Share Repurchase Methods

Share repurchase is one of the two methods that can be employed by a company in the distribution of cash to its shareholders. Dividend payment is the other method.

In a share repurchase or buyback, a company buys back its own shares from shareholders using corporate cash. These shares, which were previously issued and have now been repurchased, are known as treasury shares or stock, and can no longer be considered for future dividend payments or computing earnings per share.

There are four primary ways through which a company can repurchase its shares: (i) buying in the open market, (ii), buying back a fixed number of shares at a fixed price i.e. a fixed price tender offer, (iii) via a dutch auction, and (iv) repurchasing by direct negotiation.

Open Market Share Repurchases

When a company buys its shares in the open market, it has no legal obligation to complete the repurchase program. This is the most popular method for share repurchase due to the fact that of the four methods, it affords the company the highest level of flexibility. Besides, the method can be very cost-effective if the timing of the share repurchase minimizes price impact while taking advantage of share price undervaluation.

Fixed Price Tender Offer

Using this method, a company makes a tender offer to repurchase a specified number of its shares at a fixed price that is, in most cases, at a premium to the current market price. In instances where the number of shares being sought by a company is less than the number of shares that shareholders are willing to sell, the company may choose to buy back shares on a pro rata basis.

Fixing the date of the offer can allow a company to complete the repurchase program in a relatively short period of time.

Dutch Auction

In a dutch auction, a company stipulates a range of prices which it will accept from shareholders for its tender offer. Unlike in a fixed price tender offer, the company does not specify a fixed price for a specific number of shares.

A dutch auction allows a company to identify a minimum price at which it can repurchase the desired number of shares from its shareholders. It then pays this price to all qualified bidders.

If done correctly, a dutch auction can be completed in a relatively short period of time.

Repurchase by Direct Negotiation

Under this method, a company enters into negotiations with a major shareholder for the repurchase of its shares, usually at a premium to the market price. This arrangement cushions prices in the market from the negative impact occasioned by the sale of a large block of a company’s shares.

Question

Which of the following methods for effecting share repurchases offers a company the highest level of flexibility?

A. Open market share repurchases

B. Fixed price tender offer

C. Direct negotiation

Solution

The correct answer is A.

Companies enjoy the highest level of flexibility when they use open market share repurchases.

Reading 38 LOS 38c:

Compare share repurchase methods