Question

Bernie Sanders advocated heavily against share buybacks, calling for a regulation that would restrict them in the United States. Which of the following are most likely to be targeted for a share repurchase ban/restriction?

a.

Under levered (too little debt) firms, with many good investment opportunities.

b.

Over levered (too much debt) firms, with few good investment opportunities.

c.

Under levered (too little debt) firms, with few good investment opportunities.

d.

Over levered (too much debt) firms, with many good investment opportunities.

Answer 1

Answer c) under levered (less debt) firms, with few good investment opportunities.

Share repurchase is the practice of buying back a company's shares from the public to reduce the number of outstanding shares.

It is genrally done at a premium to the current market price.

Share Repurchase is done with use of debt. As a result, the leverage of firms enagaged in buyback will be high.

Since share repurchase involves cash outlay on part of the firm, it means that such firms have few good investment opportunities as they are using surplus cash to buy back stock rather than invest in potential return generating projects.

Hence, regulations will target under leveraged companies with few investment opportunities to restrict share repurchases.

Underlevered firms will be targetted since they have low debt and can afford to buy back shares using debt.

Option a) is incorrect since if a firm has many good investment opportunities then it is least likely to engage in share buy back using surplus cash.

Option b) is incorrect since over levered firms with few investment opportunities cannot afford to buy back shares due to already high leverage in capital structure.

Option d) is incorrect since  if a firm has many good investment opportunities then it is least likely to engage in share buy back using surplus cash.