Question

Stock repurchases are transactions in which a firm buys back shares of its own stock, thereby (maintianing,increasing,decreasing) shares outstanding, (maintianing,increasing,decreasing) EPS, and often (maintianing,increasing,decreasing) the stock price. There are three principal types of stock repurchases. (1) Situations where a firm has cash available for shareholder distributions and it distributes the cash by repurchasing shares rather than paying cash dividends. (2) Situations where the firm concludes that its capital structure is too heavily weighted with equity, and it sells debt and uses the proceeds to buy back its stock. (3) Situations where a firm has issued options to employees and it uses open-market repurchases to obtain stock for use when the options are exercised. Stock that has been repurchased by a firm is called (preferred,treasury,common) stock.

There are both advantages and disadvantages of repurchases. Its advantages are:

Repurchases send a positive signal to investors that management believes their firm's shares are undervalued.

Stockholders have a choice to sell their shares or not to sell them.

Repurchases can remove large blocks of stock that are keeping the stock price down.

Dividends are sticky, so if excess cash flows are temporary, management will prefer to distribute the excess through a repurchase rather than risking dividends that cannot be maintained.

The firm can establish a target distribution level that includes both a dividend component and a repurchase component.

Repurchases can be used to produce large-scale changes in capital structure.

Companies that use stock options as an important component of employee compensation may reissue repurchased shares for stock options when employees exercise their options.

Its disadvantages are:

Stockholders may be indifferent between dividends and capital gains.

Selling stockholders may not be fully aware of all the implications of a repurchase.

The firm may pay too high a price for the repurchased stock, to the disadvantage of the remaining stockholders.

Answer 1

Stock repurchases are transactions in which a firm buys back shares of its own stock, thereby decreasing shares outstanding, increasing EPS, and often increasing the stock price. There are three principal types of stock repurchases. (1) Situations where a firm has cash available for shareholder distributions and it distributes the cash by repurchasing shares rather than paying cash dividends. (2) Situations where the firm concludes that its capital structure is too heavily weighted with equity, and it sells debt and uses the proceeds to buy back its stock. (3) Situations where a firm has issued options to employees and it uses open-market repurchases to obtain stock for use when the options are exercised. Stock that has been repurchased by a firm is called treasury stock.

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Stock repurchase is generally done by company when the management feels market is undervaluing the company's stock and it is worth more than value. Management would use excess capital to buy back the stocks from investors currently holding it, who can choose to be a part of a repurchase activity. If they do, they receive the price from company in turn for giving their shares to company. These repurchased shares are called as TREASURY STOCK.

Now, when the company repurchases stock, number of common stocks outstanding reduces. This would boost up the Earnings per Share, since the numerator (Earnings) remain constant before and after share repurchase, but the denominator (number of shares outstanding) decreases after share repurchases. So EPS increases.

Price of a stock also generally increasaes which could be understood by 2 reasons - first, stock repurchase is a positive signal as it signals to market the confidence that the firm has in its business and that market may be undervaluing the shares. Also, from economics point of view, number of shares in market decreases (supply), so if demand increases, the equilibrium point would require the price to rise.