Repurchase of stock refers to the buyback by the firm of outstanding shares of its common stock in the market place. There may be several motives for a stock repurchases. Some of the motives may be to obtain shares to be used in acquisitions, to have shares available for employee stock option plans, to achieve gain in the book value of equity when shares are selling below their book value, to retire outstanding shares and so on. Repurchase of stock for retirement of outstanding shares is considered to be similar to the payment of cash dividends. As an alternative to paying cash dividends, a firm may distribute its income by repurchasing its own stock.
Stock repurchase can substitute the cash dividend as a way to distribute funds to stockholders. When common stock is repurchased for retirement, the underlying motive is to distribute excess cash to the stockholders. Stock repurchase programs undertaken by any firm has been more popular these days. The basic advantage of stock repurchase for retirement is that they enhance shareholder value. It is because as long as earnings remain constant, the repurchase of shares reduces the number of outstanding shares, raising the earnings per share and market price per share.
In addition to maximizing shareholders' wealth, stock repurchase may result into tax benefit for certain shareholders. The repurchase of stock substitutes dividends for capital gain which may be taxed at lower rate or later rate (when stocks are sold). The retirement of common stock by the repurchase can be regarded as a reverse dilution, because it results into increase in earning per share and market price per share with a reduction in number of share outstanding.
