When a company acquires and holds its own treasury stock (shares of their own stock), it is called treasury stock or reacquired stock. Buying treasury stock is an attractive option for companies because it allows them to reduce their share count, which can benefit shareholders in several ways. It can also be a way for companies to reinvest in themselves and provide a valuable source of capital for investment or other uses. Companies can buy back their own shares in the open market, or from existing shareholders. Here are some of the reasons why a company might purchase treasury stock.
Short-Term Benefits
A company’s chief financial officer and other senior leadership may choose to buy back their own stock if it will quickly increase their share price. Because the company is reducing its share count, the price of the remaining shares is naturally higher, as there is less stock available to trade. This is also known as “share buyback.” Many companies do this when their stock price is undervalued. Reducing the number of shares can also provide a short-term boost to a company’s earnings-per-share (EPS) ratio, since there will be fewer overall shares when calculating earnings. If the company is trying to show a record of profitability to shareholders or analysts, a stock buyback can be used to achieve this goal.
Long-Term Benefits
Treasury stock can also be used for long-term strategic purposes. Companies buy back their own stock for many reasons, but one of the most common is to raise capital for strategic investments. By reducing the number of shares outstanding, a company can increase its market capitalization, which may help attract investors or provide other benefits. Additionally, if the company’s stock price is undervalued, they can buy back their own shares while they are temporarily cheap. This allows the company to gain more shares and increase the value of their stock, provided the market is right.
Risks Involved
Buying treasury stock is not without its risks. Since the company is essentially taking its own shares out of circulation, the shares may become rare or difficult to find on the open market, thus driving up the prices of any remaining shares. In this scenario, the company can end up buying back its own stock at higher prices than normal. Furthermore, buying back share can be expensive. Companies need to be careful that they don’t spend too much of their money on treasury stock instead of investing in other areas of the business.
When a company purchases treasury stock, the implications for shareholders can vary. For example, some shareholders may be able to benefit from the increased share price. This is especially true if the company is buying back shares at a lower price than they are currently trading on the open market. Alternatively, some shareholders may feel that the company is not using their money as effectively as it should be, as the company is using it to buy back their own shares rather than investing in other activities or projects.
Regulations and Guidelines
The purchase of treasury stock is subject to certain rules and regulations. Companies must comply with any laws and regulations related to their particular jurisdiction when it comes to purchasing treasury stock. The company must also provide timely and accurate disclosure of all relevant information to shareholders and other interested parties, as required by law. Additionally, all purchases must be made in a manner that is consistent with the company’s stated investment policies and procedures.
Authority of Board of Directors
In most cases, the board of directors has the ultimate authority to determine when and how much treasury stock should be purchased. The board is typically responsible for setting the company’s investment policies, which may include guidelines regarding the purchase of treasury stock. The board may also establish an oversight committee to ensure that purchases of treasury stock are consistent with the company’s policies.
Other Considerations
When considering the purchase of treasury stock, companies should also consider the impact on other shareholders. Companies must take into account the potential for dilution of the voting rights and ownership of existing shareholders if the company buys back a large number of its own shares. Additionally, the company should assess the impact of the purchase on dividends and the potential for these to be reduced as a result of the buyback.
Tax Implications
Companies should also be aware of the potential tax implications of the purchase of treasury stock. Depending on the jurisdiction, companies may be subject to capital gains taxes on the purchase, as well as withholding taxes on dividend payments to shareholders. Companies should consult with their tax advisors and financial advisors to ensure they are in compliance with all applicable laws and regulations.
Improved Corporate Governance
The purchase of treasury stock can also be used as a way to improve corporate governance. Companies may purchase their own shares to increase shareholder control, or to meet the requirements of certain corporate governance policies. Additionally, the reduction in the overall number of shares can help to reduce the influence of outside and non-controlling shareholders on the management of the company.
Investment Motives
Finally, companies may decide to purchase treasury stock for investment motives as well. Companies may use their purchased shares to hedge against stock prices, or to increase their stake in the company if they deem it to be undervalued. Companies may also supplement their cash holdings by investing in their own stock if the market conditions are conducive for the purchase.
