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Earlier in this module under the purposes of corporate actions, we read about buybacks impacting the price of the shares. Let us discuss the concept of buyback in this unit and also reasons for buyback in the subsequent unit of this module.
What do you mean by Buyback of shares?
Buybacks are a method through which a company buys its own stock from investors. A buyback reduces the company’s cash holdings (assets) as well as the total number of outstanding shares.
Buybacks are normally done at a premium to the prevailing market price and thus rewards the shareholders. This also induces other investors to enter into the stock to take advantage of the arbitrage opportunity available and thus drives up the stock price.
Also, buybacks are perceived as a positive development since it reflects the renewed conviction of the promoter in the business. The stock purchased by the company is extinguished after successful completion of the buyback, thus reducing the equity base of the company. The promoter holding is expected to go up (generally, promoters do not participate) as they effectively own a larger percentage of the total outstanding equity shares of the company. Also, promoters now have a greater say in the decision-making of the company (more voting rights).
The company has to disclose the pre and post-buyback holdings of the promoters. To ensure completion of the buyback process speedily, the regulations have a stipulated time limit for each step.
For example, in the case of purchases through stock exchanges, a buyback offer should not remain open for more than 30 days. The verification of shares received in buyback has to be completed within 15 days of the closure of the offer. The payments for accepted securities have to be made within 7 days of the completion of verification and bought back shares have to be extinguished within 7 days of the date of the payment.
Method of buyback of shares
1. It can be done on a proportionate basis by the existing shareholder through the offer.
2. Buyback of shares can also be done in the open market through stock exchange via book building process.
SEBI guidelines on buyback of shares
SEBI’s guidelines on buyback of shares are as follows: -
1. The pre and post shareholding by the promoters needs to be disclosed by the company.
2. The company is not allowed to issue the same class of shares for the upcoming year post buyback.
3. The shares bought back have to be reduced from the number of outstanding shares of the company within seven working days.
Under the SEBI Buyback of Securities Regulation 1998, a company is permitted to buy back its shares from:
1. Existing shareholders on a proportionate basis through the offer document
2. Open market through stock exchanges using the book building process
3. Shareholders holding odd lot shares
Impact of buyback of shares
1. The number of shares outstanding goes down due to the buyback of shares.
2. Buyback leads to an increase in earnings per share (EPS). As it reduces the company’s outstanding shares, the impact is clearly evident in per-share measures of cash flow and profitability.
3. It also leads to an increase in the company’s stock price. Generally, the buyback is looked upon as a sign of increased confidence in business prospects from the promoters.