Question

What’s the disadvantage of the stock repurchases relative to the dividend payments? Stock repurchase can help avoiding setting a high dividend level that cannot be maintained. Firms may have to bid up stock price to complete repurchase, thus paying too much for its own stock. Stockholders may take stock repurchase as a positive signal – management thinks stock is undervaluated. Investors can receive income from lower-taxed capital gains rather than the higher-taxed dividends

Answer 1

Answer:

Firms may have to bid up stock price to complete repurchase, thus paying too much for its own stock.

Explanation:

Generally, the price of stocks are not fixed, so it might take a long time for a stock repurchase or buyback to be completed. Investors like buybacks since they tend to increase the price of stocks, but it makes them more expensive for the corporation to repurchase them.

Buybacks are seen positive by investors because they will eventually increase the earnings per share (by decreasing the number of shares outstanding) and they are also taxed in a lower rate than normal income. Management will tend to start buybacks when they believe the stock price is undervalued and they have excess cash. This way they will achieve achieve two objectives with one action:

1. lower equity costs
2. increase stock price