Updated August 2018
There are two main ways for companies to return cash to shareholders. Dividends are one method, and share buybacks – where a company purchases its own shares – are another. If a company buys back its own shares (assuming it doesn’t add others at the same time via the exercise of options, say), it leaves fewer shares circulating, so ongoing shareholders own a bigger (and thus – all else being equal – more valuable) slice of the firm than they did before.
When a company decides to undertake a share buyback it will typically do so in the open market – just like any other investor – or via a “tender offer”, which involves shareholders submitting a price at which they would be willing to sell. The repurchased shares are either cancelled, or sometimes kept as “Treasury” shares, meaning the company can reissue them if necessary.
Share buybacks are increasingly popular with companies – in the US, for example, buybacks took over from dividends as the main route to returning cash to shareholders as far back as 1997, says Justin Fox on Bloomberg. But they are controversial.
William Lazonick of University of Massachusetts Lowell has argued that buybacks are largely driven by management teams trying to maximise their bonuses, and various academic studies back him up – one 2016 paper from Ohio State University (“Why does capital no longer flow more to the industries with the best growth opportunities?”) concluded that changes in executive incentive schemes in the 1990s have increasingly resulted in cash being diverted from investment in growth towards share buybacks.
Others are less convinced. On Bloomberg, economist Tyler Cowen argues that money spent on buybacks ends up being reinvested elsewhere (by the shareholders who receive the money) – so in effect, it’s all swings and roundabouts.