Treasury stock
Encyclopedia
A treasury stock or reacquired stock is stock
Stock
The capital stock of a business entity represents the original capital paid into or invested in the business by its founders. It serves as a security for the creditors of a business since it cannot be withdrawn to the detriment of the creditors...

 which is bought back by the issuing company
Company
A company is a form of business organization. It is an association or collection of individual real persons and/or other companies, who each provide some form of capital. This group has a common purpose or focus and an aim of gaining profits. This collection, group or association of persons can be...

, reducing the amount of outstanding stock on the open market ("open market" including insiders' holdings).

Stock repurchases
Share repurchase
Stock repurchase is the reacquisition by a company of its own stock. In some countries, including the U.S. and the UK, a corporation can repurchase its own stock by distributing cash to existing shareholders in exchange for a fraction of the company's outstanding equity; that is, cash is exchanged...

 are often used as a tax-efficient method to put cash into shareholders' hands, rather than paying dividend
Dividend
Dividends are payments made by a corporation to its shareholder members. It is the portion of corporate profits paid out to stockholders. When a corporation earns a profit or surplus, that money can be put to two uses: it can either be re-invested in the business , or it can be distributed to...

s. 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
United Kingdom
The United Kingdom of Great Britain and Northern IrelandIn the United Kingdom and Dependencies, other languages have been officially recognised as legitimate autochthonous languages under the European Charter for Regional or Minority Languages...

 equivalent of treasury stock as used in the United States is treasury share. Treasury stocks in the UK refers to government bonds or gilts
Gilts
Gilts are bonds issued by certain national governments. The term is of British origin, and originally referred to the debt securities issued by the Bank of England, which had a gilt edge. Hence, they are called gilt-edged securities, or gilts for short. The term is also sometimes used in Ireland...

.

Limitations of treasury stock

  • Treasury stock does not pay a dividend
    Dividend
    Dividends are payments made by a corporation to its shareholder members. It is the portion of corporate profits paid out to stockholders. When a corporation earns a profit or surplus, that money can be put to two uses: it can either be re-invested in the business , or it can be distributed to...

  • 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.

The possession of treasury shares does not give the company the right to vote, to exercise pre-emptive 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.

Benefits

In an efficient market, 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, 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 value per share is unchanged. However, buying back shares does improve certain per-share ratios, such as price/earnings
P/E ratio
The P/E ratio of a stock is a measure of the price paid for a share relative to the annual net income or profit earned by the firm per share...

 (earnings per share
Earnings per share
Earnings per share is the amount of earnings per each outstanding share of a company's stock.In the United States, the Financial Accounting Standards Board requires companies' income statements to report EPS for each of the major categories of the income statement: continuing operations,...

 is increased due to fewer shares outstanding), but since the market risk increases by the same amount, the share value remains unchanged.

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 the buyback is executed when shares are under-priced); 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 doesn't apply to unscheduled (special) 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 temporarily unrealistically favourable pricing.

A company does not benefit by helping call stock options holder so this is not an incentive. A company will not do it for this reason except for the case in which the decision makers for the company have the incentive of profiting which is indeed illegal.

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 stock 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
Balance sheet
In financial accounting, a balance sheet or statement of financial position is a summary of the financial balances of a sole proprietorship, a business partnership or a company. Assets, liabilities and ownership equity are listed as of a specific date, such as the end of its financial year. A...

, treasury stock is listed under shareholder equity as a negative number. The accounts may be called equity reduction or contra-equity.

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
Par value
Par value, in finance and accounting, means stated value or face value. From this comes the expressions at par , over par and under par ....

 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
Retained earnings
In accounting, retained earnings refers to the portion of net income which is retained by the corporation rather than distributed to its owners as dividends. Similarly, if the corporation takes a loss, then that loss is retained and called variously retained losses, accumulated losses or...

. 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
Retained earnings
In accounting, retained earnings refers to the portion of net income which is retained by the corporation rather than distributed to its owners as dividends. Similarly, if the corporation takes a loss, then that loss is retained and called variously retained losses, accumulated losses or...

. In auditing financial statements
Financial statements
A financial statement is a formal record of the financial activities of a business, person, or other entity. In British English—including United Kingdom company law—a financial statement is often referred to as an account, although the term financial statement is also used, particularly by...

, 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.

According to SEC Rule 10b-18:
  • One Broker-dealer
    Broker-dealer
    A broker-dealer is a term used in United States financial services regulations. It is a natural person, a company or other organization that trades securities for its own account or on behalf of its customers....

     per Day:
    The company repurchasing shares may not use more than one broker
    Broker
    A broker is a party that arranges transactions between a buyer and a seller, and gets a commission when the deal is executed. A broker who also acts as a seller or as a buyer becomes a principal party to the deal...

     or dealer
    Broker-dealer
    A broker-dealer is a term used in United States financial services regulations. It is a natural person, a company or other organization that trades securities for its own account or on behalf of its customers....

     to acquire the shares per each day.
  • Timing of Purchase: A repurchase may not be the first trade of the day. Repurchases cannot be made in the last 10 minutes of the trading day, or 30 minutes if the company's ADTV is less than $1 million and has a public float of less than $150 million. These rules do not apply to over-the-counter
    Over-the-counter (finance)
    Within the derivatives markets, many products are traded through exchanges. An exchange has the benefit of facilitating liquidity and also mitigates all credit risk concerning the default of a member of the exchange. Products traded on the exchange must be well standardised to transparent trading....

     securities, which are not traded on the NYSE or Nasdaq.
  • Purchase Price: A repurchase may not be bid at a price higher than the highest independent bid
    Bidding
    Bidding is an offer of setting a price one is willing to pay for something. A price offer is called a bid. The term may be used in context of auctions, stock exchange, card games, or real estate transactions....

     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 executed 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

  • List of finance topics
  • Shares authorized
    Shares authorized
    Shares authorized is the maximum number of shares that a company can issue. This number is specified in the company's articles of association but can be changed by shareholders' approval...

  • Shares issued
  • Shares outstanding
    Shares outstanding
    Shares outstanding are common shares that have been authorized, issued, and purchased by investors. They have voting rights and represent ownership in the corporation by the person or institution that holds the shares. They should be distinguished from treasury shares, which is common stock held by...


  • Share capital
    Share capital
    Share capital or issued capital or capital stock refers to the portion of a company's equity that has been obtained by trading stock to a shareholder for cash or an equivalent item of capital value...

  • Public float
    Public float
    The float of a company whose stock is publicly traded has different default meanings depending on the presumed context.Without a qualifier it may refer to the entire market capitalization of the company or only its publicly traded equity....

  • Shareholders' equity
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