Dell, the purchases of its stock at inflated prices came at a time when the firm's cash flow was being squeezed by a weak PC market.
When a company purchases shares of its own publicly traded stock or its own bonds in the open market, it's called a buyback.
The most common reason a company buys back its stock is to make the stock more attractive to investors by increasing its earnings per share. While the actual earnings stay the same, the earnings per share increase because the number of shares has been reduced.
Companies may also buy back shares to pay for acquisitions that are financed with stock swaps or to make stocks available for employee stock option plans.
They may also want to decrease the risk of a hostile takeover by reducing the number of shares for sale, or to discourage short-term trading by driving up the share price.
Companies may buy back bonds when they are selling at discount, which is typically the result of rising interest rates. By paying less than par in the open market, the company is able to reduce the cost of redeeming the bonds when they come due.