1. Enhanced dividends and E.P.S.
Following a stock repurchase, the number of shares issued would decrease and therefore in normal circumstances both D.P.S. and E.P.S. would increase in future. However, the increase in E.P.S is a bookkeeping increase since total earnings remaining constant.
2. Enhanced Share Price
Companies that undertake share repurchase, experience an increase in market price of the shares. This is partly explained by increase in total earnings having less and/or market signal effect that shares are under value.
3. Capital structure
A company’s managers may use a share buy back or requirements, as a means of correcting what they perceive to be an unbalanced capital structure.
If shares are repurchased from cash reserves, equity would be reduced and gearing increased (assuming debt exists in the capital structure).
Alternatively a company may raise debt to finance a repurchase. Replacing equity with debt can reduce overall cost of capital due to tax advantage of debt.
4. Employee incentive schemes
Instead of cancelling all shares repurchase, a firm can retain some of the shares for employees share option or profit sharing schemes.
5 Reduced take over threat
A share repurchase reduced number of share in operation and also number of ‘weak shareholders’ i.e shareholders with no strong loyalty to company since repurchase would induce them to sell.
This helps to reduce threat of a hostile takeover as it makes it difficult for predator company to gain control. (This is referred as a poison pill) i.e. Co.’s value is reduced because of high repurchase price, huge cash outflow or borrowing huge long term debt to increase gearing
Disadvantages of stock repurchase
1. High price
A company may find it difficult to repurchase shares at their current value and price paid may be too high to the detriment of remaining shareholders.
2. Market Signaling
Despite director’s effort at trying to convince markets otherwise, a share repurchase may be interpreted as a signal suggesting that the company lacks suitable investment opportunities. This may be interpreted as a sign of management failure.
3. Loss of investment income
The interest that could have been earned from investment of surplus cash is lost.