On 10 May 2010 1:22:53 AM Pradeep Kumar answered :

Companies list their shares and undergo a huge compliance cost so that the intrinsic worth of their capital is realised by way of price earning multiple that the market gives. Companies indulge in buyback of securities when they perceive that the valuations given by the market are not correct and the share is quoting much below its intrinsic worth. In such circumstances, a buyback decision is taken after balancing the cost of compliance (due to delisting) versus the perceived depreciation in valuations. This is the economic justification for buyback. Such buybacks happened in the case of several multinational companies when the stock markets were down and the true worth of the company’s shares did not get reflected in its share prices.

Buyback is also legally mandated in cases of a company’s public share holding going below 20%. The company comes in the delisting zone and unless exit is given to all the shareholders, delisting is not permitted. Such exercises can be expensive for the company as some shareholders may choose to continue to hold the shares and the delisting exercise may fail. This entails a huge cost due to fees charged by merchant bankers, lawyers and the logistics in running a reverse book building exercise.

However, it is not always legal compulsion or economic motive that induces companies to introduce buyback. A leading electronics company which came with one of the first buybacks agreed to buyback just 2% of its shares at a price much above the prevailing share price. This buyback price became a sort of benchmark for the true company valuations and the markets drove the prices to that level. Hence, the intention of this buyback was more to influence the price movement to a desired level rather than to buy back the stock as only 2% of the share capital was the targeted purchase.

There are examples of companies announcing buyback of shares and not purchasing a single share. This proves beyond doubt that the company is declaring that this is the

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