In 2014, a $1 billion share buyback programme was initiated by Glencore plc, the biggest mining company in the world that has also strong interests in coal, copper and commodities. This move typified an ongoing trend of companies acquiring their own shares that has proved especially prevalent in the United States, with 2014 seeing a more than 50% rise in the use of company buybacks.
However, as even many firms in the UK and Europe with an interest in company compliance now contemplate buyback schemes, it makes sense to run the rule over the potential benefits and drawbacks. Glencore plc and many other companies have been criticised for using share buybacks, on the basis that such schemes frequently make more sense for enhancing a company’s financial indicators or executive remuneration packages than giving value to shareholders.
It is relatively easy to understand how company buybacks are treated from an accounting perspective. A company purchases its own equity with borrowed funds or its own cash, often but not always in the open market. This is followed by the cancellation of the equity or – in some countries – its treatment as treasury stock, so that it can be sold by the company in future. It is generally necessary for private companies and public companies with unlisted shares to cancel any repurchased shares.
To reduce the likelihood of companies depleting their capital base at creditors’ expense, it is then usually required of companies using buybacks to transfer an equivalent amount in value from their realised reserves to a capital redemption reserve. This reserve is generally only available for the later issuance of bonus shares by a company. Should the shares be self-purchased at a premium, the accounting entries can be complex, although the aforementioned basic accounting principles remain applicable.
The use of buybacks is often supported by directors and senior managers for self-interest reasons, with many director and senior executive bonus incentive compensation schemes, for example, being based on various financial and performance indicators. Buyback schemes have also often been said by observers to indicate a lack of ideas within a company as to how to use substantial cash resources sitting in their balance sheet.
There is also the risk of companies destroying a large amount of existing shareholder value if they buy their shares at a high market value, only for that market to then ‘correct’ or collapse shortly afterwards. Nonetheless, there’s little denying the resurgent popularity of buyback schemes on both sides of the Atlantic in recent years, with the total buybacks of US companies in 2014 estimated at more than $300 billion, compared to just under $40 billion for European companies.
With such a wide range of factors to consider, it is therefore strongly advised that companies giving thought to a buyback initiative of their own receive suitably tailored, expert and informed advice and guidance.