From time to time you read about companies reducing their capital by repurchasing a part of the stock circulating from their own shareholders. Now this might sound a moronic question, but: What would happened if a company managed to repurchase each and every share that has ever been emitted? Who would be owner of the corporation?
Repurchased shares add equity to existing shares. Say 10 shares exist, and the company buys five of them back. The other five shares now represent the entire value of the company; the bought-back shares are effectively taken out of existence. Continue until only one share is left – someone owns the entire company. Can’t have less than one share.
It’s called privatization - typically, a family-owned (or closely held) company listed, did well, and the original owners think they can do better without the extra shareholders, so they buy it back. It happens. The owners are the people left with the remaining shares. Obviously, it’s de-listed from the stock market afterwards.
Often, companies buy back some shares to increase shareholder value. IE, they put profit into purchasing their own stock, and the shareholders who hang in are richer as a result. This is an alternative to reinvesting in the business or using the capital to take over a rival/new business.
Do shares repurchased by a company necessily cease to exist? I’ve read about cases where company execs or board felt the shares were undervalued on the market and bought them as both an investment and a demonstration of faith in the company’s future. In these cases, the shares were treated like any other company investment. They didn’t decrease the number of shares outstanding and they didn’t directly increase other shareholders’ equity. The company simply bought the shares and held them until they felt the market better represented their value, then they cashed in or used them to fund an employee option program. I could be wrong, but that was my understanding of at least a couple of the buy-backs I’ve read about.
From my understanding, a companies Assets = Liabilities + Shareholders Equity. What essentially happens is that the company credits (decreases) their Cash account (an Asset) and makes a corresponding debit (decrease) to their Common Stock account (a Shareholders Equity).
Basically, in laymans terms, the company is worth less on paper however it is spread among fewer shares of stock.
Now what may have happened in your example is that the execs or the board bought the shares as an INVESTOR, not as an agent of the company. Basically, showing people “hey! I’m so confident that I am willing to purchase the stock myself!” It’s like if you, as an employee of a company decide to buy some of it’s stock. That’s not considered a buyback.
There’s actually a semi good reason to repurchase shares…
TAXES.
See, the company is worth $100, and there are 100 shares, each share is worth a dollar.
Now, lets say the company makes $50 this year.
It could distribute the $50 as a dividend.
Or, it could buy 50 shares.
If you get 50 shares as a dividend, it’s 100% taxable.
If they buy 50 shares and each share is worth $2, it’s taxable as a capital gain (less).
A similar thing is done in Bond funds. Like the permanent portfolio fund, run by Terry Coxton.
First, there are several rules around a company repurchasing their own shares.
Second, a company does not necessarily have to cancel the shares they repurchase. They are listed as “Treasury Shares”. However as mentionned, there are very strict rules around Treasury Shares.
Third, a company must make a public announcement regarding the repurchase of shares (see this example). Repurchases are done for a variety of reasons - to bolster the share price (previous example), to privatize the company (example) or as an investment (i.e Treasury Shares).
Fourth, as msmith537 pointed out, executives of (floundering) companies annouce purchases as signaling confidence in the future prospects of an organization. Note that these would have to be disclosed anyways due to inside information regulations.