Headline : What is share buyback?
Why in news?
- With prominent companies such as Infosys, TCS and L&T having gone for a share buyback, here is a low-down on the mechanism and the reasons for firms taking such a step.
What is a buyback?
- A buyback is a mechanism through which a listed company buys back shares from the market.
- A buyback can be done either through open market purchases or through the tender offer route.
- Under the open market mechanism, the company buys back the shares from the secondary market while under tender offer, shareholders can tender their shares during the buyback offer.
- Historically, most companies had preferred the open market route.
Why does a firm go in for a buyback?
- Buybacks are typically done when a company has a significant cash reserve and feels that the shares are not fairly valued at the current market price.
- Since the shares that are bought back are extinguished, the stake of the remaining shareholders rise.
- Promoters also use this mechanism to tighten their grip on the firm.
What are the benefits?
- Since the bought back shares are extinguished, the earnings per share (EPS) rise by default.
- Also, since a buyback is usually done at a price higher than the then prevailing market price, shareholders get an attractive exit option, especially when the shares are thinly traded.
- It is also more tax-efficient than dividends as a way to reward shareholders.
How can a company execute a buyback?
- A company can use a maximum of 25% of the aggregate of its free reserves and paid-up capital for a buyback. A special resolution needs to be passed at a general meeting.
- However, if the company plans to use less than 10% of its reserves then only a board resolution is required.
Can a firm opt for regular buybacks to boost EPS?
- A company cannot do a second buyback offer within one year from the date of the closure of the last buyback.
- Also, there are time-bound limitations on further share issuances like preferential allotment or bonus issue post a buyback.
- These checks have been put in place so that companies do not misuse the buyback mechanism.
Do retail investors get a reservation in buy back?
- The Securities and Exchange Board of India (SEBI) has recently revised the buy back regulations that stipulate 15% reservation for retail shareholders in a buy back offer.
- This gives retail investors a fair share in the offer, which otherwise could see large institutional investors tendering their shares leaving little or no room for small investors.