My understanding is that when companies perform stock buybacks, they repurchase shares from stockholders at the current market price. In other words, if I own a share of company A and one share of company A is currently trading at $10 per share, company A will buy my stock back from me for $10.
In that case, what’s the incentive for me to sell my share to the company? The company is only paying me the market value of my share; it’s not paying me anything above it. What incentivizes me to sell my share back to the company as opposed to simply selling it in the market and receiving the exact same price? I’d understand how companies would be returning value to shareholders if, for example, they were to buy my share at $12, not the current market price.
Issuing dividends seems to me to return greater value to shareholders, as it seems like it’s “free money”, although it does come with a dip in the stock price and thus lowers the value of the share that I own...
Anyone have any thoughts?
I'll start this by saying I'm generally not a huge fan of share buyback, as I see it a bit like a way for a company's management to use asymmetry of information (between investors and management) and an agency cost. There are however some benefits on both the investor and company side.
Firstly, more buyback are through open market, so effectively the company becomes a buyer on the market. You're not selling your share to the company directly generally. So the company becomes a buyer in the market (share price can move up).
Secondly, in a lot of countries, there is a tax benefit to return money to investors through buyback rather than dividends. Dividends get taxed on issuance, while cap gains are taxed later and can be netted off against losses. In some places, tax rates are also different, almost always higher for dividends.
Thirdly, dividends are not free money, it's a transfer of cashflow from the company to the investor. Same as a buyback. In fact, I would almost never participate in a buyback, because I buy companies that I think are undervalued. So a buyback transfers upside from other shareholders to me.
What I really don't like is two things. Management that tells me they are buying back stock after issuing stock to executives "so they don't dilute me". They dilute the value of the company though trough high executive compensation. Also, management that starts buying back shares when their bonuses are linked to EPS.
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