When a corporation buys back stock, it reacquires outstanding shares currently traded on the open market. These shares are known as the float. Common motives are to boost the stock price and shareholder value, optimize excess cash usage and obtain internal control of shares.
Stock Price Appreciation and Shareholder Value
A primary motive for a stock buyback is to boost the share place and subsequently to strengthen shareholder value. Though some criticize buybacks as being negative to the economy, this motive aligns with a core business objective of many for-profit corporations, which is maximizing shareholder value.
When a business buys back a quantity of shares, it reduces the amount traded in the open market. Applying basic economic supply and demand principles, the fewer shares owned by the public in a business, the more each share is worth. Over time, this principle plays out as investors fight over the lower quantity of public shares available. As company directors, executives and employees often are major shareholders, they have a personal stake in boosting the share price as well.
Corporations sometimes use buybacks as a way to provide for or balance out stock option compensation given to high-level employees.
Optimized Cash Usage
A stock buyback normally occurs when a company has an excess cash position. This financial strategy is selected over others, such as paying dividends or investing in growth. As with dividends, shareholders can receive a tax break when reporting capital gains connected to a buyback. When a corporation doesn't have plans to utilize its strong cash position anytime soon, a maneuver such as a buyback essentially reverses the process of issuing shares to acquire cash. Sometimes companies issue more shares than necessary to ensure enough capital, and then reacquire the excess later on.
Internal Stock Flexibility
Reacquired shares are recognized as treasury stock after the buyback. The business has two basic options on how to use treasury stock. One option is to hold the shares and either resell them to raise capital or distribute them as incentive pay to company insiders. The other is to retire the stock pending a board of directors vote, thus reducing the number of outstanding shares.