Question

MGM recently announced a share buyback program. In the release, CEO Jim Murren states that shareholder value is driven by, in part, by its share repurchase program.

"We are pleased with the Company's strong balance sheet, which has allowed us to take a balanced approach to driving shareholder value through our quarterly dividend and share repurchase program, as well as continuing to invest in our properties and explore prudent growth opportunities."

(https://www.prnewswire.com/news-releases/mgm-resorts-international-announces-new-2-0-billion-share-repurchase-program-300646214.html)

Do share buybacks create shareholder value? Explain your answer from a residual operating earnings (ReOI) perspective.

Answer 1

Solution:

Buyback of shares means the shares of the company which is issued in the market are purchased by the company. The buyback happens when the company has excess cash and reserve. Due to buyback the number of shares of the company issued in market are reduced. It will help to increase the shareholders’ value and wealth.

In the instant case MGM wants to buy back the share of the company. The CEO of the company announced that the strong balance sheet of the company allowed them to buy back the shares as well as it will also help to increase the shareholders’ value due to quarterly dividend and investment opportunities of the company. As a result of buy back the total number of shares of the company will reduces which will help to increase the earnings per share. The increase in earnings per shares also help to increase the market price of the share as well as wealth of the shareholders. The residual income will distribute among the less number of shares which will helps to increase the earnings of the shareholders. Also the debt-equity ratio and the financial leverage get changed due to buy back of the share by the company.

References:

Admati, A. R., DeMarzo, P. M., Hellwig, M. F., & Pfleiderer, P. (2018). The leverage ratchet effect. The Journal of Finance, 73(1), 145-198.

Zhang, Y., Donohue, K., & Cui, T. H. (2015). Contract preferences and performance for the loss-averse supplier: Buyback vs. revenue sharing. Management Science, 62(6), 1734-1754.