Share Buybacks and Shareholder Equity

Abstract

Off market share buybacks by Australian companies have involved complicated tax arrangements which generally lead to participation only by low marginal tax rate shareholders. This has led to many commentators raising questions in the financial press about equitable treatment of shareholders. We develop a simple model which enables us to derive a method of assessing whether buyback terms are equitable across shareholder groups which is then used to examine the Australian data. Definitive results hinge upon the contentious issue of the market value ascribed to franking credits, but it appears that buyback characteristics have meant a transfer of corporate value in favour of low marginal tax rate shareholders at the expense of high marginal tax rate shareholders.

Management choice of buyback method: Australian evidence

“…The tax treatment of off‐market buybacks has led to them becoming an economically important mechanism for Australian companies to return cash and franking credits to shareholders. For example, over the years 1996 to 2008 almost $27 billion was spent by Australian companies in off‐market buybacks, with around $7.6 billion of franking credits distributed (Brown and Davis, 2009). In the United States, on‐market repurchases dominate in terms of both number of buybacks and the dollars distributed to shareholders.…”

“…However, in Australia signalling is more likely to be a factor influencing on‐market buybacks rather than off‐market buybacks. Brown and Efthim (2005) and Brown and Davis (2009) show that when a portion of off‐market proceeds can be structured as a fully franked dividend, Australian firms generally offer less than the market value of the stock. As the consideration paid by management is below the current market price, there can be little credibility to using this means to signal undervaluation.…”

The Announcement Effects of Off-Market Share Repurchases in Australia

“…Anderson and Dyl (2004) argue that taxes affect the structure of open-tender repurchases in the U.S., and in Australia Brown and Efthim (2005) find a positive and significant relation between the discount in off-market repurchases and the imputation tax credits passed on to participating shareholders. Brown and Davis (2006) argue that because the buyback triggers an overall reduction in shareholder tax liabilities to the cost of the government, shareholders in aggregate must be better off.…”

“…On days 0, 1, 2, and 3 volumes are above normal. This temporary demand for the shares is argued by Brown and Efthim (2005) and Brown and Davis (2006) to originate mainly from superannuation funds which gain tax advantages from participating in the buyback because of their low marginal tax rate. Once positions in the stock have been set, abnormal volume and abnormal returns drop and become significantly negative by day 4.…”