FIN 614: Financial Management
Larry Schrenk, Instructor
1. What are Stock Repurchases?
2. Repurchases versus Dividends
3. Advantage and Disadvantages of Stock
Repurchases
Repurchases: Firm buying own stock back
from stockholders.
Firm announces intent to repurchase stock.
Three ways to purchase:
Have broker purchase on open market over time.
Make a tender offer to shareholders.
Make a block (targeted) repurchase.
Firm doesn’t have to complete its announced
intent to repurchase.
Note that stock price drops by dividend
per share in model.
If it didn’t there would be arbitrage
opportunity (assuming no taxes).
In real world, stock price drops on
average by about 90% of dividend.
Announcement of a repurchase might send a
signal that affects stock price, but the actual
repurchase has no impact on stock price:
If investors thought that the repurchase would
increase the stock price, they would all purchase
stock the day before, which would drive up its
price.
If investors thought that the repurchase would
decrease the stock price, they would all sell short
the stock the day before, which would drive down
the stock price.
Consider a firm that wishes to distribute $100,000 to its
shareholders.
Assets
Liabilities & Equity
A. Original balance sheet
Cash
$150,000
Other Assets
850,000
Value of Firm
1,000,000
Debt
0
Equity
1,000,000
Value of Firm
1,000,000
Shares outstanding = 100,000
Price per share = $1,000,000 /100,000 = $10
If they distribute the $100,000 as a cash dividend, the
balance sheet will look like this:
Assets
Liabilities & Equity
B. After $1 per share cash dividend
Cash
$50,000
Debt
Other Assets
850,000
Equity
900,000
Value of Firm
900,000
Value of Firm
900,000
Shares outstanding = 100,000
Price per share = $900,000/1 00,000 = $9
0
If they distribute the $100,000 through a stock
repurchase, the balance sheet will look like this:
Assets
Li abilities & Equity
C. After stock repurchase
Cash
$50,000
Debt
0
Other Assets
850,000
Equity
900,000
Value of Firm
900,000
Value of Firm
900,000
Shares outstanding = 90,000
Price per share =
$900,000 / 90,000 = $10
Tax break for investors
Unwillingness to cut dividends
Price pop after a repurchase
As an alternative to distributing cash as
dividends
To dispose of one-time cash from an asset
sale
To make a large capital structure change
To use when employees exercise stock
options
Stockholders can choose to sell or not
Avoids a high dividend that cannot be
maintained
Income received is capital gains rather
than higher-taxed dividends
Stockholders may take as a positive
signal that stock is undervalued
May be viewed as a negative signal
(firm has poor investment opportunities)
IRS could impose penalties if
repurchases were primarily to avoid
taxes on dividends
Repurchase
Stock price doesn’t fall at time of
repurchase
Number of shares falls
Dividends
Stock price falls by amount of dividend at
time of payment
Number of shares doesn’t change
FIN 614: Financial Management
Larry Schrenk, Instructor