Share Repurchase: Should We Apply It?

Introduction

Background information

Share repurchases has become a common practice in most of the financial markets. It is adopted when the intrinsic value is below the market value of a share. This report will focus on main mechanisms of share repurchase that is, how these programs are carried out. The various mechanisms could be open market repurchases, self offer tenders and the off-market mechanisms. Companies could also come up with derivatives to implement the program as they have less effect on their cash flows and liquidity.

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The regulatory issues which govern the share repurchases programs are discussed. These rules ensure that the interests of the investors are catered for so that, the managers do not take advantage of the situation. The rule 10b-18 evolved in 1982 and since then, many firms have taken up this policy since it protects them. The treatment of the shareholders should be fair in that, the insiders should not take advantage of the situation where investors are not informed. This is governed by the disclosure rule, as the companies have to make it public their intentions to repurchase and, their reasons. The factor of possible price manipulation is also governed by the policy of repurchasing through one agent only.

The factors which affect the repurchase programs are evaluated. These are the undervaluation of the shares which is the main reason for a repurchase. Stock options are offered as an incentive to the managers so that their interests with those of the investors do not conflict. The leverage of the firm is also increased and this reduces the possibility of any hostile take-over. Cash flow and the liquidity of the firm increases thus it is also a motivating factor for a repurchase. Most firms are driven by these factors when making decisions on these programs.

These programs affect the firm and the economy in both the short run and in the long run. Repurchases are treated as capital gains for taxation purposes unlike dividends which are treated as income. This reduces the tax liability to the shareholders and in turn decreases the tax income earned by the government. The companies are also able to improve their influence in the economy. This is because, when they implement the programs, individuals and other companies will want to benefit from the gains derived from the repurchase.

Since share repurchase is not allowed in the Saudi stocks market (TAWADUL), the study aims at evaluating the benefits the repurchase of shares would have on this market. This market is very volatile and these programs would work well if they are properly implemented. If the large firms announce a repurchase most investors will take it up as they expect to benefit from the rises in the share value as the market fluctuates.

Definitions and mechanisms for Stock repurchase (SR)

Definition of SR

Stock Repurchase is defined as a program where a company buys its own shares from the market. This reduces the number of shares in the market and normally this might be done when the company sees like its shares are being undervalued. While reducing the number of share in the market, the earnings per share is increased and, the market value of the remaining shares tend to rise. When a company undertakes a share repurchase, it considers it as the best investment. SR aims at cash redistribution to the shareholders in exchange of an outstanding equity of the firm. These shares bought back are either retired or kept as treasury stock for future re-issuance.

Scope of SR

The scope of this report is to find out how SR works and, its effects on the firm and the economy, factors affecting SR and the benefits it would bring if taken up by Saudi stock market (TAWADUL).

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Main mechanisms for SR

Open market repurchases programs

This has been the most common form of repurchase. Due to variations in the stock markets, many companies experience fluctuations in the trading prices of their stocks. Companies use this program to take advantage of downturns in the market and any undervaluation in their stocks. When instituting this program, companies are needed to review their incorporation laws as well as the organizational documents. This is necessary to ensure that a company has the authority to buy back its shares and that the acquisition does not in any way breach its contractual restrictions. The company should also consult with its accountants and the tax advisors on the consequences the repurchase would have on its accounts and taxes. This program needs the approval of the Board of directors of the corporation, so that the challenge of discontented investors is withstood. It is important that the directors have a well documented reason which is genuine, as to why they are undertaking this business policy. All the decisions made should be a reflection of the company’s policies. The minutes of the Boards minutes and documents should show the possible pros and cons of the policy to the company and, to the remaining shareholders (Deborah 2009, par. 1-5).

Self-offer tenders

These are when a company offers to buys its own shares at a price above the market value. This does not have any concern with the target number of shareholders but it can be said to be an attempt to avoid any takeovers of the company. If a firm is the main shareholder of its stocks it makes it difficult for any unfriendly takeovers and this also makes it very expensive for the firm attempting to buy it. An important determinant for the self-offer tender is the elasticity of the stock market which is mainly determined by the taxes. The offer premiums are also determined by the size of the firm and the stock performance before the offer. Since the capital markets are imperfect, the imperfections between the demand and supply of the shares of the firm will definitely result to elasticity of the stock prices. The capital tax gains affect the behavior of the investors. Those shareholders who have unrealized capital gains may require premiums to enable them tender their shares as it attracts taxes. These offer are normally larger compared to the open market programs. Basically, these offers include a reasonable size of premium over the prices of the firms share before the offers are made. A part of this premium is determined by the assessment of the bidder on the supply curve’s

Off-market/ over the counter repurchases

Off-market repurchases is a popular and an important capital management means used by the large companies. This method enables the companies to return the cash to the shareholders in a way which is tax effective and, where they will have capital gains. This method has been criticized since the treatment of shareholders is viewed as inequitable. This has become a topical issue and the Taxation board has been asked by the Federal Treasurer to evaluate the treatment and importance of the off-trade market. The capital component which determines how much capital benefits will be generated should be determined in this form of repurchase. If the approval process by the Board of the company is simplified, it will be beneficial for the management of capital to be efficient. The shareholders should be in a position to distinguish the immoral exploitation activities when, the companies offer them a discount for the purchase of their shares. They should establish that the exercise is a lawful repurchase of the shares, which will be beneficial to them. There has been debate on off-market purchases recently and suggestions are being raised on the evaluation of the dividend attribution performance and, the rates of the corporate taxes. Shareholders should be aware of the consequences of the running of their portfolio. Off-market repurchase which is well organized is a good practice of the management of the company’s capital (Kevin 2006, pp. 1-2).

Derivative-based share repurchases

Greater results are gotten when derivative results are used. Derivative-based approaches may be used to improve the repurchases businesses. This is because the impact of the derivative on the liquidity and cash flow of the company is less. In some cases, the derivative affects the accounting record and a minimal effect on the balance sheets. The derivative programs used together with the repurchase programs are: forward-equity purchases, total-return swaps, buying call-options and selling-puts. The effect of the forward equity purchase is similar to that of a repurchase financed by debt. When choosing this derivative, the effects it has on the balance sheet and financial ratios of the company should be considered. Also, the impact on the corporate taxes, regulatory treatment and the effects on the earnings per share should be considered (Harris 2000, p. 1).

The total-swap derivative does not require a direct investment. In this derivative, the total return on stock is negative unlike the case of the classic interest rate swap where, the fixed and floating flows move in reverse directions. The direction of the stock and interest cash flow is the same in the total return swap derivative. This method is also flexible compared to the other derivatives, and the cash flows can be confined in a certain range of the share values.

Selling-put option is a popular strategy for decreasing the price of the shares repurchased. This is done by paying out the money over the counter against shares of the company. The premium the company receives is used to reduce the repurchase program cost. An attractive put price is set by the company and, the company can adjust the strike price depending on the prevailing conditions.

The buying-call option is a strategy to protect the program from the market instability and the expenses of buying shares in a rising market. The fall in the share prices gives an advantage to the company and they are able to get the average costs of the share stock repurchased. This strategy works well when the share price is unstable. But if the market is dull, this strategy will not work well (Harris 2000, p. 3)

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Share repurchase in today’s market

Share repurchase has become a common practice in the current financial markets. This is an investment decision besides being an investment in itself. Also, it is a payout decision to providing dividends. In the recent years SR has become an important global investment activity. In the 1970’s this was not a common practice and for a repurchase to be noticed, one had to look back in the records of the previous fifteen years. Today, one only has check on a few previous months to notice a repurchase. The decision to own companies with share repurchases and a big cash flow has been one of the best investment decisions. Profits on corporates are increasing and it has accounted for the highest share of the gross domestic product of the US since the 1970’s. Since the profits of a company vary depending on the stability of the economy, the companies should be cautious when making decisions on SR. Today, more than three quarters of companies are which are having their share prices below the market value are repurchasing their shares in an attempt to benefit their shareholders. The table below shows the share repurchases programs announced by the S&P 500 and S&P 100 from 1996 to 2000.

For the past seven years, companies took their time to focus on their internal status and this led them to the position they are in today. In 2005, the returns on capital were high and the same happened to the cash flow margins. This occurred against the stable growth and the gains in productivity. With the current economic crisis, most companies are undertaking repurchases of their shares. Like the Royal Bank of Canada, it has plans of repurchasing about 20 million of the shares. This will enable the bank relax over its level of capital and its earnings will be increased. Since their lenders issued them funds to raise their capital during the financial crisis, the earnings per share were weakened. Analysts are still watching what this bank will do since the shares are expensive compared to the beginning of the year. As this bank is one of the strongest in the world, it will be in a better position to make use of their excess capital through repurchases. Other companies like YIT Corporation, KBR, Microsoft, Rim, NTT Docomo and Novo Nordisk among other giant companies have recently announced share repurchases.

Regulatory Issues and associated tools

Before 1982, there were no regulations to guide the repurchases by the companies. Many companies were left out of the market because of the market powers and control of prices by the powerful industries. A rule was set to guard against the manipulation of prices and, it also aimed at encouraging the companies to support their stocks in the market. The rule 10b-18 was self-harbor, in that if the companies complied with the marketing restrictions, they would be protected against the consequences of the manipulation of the prices (Joel & Donald 1997, pp. 182-3).

Fair treatment of shareholders

During repurchases, the company may not be in a position to treat all its shareholders equally as some will sell their shares and others will not be willing to. The shareholders who could have invested in as a strategy to reduce their risks may be affected by the company’s decision to reduce its capital and increase the cash flow. To deal with the unfair treatment of the shareholders, disclosure requirements have been emphasized. Before the actual repurchase, companies are required to make it public that they have been permitted by the Board to repurchase its own shares. Therefore, the shareholders will be informed of the company’s intention to repurchase its shares although they might not be aware of the specific broker transacting on the company’s behalf. The firms are required to make public the amounts they spend on the repurchasing of stock in each quarter. The shareholders have to be aware of the total number of shares repurchased, the average price per share and the numbers they plan to repurchase in the future. This will make sure that the shareholders know the prices of the company and so, it will be hard for the company to take advantage of them during the repurchasing.

Information asymmetric and insider information

The managers of companies have inside information and thus, they will tend to come up with the SR programs when their shares start loosing their market value. Therefore, the SR program can be said to be an indirect insider trading. The outside shareholders may lack proper information on the repurchasing due to poor disclosure by the company. This situation happens when there is insufficient communication between the inside and outside shareholder, thus giving an advantage to the insiders. They will have the incentive to sell their shares when the company is supporting its market share price by a repurchase. In the case of open market repurchase, the managers could decide to buy the undervalued shares and forget the repurchase. This concern is taken care of by disclosure that the companies have decided to undertake a repurchase. In this case, the prices of the shares will rise and the outside shareholders will be in a position to benefit from the repurchase. In the US however, insider trading is not a major concern as long as they return the profits to the company in a six month trading activity. But, it is difficult to regulate a legal insider trading thus, ‘back out periods’ are enforced which restrict the trading during the sensitive times.

Orderly market and manipulation

During repurchases, companies may manipulate the share prices to their advantage. Therefore, regulations the movement of prices, repurchase timing, purchasing method and trading volumes has to be imposed. This will considerably decrease the company’s capability to manipulate the prices upwards. A company is required to select a single broker through whom the trading will take place. The appearance of diverse trading will be avoided if many brokers are avoided and this will provide security, and trust of the whole activity to the shareholders. There is also a rule which prohibits any trading activity in the last thirty minutes of trading in any day. This is because during this time the marking activity has a strong indicator on the shares market value, the demand and the trading direction. For stable companies, this rule was eased in 2003 because manipulation of the prices rarely occurs and for them, only the last ten minutes of trading are prohibited. The price settled at should not exceed the highest price among of the last sale price or the current bid price. This rule restricts the company from coming up with a price thrust. Another rule is that the purchases made in a single day should not be more than 25% of the regular trading amounts for the previous four weeks. This is a restriction for the companies so that they will not dominate the share market with their securities.

General regulatory tools regarding compliance with SR rules

With the regulations being established, actual compliance with the rules is a bit hard to monitor. Therefore, financial markets have come up with statutory bodies to monitor the operations of the companies listed in the stock exchange. These bodies have the mandate to supervise and enforce the rules and regulations governing the operations of the securities in the present and future markets. These bodies are privately managed by their members but, they are given the mandate by their respective governments to operate the activities of the stock markets. These will ensure that companies carry out their operations as required.

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Companies are also required to carry out their operations as per the requirements of the rules that govern their activities. Since the company is governed by its incorporation laws, it is required to submit them to the registrar of companies. Incase any amendments are made they should be done through their registrars. They act as a tool which will make them comply with the SR rules because it is a crime to violate the rules of the company’s act.

The disclosure rule is another regulatory rule to ensure that they comply with the SR rules. Companies are required to announce their intention to repurchase prior to the actual process. They should disclose the decision of the Board to repurchase and the reasons of coming up with the decision. This makes their actions public and since they do not want to ruin their reputation, they are forced to comply with the rules that govern their intended action.

Institutional and policy changes of share repurchasing

Reasons for share repurchase

Firms may want to repurchase shares for varied reasons depending on the financial status and economic effects on the company. The various reasons for share repurchase by companies are shown in the table below in percentage.

One of the main reasons of SR is to increase the price of shares. The management adopts this strategy when the market value of their share is undervalued by the stock analyst’s. When the share is bought back from the shareholders, they are protected from the damage on the value of their investment. This is because, the share will be bought back at a higher price and thus the shareholders will benefit from these programs. This will in turn increase the cash flow in the company since they may be an considerable investment for the excess cash flow after all the capital investment needs have been met. Repurchase is a sign of the management’s confidence that the shares are undervalued at that particular time. Also, for corporate governance such that the excess cash is not wasted but, used to acquire additional investment.

The balancing of the capital structure of the company may also be another reason for a repurchase. This enables the company to maintain a high debt-equity ratio. This will shield the company from any possible unfriendly takeovers since the net worth of the company will be higher than any debts they incur. This may also be an attempt to substitute the dividend which could be paid to the shareholders. The dividend income earned attracts high taxation unlike the capital gains which result from a repurchase. This offers an advantage to the longtime shareholders from the taxation perspective. Moreover, the dilution of earnings is decreased. This is because a repurchase will probably increase the earnings per share. This saves the company the deficiencies which might be caused by the stock option grant exercises. The companies use this strategy to cover for the possible acquisitions and mergers through its own shares (Swaminathan et al 2001, p. 44).

A numerical model of Canada’s Toronto Stock Exchange Market to show an advantage of SR

An example of Canada’s Toronto Stock Exchange Market can be used to show the aggregate cash distributions resulting from the dividend payments and repurchase programs. This is for a period of ten years from 1995 to 2004. This data is used to show an advantage of share repurchase in the distribution of cash. In this period , it is evident that SR was high by the year 2004 and the following years up to date they remain the method that distributes a lot of capital.

The chart above shows the distribution of cash in Canada as a result of dividend payments and share repurchase programs. The repurchases curve is far much below the dividends curve in 1995. This could be because many companies had not adopted the policy of repurchase by then. The cash distributed by the repurchases increased from one year to the other and in 2000, it was higher than that of dividends. In the year 2001, it dropped sharply and then it began to rise. By 2005, it was far much higher compared to dividends meaning that more cash was distributed to the investors. The repurchases curve is more cyclical showing and they are more unpredictable. This shows that the effects of repurchases are not temporal as their effects on the distribution of cash flow are noticed over the years. The dividends curve is almost at the same range over the years showing that their effects on cash are almost constant.

Effects on the firm

Growth and profitability

One of the key effects of a repurchase is the profitability and growth of the firm. The market position of the product of a firm determines the value of the shareholders. Repurchase affects these values in a positive or a negative way. Firms which portray an attractive profitability potential, could be better if they invested the cash elsewhere. The investor’s behavior can misguide the firm to making a decision on repurchase which might turn out to be unfavorable for the growth and profits of the firm. On the other hand, shares that are performing poorly in the market can be repurchased as an attempt to increase the return on capital. This could be a sign that the management is taking measures to welcome positive business activity that will be of benefit to the shareholders, the firm and to the entire economy.

Implications on the Finance officers

When a decision to repurchase is reached, the value on the remaining shareholders is affected. This is referred to as the ripple effect. When the finance officers are making decisions on these programs, they must have determined the requirement for investment funds and the possible opportunities for investment. They also need to consider invisible funds in supply and this is determined by the profits of the firm. Considering all these factors, it is evident that the decision made should put into consideration the value of the remaining shareholders. This makes it a difficult task for the finance officers when coming up with and implementing these programs. These officers are the key advisors when making such a decision because they have to combine their expertise in finance and strategy development. As the architects of this program they must consider all the regulatory requirements governing these programs, so that the desired results are achieved by the company (Swaminathan et al 2001, p. 45).

Investment opportunity

Share repurchases are an investment opportunity for firms. For some, it could be a poor decision while others might benefit from it. The excess cash flow can be used to repurchase shares as a strategy to improve the capital structure. The property portfolios of the company should help the company in determining if this is the best investment opportunity. Most firms benefit from these programs as they turn out to be the best strategies. Instead of sitting back and watching the market value of the firm decline, the repurchase turns out to be the better option for these firms. However, for companies which are stable and have chance of growth and profit making may be well suited to invest this money elsewhere. The repurchase programs turn out to be not the best strategy for some firms while for other it is the best (Walter 2009, pp. 10-11).

Tax effect

When the companies offer dividends to their shareholders, it attracts high taxes. This is because dividends are treated as any other income for the tax purposes. On the other hand, the repurchases are treated as capital gains and they attract similar taxes. The repurchases give a timing option to the shareholders and the company since it is not mandatory. Thus, they have a tax advantage in this case unlike the dividend pay which are compulsory to all the shareholders. For this reason many may prefer the programs as a strategy to reduce the tax burden incurred.

Liquidity effect

The share repurchase programs may have a temporal or a permanent effect on the liquidity of the firm. Changes in liquidity mean that there is a change in the costs of executing the program from the investor’s side and this affects the repurchasing capital costs. The decrease of the share base is likely to reduce the liquidity of the firm and the market traders may increase the cost of bid selection also affecting the liquidity. The share repurchases decrease liquidity because the presence of well informed managers has a high probability. This in turn will increase the possibility of an undesirable choice cost element of the bid-ask spread. However, the program may also increase the liquidity of the firm. This is because, the selection cost element tends to decline since managers have private information of the status of the company therefore, decreasing the information asymmetry.

Effect on the macro-level

Repurchase programs create economic value of the shareholders who does not participate in the program. This is because when the number of share in the market decreases, the market value of the remaining shares will rise. This enables the shareholders to benefit from the program and they will also attract bigger dividends. The companies are able to transfer cash to their investors in the return of their shares and this will lead to a reduction in claims of outstanding equity.

The return on the investments is negatively related to open market repurchases of the firms whose opportunities of investment were high. SR may also cause the allocation of capital to more productive areas in the economy from the less productive areas. The allocation of capital in a free economy should be considered when the company is short of any investments that add value.

Since a repurchase program affects the tax amounts, the amount raised in form of taxes will reduce. The repurchases are treated as capital gains and they do not attract high taxes like the dividends which are treated as income. This will reduce the income that the government will raise from the shares and could affect the national budget since the amounts targeted may not be reached.

The amount of money in circulation is also affected. When a repurchase takes place, the company aims at increasing the cash of their investors. The liquidity increases and this add to the money circulating in the economy. This will in turn increase the demand of goods and services and if the regulatory institutions do not take necessary measures, inflation could arise. The measures that may be taken to reduce the amounts in circulation is to increase of interest rates so that people can save more and spend less.

Factors of Share repurchasing

Stock options

The compensation of the senior executives is one of the factors affecting repurchase of shares. This strategy came up in the United States in the 1980’s and in the past fifteen years, it has spread in European countries. Managers can be awarded with the stock options so that they can also consider the interests of shareholders. If well rewarded, the managers could pay the free cash flow to the shareholders instead of investing them in undeserving projects. Thus, the relationship between the repurchases and stock options should be positive. They could also have an effect if repurchases are used in the place of dividends as an attempt to return the capital to the shareholders. Managers will prefer the stock options to maintain the ratio of the payout since they have a negative impact on the dividends. They are able to counter any conflict of interest between the shareholders and the management. This might remain as the only option between the balance of the new probable management and the initial shareholders. This factor does not affect the size of the firm’s earnings but only the way it is split up. These stock options may reduce the earnings per share although they act as an incentive on the other hand. Performance based options may be imposed so that the employees are compensated depending on their targets. This will ensure that this plan is not misused by the top officials for any reasons.

Agency costs

By repurchasing, the firm considerably reduces the agency costs. Here, the shareholders assign the firms running to a manager and a sequence of control devices to ensure that all the operations are in the interest of their agents. There is no limit on the conflict of the interests of the managers and the stockholders. The managers seek to maximize the objectives of the shareholders. The managers are in a position to adjust the decisions of the firms to their own advantage. The agents could use the excess cash derived from projects for their own benefits by investing in improper investments or increasing their remuneration instead of giving back the excess benefits to the shareholders. Since there is a rule that only one agent is used during the repurchasing process, the entire process may depend on this agent. This is because the agent is the only one in charge of making any transactions on behalf of the company and any deal between them may remain unrevealed. Nevertheless, the repurchasing process reduces the costs of the agents because only one agent is used. This implies that all extra costs are uniform for all the shareholders and could only vary depending on the number of shares being sold back. The costs will be high for the firms with a huge amount of free cash foe the repurchasing purposes.

Leverage

Repurchasing decisions may also be affected by the leverage of the firm. The firms with a high influence will most likely not repurchase shares since the costs of bankruptcy might rise. Free cash flow is affected by leverage and also the flexibility of the firm is affected. This makes the firm very cautious in their decisions to repurchase and most likely they end up saving the free cash flow for other investment purposes. The leverage of the firm is computed as preferred stock added to total debt and, divided by the entire capital. As formulae, it is expressed as:

Leverage= (market value of equity+ book value of debt) / book value of preferred stock
Also, leverage= firm’s leverage – average leverage of the year

A benefit of leverage is that the average cost of capital of the firm is reduced. This is as a result of the interest incurred on debt which attracts a tax deduction. Thus, the cost of debt after the tax will be less than the anticipated return on equity of the shareholders. However, the debt financing is only proper if they do not cause any financial problems to the company and attracts taxable profits on the interest expenses. For companies which experience rapid growth, the decisions to use debt financing are difficult to make. Since such situations are very risky, equity financing is preferred to the debt financing. Debts finances make the managers more disciplined because they are bound to repay them. Those companies which are financed by their equity may not forgo most of the benefits of the cash flow, but may take-up the necessary performance measures to impersonate some of the benefits.

Undervaluation

When the shares are below the market rates, the managers may result to repurchasing. This will be done in an attempt to save the shareholders from the market problems and to increase the cash flow of the firm. Possible undervaluation is captured by the use of the market to book value ratios.

Market book value= [assets book value – (equity book value + equity market value)]/ book value of assets.

Signaling

Managers may want to buy back the undervalued stock and thus, a repurchase is common when the market value is low compared to the intrinsic value. The demand for the shares may rise when a repurchase is announced and for those who are in need of cash will sell back their shares while the remaining ones, will benefit from the increased share value. It is also a tool of management to portray the company’s promising future to the market.

Free cash flow

Another factor for a repurchase is the availability of surplus cash flow. This is used as an investment opportunity when there are no other suitable investments. Also, the surplus cash at the disposal of management is reduced to minimize over investment in unreliable projects. Thus the operating cash flow of the firm is directly proportional to the amounts repurchased.

Take over defense

At times when the managers come to a decision to repurchase, it is at the expense of the shareholders. This is a tactic of defense against any hostile takeovers. The numbers of shares held by the public are reduced and leverage is increased on the target company

Investors reaction

The way in which the shareholders react to the share may lead to a decision to repurchase. It may also be in an attempt to consolidate the control by the insiders’ in decision making. Since the dividends might lower the share price, this becomes a better alternative.

Share repurchase in Saudi stock market

The Saudi stock market has suffered a fall in the market value of most shares mostly as a result of the current global and economic crisis. Share repurchase has become common in most markets in the world but in the Saudi market, this application is not allowed. The stock market currently is experiencing the lowest levels in five years. This is after loosing a value of about nine percent as most companies are closing daily stocks down their share value.

Benefits share repurchase could have to Saudi stock market

To the company, the share repurchase will have a positive effect on the performance of the cash flow since it will increase. The earnings per share will increase and this will change the performance of the share in the market and also the company’s picture. In addition, the return on equity is also expected to rise since the capital structure will improve due to the investments made. The shareholders who will not sell their shares will experience a rise in the share’s net asset value. This is because the number of shares in circulation will reduce hence; those that will remain in the market will be stronger than before.

Moreover, the financial flexibility increases because this provides an opportunity for those shareholders who are in need of cash in the present time. The leverage of the company increase and any possible takeovers which are unfriendly are avoided. This is because when the net worth of the company is increased, most of the assets belong to the company because they are not financed by debt. This will make it difficult and expensive for the company which wants to take over. It also provides incentives to the managers and this will enable them give the interests of shareholders a priority.

Another benefit is that the liquidity of the market increases. When a share repurchase takes place, the cash paid to the shareholders increases the amount of money in circulation. This may in turn lead to the increase in the demand of goods and services in the economy. The market will also deepen since the remaining shareholders will have a share with a high value. This will make it hard for them to dispose and the shares repurchased may at time be kept as a capital stock for future re-issuance. In the Saudi market, the prices will definitely shoot due to the limitations in the shares tradable. This will improve the stock market and the decreasing shares will increase their value.

Recommendations

Share repurchase is a good strategy when the value of shares is below the market value. When adopting this strategy, companies should have included it in their institutional policies as one of the policies. The Board of Directors should first discuss and announce the decision of having a repurchase and reasons for that course of action should be made public.

When undertaking a repurchase, the rules and regulations governing this policy should be followed so that it becomes a legal action. This should be in the attempt to be fair to the shareholder which is a requirement and, to counter any possible price manipulations. Also the information asymmetry and insider information are avoided when all the decisions of the firm are made public.

Considering the volatility in the Saudi stock market, this policy would have positive results when implemented. This will attract many individual and company investors because they would expect a value gain of shares.

The Saudi market should allow share repurchase since most of the shares are trading at prices below the market rates. This will save most companies as they will be able to improve their capital structure and position in the financial markets.

Conclusion

The recent status of the Saudi stock market is very unstable. Large cap companies like Al-Rajhi and SABIC control the stock market and if these large companies decide to repurchase their shares, the investors will most likely take up the idea so that they can benefit from the price gain. The volatile status of the market will also make other investors buy the shares as they predict a possible rise in the share value. This will increase the demand of the shares and there will be a positive response to repurchase announcements. The improved liquidity will lead to an increase in the value of shares and the numbers traded. The financial ratios of the company in the annually and quarterly basis will rise creating a positive picture to interested and existing shareholders (Alrajhi Financial Services Co. 2008, par. 10).

The repurchase will have long term and short term effects on the market. In the situation of TAWADUL, repurchase will immediately awaken the ailing markets as a short term response. Also as a short term response, the amount of cash distributed to the shareholders will increase and the share prices will increase in value. In the log run, dynamic energy given to the market will prevail and new points of equilibrium will be created for the respective companies. Also, the liquidity of the firm will increase in the long run and this could be as a result of the improvement in the prices, and the reduced instability in the market prices.

Therefore, putting in consideration that this is a practice in most markets, it would impact the Saudi stock market positively if they would allow the repurchase policy. It would be a good strategy if adopted by the firms as it changes the position of the company in the market. It will also change the influence the company has in the market positively. With the present global and economic crisis which has hit all the financial markets, it will be a good strategy to save the shares which are continuing to loose their market value. Also, it will be a safe strategy to avoid any takeovers that might result due to bankruptcy. Thus, it will be beneficial to the Saudi stock market if they would allow share repurchase as one of their policies.

References

Alrajhi Financial Services Co. 2008, Share Repurchase- Saudi perspective, Saudi market update. Web.

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