A treasury stock or reacquired stock is stock which is also bought back by the
issuing company, reducing the amount of outstanding stock on the open market.
Stock repurchases are used as a tax efficient method to put cash into
shareholders' hands, rather than paying dividends, in jurisdictions that treat
capital gains more favorably. Sometimes, companies do it when they feel that
their stock is undervalued on the open market. Other times, companies do it to
reduce dilution from incentive compensation plans for employees.
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.
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 When shares are repurchased, they may
either be canceled or held for reissue. If not canceled, such shares are
referred to as treasury shares. Technically, a repurchased share is a
company's own share that has been bought back after having been issued and fully
paid. A company cannot own itself. The
possession of treasury shares does not give the company the right to vote, to
exercise preemptive rights as a shareholder, to receive cash dividends,
or to receive assets on company liquidation. Treasury shares are
essentially the same as unissued capital and no one advocates classifying
unissued share capital as an asset on the balance sheet, as an asset should
have probable future economic benefits. Treasury shares simply reduce ordinary
share capital. Buying back shares
= Benefits= In an efficient market, a company buying
back its stock should have no effect on its price per share valuation. If the
market fairly prices a company's shares at $50/share, and the company buys back
100 shares for $5,000, it now has $5,000 less cash but there are 100 fewer shares
outstanding; the net effect should be that the underlying value of each share
is unchanged. Additionally, buying back shares will improve price/earnings
ratios due to the reduced number of shares(and unchanged earnings) and
improve earnings per share ratios due to fewer shares outstanding.
If the market is not efficient, the company's shares may be underpriced. In
that case 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. Call 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 so, call option holders benefit. A dividend payment short term
always decreases the value of shares after the payment, so, for stocks with
regularly scheduled dividends, on the day shares go ex-dividend, call option
holders always lose whereas put option holders benefit. This does not apply to
unscheduled dividends since the strike prices of options are typically adjusted
to reflect the amount of the special dividend. Finally, if the sellers into a
corporate buyback are actually the call option holders themselves, they may
directly benefit from temporary unrealistically favorable pricing.
= After buyback= The company can either retire the shares
or hold the shares for later resale. Buying back stock reduces the number of
outstanding shares. 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 shareholders' equity as a
negative number. The accounts may be called "Treasury stock" or "equity
reduction". 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, it 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 under the auspices of the Securities and Exchange
Commission. United Kingdom regulations
In the UK, the Companies Act 1955 disallowed companies from holding their
own shares. However, the Companies Act 1993 later repealed this.
See also