Dividend Decisions^339
shareholders by repurchasing its own shares. Assuming that the repurchase does not
adversely affect the firm's earnings, the earnings per share on the remaining shares will
increase, resulting in a higher market price per share, which means that the capital
gains will have been substituted for dividends.
A repurchase that is part of capital restructuring is different from a regular repurchase
mentioned above. In a capital restructuring repurchase plan asset sales and issuance of
debt are used to bring in additional capital and then this capital is distributed to shareholders
through a major, one-time share repurchase.
Disadvantages/ Advantages of Share Repurchases
- Repurchase announcements are viewed as positive signals by investors because
the repurchase is often motivated by management's belief that the firm's shares
are undervalued. - The shareholders have a choice to sell or not to sell in share repurchase situation.
So those who prefer capital appreciation can get the same and those who prefer
cash can sell the shares. - Repurchase can help reduce the supply of shares in the market, thereby increasing
the value of the share. - Management dislikes increasing cash dividend as it sends positive signals about
future profitability and if the company cannot maintain the same in the future it
may result in a sharp fall in the share price. Therefore, if the earnings increase is
only temporary then the management may prefer to make the distribution in the
form of a share repurchase. - It can help in drastically changing the capital structure of the company, which is
otherwise very difficult.
There are certain disadvantages too:
- The shareholder may benefit more from cash dividends than share repurchase if
the market discounts the earnings more than a given level. - The selling shareholder may lose because of the share repurchase plan as he
would get the long term benefit of share repurchase. - The company may pay too high a price for share repurchase, resulting in a reduction
in value for existing shareholders.
All this means that share repurchases on a systematic, dependable basis is probably not
a good idea. However, it can be given careful consideration if the market is not discounting
the share in a proper manner and the company has extra cash that it can utilise for the
same. Repurchases can be especially valuable to a firm that wants to make a large
shift in its capital structure within a short period of time.