How might various providers of capital (shareholders and creditors) react if Gainesboro repurchased its shares? Should Gainesboro do so?
Repurchasing shares or share buyback:
– Open market repurchases (buy over time as
– Tender offer (buy shares at a precise date)
– Targeted repurchase (buy from major shareholder
There are ways for shareholders to receive cash without being paid dividends. A firm can buy back some of its shares with the advantage being that most investors are not taxed as heavily on shares sold as they are on dividends received.(The Dividend Puzzle)
Any increase in the dividend that is not financed by external financing will hurt creditors. Any money that is payed out in dividends is lost to the creditors if trouble develops.
Repurchases are an efficient way to reduce agency costs of free cash flow, like dividends, but repurchases increase the debt-equity ratio with possible debt overhang costs.
Shareholders would benefit from share repurchases as they would pay lower tax on the capital gain then they would on a dividend income payment. They could potentially find themselves to be better off with a repurchase. Shareholders would view a repurchase as positive as if the market reacts positively to announcements of dividend increases then it should also do for repurchases. Share prices traditionally rise by 3 % when firms announce open-market share repurchases.
Buybacks can also signal to shareholders that the firm is underpriced; however Gainesboro could also be buying back shares from particular shareholders in order to distribute cash to insiders before revealing bad news to the market. So Gainesboro must be careful in the way it undertakes the buyback if it wants to portray positive news to shareholders.
Share repurchase may also have an effect on ownership structure of the firm; this changes control and agency conditions, with an effect on value also possible.
Please join StudyMode to read the full document