This lesson examines share repurchases as an alternative mechanism for returning capital to shareholders. It covers the mechanics, advantages, signalling effects, and comparative use of buybacks versus dividends .

• Definition and Mechanics: A share repurchase is when a company buys its own shares from the market. Share repurchases, or buybacks, most often occur in the open market. Alternatively, tender offers occur at a fixed price or at a price range through a Dutch auction .

• Advantages of Share Repurchases over Dividends:

  • Flexibility: Share repurchases usually offer company management more flexibility than cash dividends by not establishing the expectation that a particular level of cash distribution will be maintained .

  • Signalling: Repurchases can signal that company officials think their shares are undervalued .

  • Tax Efficiency: In many jurisdictions, capital gains may be taxed at lower rates than dividends.

  • No Commitment: Unlike dividends, repurchases do not create an expectation of ongoing payments.

• Earnings Per Share (EPS) Effects: Share repurchases made with excess cash have the potential to increase earnings per share, whereas share repurchases made with borrowed funds can increase, decrease, or not affect earnings per share depending on the company’s after-tax borrowing rate and earnings yield . If the buyback market price per share is greater (less) than the book value per share, then the book value per share will decrease (increase) .

• Signalling Effects: On the one hand, share repurchases can signal that company officials think their shares are undervalued. On the other hand, share repurchases could send a negative signal that the company has few positive NPV opportunities .

• Share Repurchases as a Supplement to Dividends: Companies can pay regular cash dividends supplemented by share repurchases. In years of extraordinary increases in earnings, share repurchases can substitute for special cash dividends .

• Comparative Use of Dividends and Share Repurchases: The relative use of dividends and share repurchases varies across countries. For example, in Germany, dividend restrictions are predominantly mandated, while in the UK, mandated restrictions are supplemented by debt covenants. In the US, dividend restrictions follow primarily from debt contracting . Empirical evidence suggests that US firms distribute more cash via share repurchases than dividends, while European firms are more committed to stable dividend policies .