A treasury stock or reacquired stock is stock which is bought back by the issuing company, reducing the amount of outstanding stock on the open market ("open market" including insiders' holdings). Stock repurchases are often used as a tax-efficient method to put cash into shareholders' hands, rather than pay dividends. Sometimes, companies do this when they feel that their stock is undervalued on the open market. Other times, companies do this to provide a "bonus" to incentive compensation plans for employees. Rather than receive cash, recipients receive an asset that might appreciate in value faster than cash saved in a bank account. Another motive for stock repurchase is to protect the company against a takeover threat. The United Kingdom equivalent of treasury stock as used in the United States is treasury share. Treasury stocks in the UK refers to government bonds or gilts.
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Limitations of Treasury Stock
- Treasury stock does not pay a dividend
- Treasury stock has no voting rights
- Total treasury stock can not exceed the maximum proportion of total capitalization specified by law in the relevant country
Buying Back Shares
Benefits
If efficient market theory is correct, a company buying back its stock should have no effect at all on its stock price. If the market fairly prices a company's shares at $50/share, if a company buys back 100 shares for $5000, it now has $5000 less cash but there are 100 fewer shares outstanding; the net effect should be that the value per share is unchanged. However, buying back shares does improve certain per-share ratios, such as price/earnings (earnings per share is increased due to fewer shares outstanding), but that is only because valuing a company's shares according to those ratios is not accurate when a company is holding a lot of cash. If a company's shares are underpriced, then a company can benefit its other shareholders by buying back shares. If a company's shares are overpriced, then a company is actually hurting its remaining shareholders by buying back stock.
Incentives
One other reason for a company to buy back its own stock is to reward holders of stock options. Option holders are hurt by dividend payments, since, typically, they are not eligible to receive them. A share buyback program may increase the value of remaining shares (if the buyback is executed when shares are underpriced); if so, option holders benefit. A dividend payment short term always decreases the value of shares after the payment, so, on the day shares go ex-dividend, option holders always lose. Finally, if the sellers into a corporate buyback are actually the option holders themselves, they may directly benefit from temporarily unrealistically favorable pricing.
After Buyback
The company can either retire the shares (however, retired shares are not listed as treasury stock on the company's financial statements) or hold the shares for later resale. Buying back stocks reduces the number of outstanding shares. To see this, note that accompanying the decrease in the number of shares outstanding is a reduction in company assets, in particular, cash assets, which are used to buy back shares.
Accounting for Treasury Stock
On the balance sheet, treasury stock is listed under shareholder equity as a negative number. One way of accounting for treasury stock is with the cost method. In this method, the paid-in capital account is reduced in the balance sheet when the treasury stock is bought. When the treasury stock is sold back on the open market, the paid-in capital is either debited or credited if it is sold for more or less than the initial cost respectively. Another common way for accounting for treasury stock is the par value method. In the par value method, when the stock is purchased back from the market the books will reflect the action as a retirement of the shares. Therefore, common stock is debited and treasury stock is credited. However, when the treasury stock is resold back to the market the entry in the books will be the same as the cost method. In either method, any transaction involving treasury stock cannot increase the amount of retained earnings. If the treasury stock is sold for more than cost, then the paid-in capital treasury stock is the account that is increased not retained earnings. In auditing financial statements, there is a common practice to check for this error to detect possible attempts to "cook the books".
United States Regulations
In the United States, buybacks are covered by multiple laws. According to Rule 10b-18:
- One Broker-Dealer per Day: The company repurchasing shares may not use more than one broker and/or dealer to acquire the shares per each day.
- Timing of Purchase: A repurchase may not be the first trade of the day. Repurchases may not be made in the last ten minutes of the trading day. These rules do not apply to over-the-counter securities.
- Purchase Price: A repurchase may not be bid at a price higher than the highest independent bid or last price of the last trade.
- Volume: Repurchases per day may not exceed 25% of the average daily volume of the previous 4 calendar weeks. Block purchases not effected by a broker-dealer are excluded from this restriction.
United Kingdom Regulations
In the UK, the Companies Act of 1955 disallowed companies from holding their own shares. However, the Companies Act of 1993 later repealed this.
See also
External links
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| Types of stocks | Stock · Common stock · Preferred stock · Outstanding stock · Treasury stock |
| Participants | Market maker · Floor trader · Floor broker |
| Exchanges | Stock exchange · List of stock exchanges |
| Stock valuation | Gordon model · Dividend yield · Income per share · Book value · Earnings yield · Beta coefficient |
| Financial ratios | P/CF ratio · PE ratio · PEG ratio · Price/sales ratio · P/B ratio · D/E ratio · ROIC · ROE |
| Trading theories | Dow Theory · Elliott Wave Theory · Fundamental analysis · Technical analysis · Mark Twain effect · January effect · Efficient market hypothesis · Arbitrage pricing theory |
| Related terms | Dividend · Stock split · Growth stock · Investment · Speculation · Trade · Day trading · Stock trader/investor |
