Companies of all sizes buy back their own stock for a number of reasons, such as to try to pump up the share price or to insulate the company from the possibility of a hostile takeover. When a company repurchases stock, it can affect the value of the remaining outstanding shares, the payment of dividends and even control of the company itself.
A stock buyback often leads to an increase in the price of the company's shares. The basic principles of supply and demand suggest that if you reduce the supply of something while demand remains unchanged, the price will naturally rise. Also, after a buyback, the value of the company is spread over fewer available shares, so each outstanding share represents a bigger piece of ownership, and therefore is worth more. This price effect is a big reason why buybacks are usually popular with stockholders: Even those who don't sell their shares back to the company will benefit because it will make their shares more valuable.
Companies do not have to pay dividends on shares they have repurchased. Assuming a company pays dividends at all, this gives it a couple of attractive options. It could pay the same total amount in dividends as before, but pay a larger amount for each share still outstanding, something that will usually make the stockholders happy. It could also pay the same amount per share as it did before the buyback, which could at least keep the shareholders satisfied. But since there are fewer outstanding shares, the total amount paid out will be smaller, allowing the company to retain and reinvest a greater portion of its profits.
Repurchased shares do not carry any voting rights. One reason companies buy back their stock is to reduce or eliminate the possibility of an outsider taking control of the company -- or gaining too much influence -- buy buying up shares. Say your company has 100,000 shares of common stock outstanding, each with a single vote, and the company founders own a combined 45,000 shares, or 45 percent of the firm. If the company buys back 10,001 shares from other stockholders, the founders' stock becomes a majority stake.
In a stock buyback, a company is literally buying out some of its shareholders. By definition, that will reduce the amount of stockholders' equity in the company. This shows up in the equity section of the balance sheet. The amount the company paid for the bought-back shares goes into an account called "treasury stock." This is a negative-equity or contra-equity account, meaning the balance reduces the total amount of stockholders' equity. If a company has, say, $500,000 in stockholders' equity and spends $25,000 to buy back shares, its balance sheet will show $500,000 in equity, less $25,000 in treasury stock, for a total of $475,000. On the asset side of the balance sheet, the company reduces its cash account by $25,000, and the sheet remains in balance.
- "Financial Accounting for MBAs," Fourth Edition; Peter Easton, et al
- USA Today: Stock Buybacks Lose Some Luster
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