Share Repurchase: To Buy or Not to Buy.

• Author: Swaminathan G. Badrinath
• Position: Statistical Data Included

Thinking share repurchase? Don't assume you need only buy back some stock, sit back and wait for your EPS numbers to jump off the charts.

In March 2000, The Wall Street Journal proclaimed: "Now stock buybacks have suddenly gotten even more popular. But to the frustration of corporate treasurers, many of the stocks aren't enjoying the expected price pops, despite the presumption that that is what a buyback would do."

Indeed, in nearly every year since 1994, stock buybacks have leap-frogged corporate stock issues by ever-increasing amounts. In fact, the $50 billion of buybacks set in motion in the early part of 2000 was the biggest burst of share-repurchase activity since late 1998. What's more, the total number of shares repurchased in the last six years has far outstripped the total number of new shares issued (see the chart on page 44).

What's behind this growing surge of buybacks? And why aren't they always the adrenaline shot in the arm that companies expected them to be? In March 1999, an electronic poll of 155 FEI members was con ducted during a teleconference on share repurchases that was moderated by FEI President Philip B. Livingston. These are among the key findings:

1) Thirty-nine percent of the respondents instituted a share repurchase program in order to improve their earnings per share numbers.

2) Twenty-eight percent said their companies were using buybacks as a way to distribute excess cash to shareholders.

3) Twenty-one percent reported that their companies were trying to reduce the cost of employee stock option plans.

4) Twelve percent noted that adjusting capital structure was the main reason for their stock buybacks.

To delve further into the tremendous popularity of stock buybacks, Financial Executives Research Foundation commissioned a research project to study the subject. The mission: to determine the long-term effects of stock buyback programs on a company's stock price and to assess which companies benefit most from these programs. The analysis of results and implications of 200 firms that announced, conducted and completed share purchase programs from 1991 to 1996 are published in the study, The Share Repurchase Decision: Causes, Consequences and Implementation Guidelines.

The research focused on what was defined as "completed repurchase plans," one in which the firm announced and later repurchased at least 50 percent of the shares authorized for the program. Completed plans were the focus since many firms announce buyback programs but actually repurchase very little stock; thus, completing a repurchase signals the level of commitment that the underlying firm has to the repurchase program.

Why repurchase shares?

The five most commonly cited reasons to set up a share repurchase program are:

1. To increase share price. This is often a strategy that management adopts when it believes the company's stock is undervalued by market analysts.

2. To rationalize the company's capital structure. In this case, a share repurchase program allows the company to sustain a higher debt-equity ratio.

3. To substitute share repurchases for cash dividend payouts. Since capital gains may be taxed at lower rates than dividend income, a share repurchase program...