Why Companies Buy Back Shares

There is a term in the professional investing world called the buyback. This occurs when a company purchases shares of its own stock. The reasons why companies buy back shares vary depending on circumstances. Basically, a buyback occurs when a company wants to reduce the number of available shares. The reason for this is to potentially increase share value or to eliminate takeover threats from those who may be close to a controlling number of shares. The company is investing in itself. There are two main ways this can take place.

Investors who hold shares of the stock may be approached and made an offer for their shares. They can relinquish some or all of the shares they hold within a deadline to receive more than the market price for them. The company can even offer buyback incentives to employees who own shares of stock. The extra money is compensation from the company to entice the shareholders to give up their shares instead of keeping them. The other way buybacks take place is when the company purchases shares on the stock market, usually over an extended duration.

So in basic terms, the reasons why companies buy back shares are either to avoid a takeover or increase stock value. For example, a company may be generating a decent amount of cash without needing to spend capital. This is something that takeover artists look for when seeking a company to seize. To prevent such a takeover, the company may get rid of cash by buying its own stock, which does double duty by raising the price of shares. If there were to be a takeover attempt at that point it would cost a lot more.

As mentioned previously, there are two primary ways a company can buy back its own stock shares. However under United States corporate law there are actually five methods. The first two are those already mentioned, open market purchases and privately negotiated purchases. The other three types are the repurchase of put rights, fixed price tender offers and Dutch auctions. In the past two decades, the amount of shares repurchased by companies has risen by hundreds of billions of dollars.

Now that you know why companies buy back shares, you may wonder who makes the decision to do so. Because this is an intricate financial matter that can make or break a company, the decision is not made by one person alone. In-depth financial analysis and board meetings usually take place before buybacks are ordered. For whatever reason, the procedure of company share buybacks is a corporate financial maneuver used by more and more companies these days.

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