ECONOMICS I

ECONOMIC ANALYSIS OF SHARE BUYBACK AND

SPECIAL EMPHASIS OF PSUs

Submitted By:

RAHUL KUMAR

I.D No: 2324

Trimester I, 1st Year, B.A. LL.B (Hons.)

Date of Submission: September 08, 2016

TABLE OF CONTENTS
INTRODUCTION......................................................................................................................3
OBJECTIVES OF STUDY................................................................................................3
CHAPTER: 1.............................................................................................................................4
OVERVIEW OF SHARE BUYBACK..................................................................................4
REASON FOR SHARE BUY BACK...............................................................................5
ROLE OF OPPORTUNITY COST IN SHARE BUY BACK...........................................6
Chapter 2....................................................................................................................................7
EFFECT OF SHARE BUYBACK.........................................................................................7
INCREASE IN THE DEMAND OF SHARES.................................................................7
INCREASE IN PRICE OF SHARES................................................................................8
INCREASE IN VALUE OF SHARE AND CONTROL OVER THE COMPANY..........9
INCREASE IN EARNING PER SHARE..........................................................................9
STABILISATION OF MARKET DUE TO SHARE BUYBACK...................................11
CHAPTER: 3...........................................................................................................................12
BUY BACK OF SHARES BY PSUs...................................................................................12
DISINVESTMENT IN PUBLIC SECTOR UNIT...........................................................12
REASONS FOR GOVERNMENT ASKING PSUs TO BUYBACK SHARES.............13
CONCLUSION........................................................................................................................15
BIBLIOGRAPHY................................................................................................................16
ARTICLE.........................................................................................................................16
WEBSITES......................................................................................................................16

National Law School of India University Page 2

INTRODUCTION
After the independence till 1991 India was achieving an admirable growth in the public sector
enterprise. And in the last one and an half decades due to the poor performance of the public
sector enterprise in relation to the achievement of the huge growth, altered the assumption of
the role of the public sector enterprise. The continuously poor performance of the public
sector enterprise needs the reform.

It can be said that the economic crisis of 1991 leads to the public sector unit into the bad
situation and since then public sector was not able to achieve the growth and failing in
achieving the return on the investment. The serious problem was seen in the decline in the
productivity, lack of the bringing of new technologies, not proper attention on the research
and development.

Share buyback program started by government in the view to reduce the fiscal deficit and to
bring the public sector enterprise in the path of growth by allowing the private sector. For the
purpose of privatisation the government started disinvestment in the public sector units in
which government sell their shares to the private sector.

The scope of the paper is to analyse the economic aspects of share buyback which is now a
days become very efficient for the companies as well as for the government. Further, the
researcher has discussed about reasons and how share buyback is helpful for the companies
and the government both. In the end researcher tells that how share buyback is an efficient
method for the government.

OBJECTIVES OF STUDY
1) To study the share buyback, ways in which it can be done and reasons for it.
2) To find out the share buyback as a good way for companies and the public sector unit
as well.

CHAPTER: 1

OVERVIEW OF SHARE BUYBACK

Share buyback is a program in which company buyback the shares from the shareholders

National Law School of India University Page 3

from the market place at slightly higher price than the market price. The company buyback
the shares because the company might think that its shares are undervalued and when the
company is having large cash reserve with them and company do not have immediate
investment program so it can use the reserve price and buyback the shares. 1 And once the
shares are repurchased it become treasury shares (these are the portion of the shares that a
company keep them in its own treasury). The aim of this program is to reduce the number of
shares in the market place and to improve the price of shares in the market. The program
enables the promoter to strengthen their control and enhance the value of the shareholder.
Share buyback can be done in the following ways:-

1) Buy back at Market price: In this type of program the company buy back its share
directly from stock market like as other investors do by an advance announcement made by
the company and the shareholder sell their shares in the stock market and pays stock
transaction tax for the sale like as other sale of share. In this type of buyback of share the
seller of the share is unknown of the buyer's name like as other normal share purchase in
stock market2.

2) Buy back at fixed price: In this type of program the company directly provides offer to
share holder to buy back its share. So in this the shareholder directly transfer the share to the
company in company's demat account (an account in which the shares and securities are held
electronically) or shareholder can send the physical share certificates and transfer form
signed by the shareholder to the company and the amount is directly transferred to the
shareholder by company. These kinds of transfers are not done out on stock market and are
not put through Securities Transaction Tax (STT).3

3) Dutch Auction Method of Share buyback: This method is almost same as the fixed
price method but slight difference in this method is that instead of specifying a fixed price of

2 Id

3 Id

National Law School of India University Page 4

shares it set the range of price (maximum and minimum). Then the different shareholders
would say different amount at which these shareholders are willing to sell their shares. After
getting all bids from shares, the company will start qualifying these bids from the minimum
price till the company has qualified numbers of shares. Such as if a company is willing to buy
50 thousands shares then the company will move until it has the qualified 50 thousands
shares.4

4) Share buyback by direct negotiation: in this method the company will go to shareholder
and negotiate with them at a certain price with the certain large shareholders and then buy the
shares from these shareholders. In this method the price will be high than the current market
price. And the company by doing this can keep away the large shareholders in gaining their
representation.5

REASON FOR SHARE BUY BACK

A share buyback lowers the total assets of the company and due to which many metrics of the
company improve such as return on equity and return assets when we compared with not
buying back the share. By reducing the number of shares earning per share and revenue
grows more quickly than earlier. If the company pays the same amount of money to each
shareholders annually in dividends and when the total number of shareholders decreases then
each shareholder receive a large amount of money than the earlier.6 Companies buy back
share in order to improve the value of share, because buy back gives a means to allocate the
companies surplus funds and the other means in which company can invest these surplus
funds are not attractive or useful. It also increases the earning per share as post share buyback
the number of shares in the markets decreased so the earning per share increases. Company
buy back shares particularly when the price of the shares in market are lower than the book
value of shares or what price the company might think to be its real value.7

4 What is Share Repurchase and Method of Share Repurchase, available at

http://financetrain.com/what-is-share-repurchase-and-methods-of-share-repurchase/ (Last
visited on August 29)

5 Id

6 S. Whyte, The Reason For Disinvestment, KAIETEUR NEWS, (May 21, 2012), available at
http://www.kaieteurnewsonline.com/2012/05/21/the-reasons-for-divestment/ (Last visited on
August 27)

National Law School of India University Page 5

Company can also buy back share at the time when company have enough cash with it and
there is no better option to invest the cash. The main reason behind this program of share
buyback is that since the tax can be levied on the profit making by the company not on the
revenue. So it is preferable for the company to invest their excess cash in buy backing the
share in order to decrease the tax.

This program gives a signal which shows that the companys shares are undervalued and this
time can be seen as efficient time to give money back to the shareholder. 8 It is also a good
sign for those who are willing to invest in future because it shows that the company is not
only having the enough cash with them for the emergency but also better look on future of
the company because if a company is happy with buying back of the share it means that there
is less probability of company troubles in future.9

ROLE OF OPPORTUNITY COST IN SHARE BUY BACK

Opportunity cost generally known as hidden cost. If a company is having excess cash with it
and they have no better plan to invest the money. So by keeping excess cash with them they
would not getting anything or they will get few interest on it. But if a company is having
extra cash it means that the company is in good situation and performing well in current
situation and will also perform better in future. Instead of keeping money with them or earn
few interest on the money it will be better for a company to invest the money in buyback
program which will give them more profit in future than keeping money with them, by
increasing the earning per share. It also increase the dividend as the number of outstanding
share will decrease.

7 Id

8 R. Dobbs, The Value of Share Buy Back MCKINSEY AND COMPANY (August, 2005)
available at http://www.mckinsey.com/business-functions/strategy-and-corporate-
finance/our-insights/the-value-of-share-buybacks (Last visited on 28 August)

9 S. Whyte, The Reason For Disinvestment, KAIETEUR NEWS, (May 21, 2012), available at
http://www.kaieteurnewsonline.com/2012/05/21/the-reasons-for-divestment/ (Last visited on
August 27)

National Law School of India University Page 6

National Law School of India University Page 7
Chapter 2

EFFECT OF SHARE BUYBACK

INCREASE IN THE DEMAND OF SHARES

The reason for share buyback could be like that which would affect the market, market in
India is so sentimental that the investors dont see how the company is performing in the
market they see that what is the demand of shares of a company in the market. When a
company start buying back their shares, then the number of investors will increase and thus
increases the demand of shares of in the market. When investors see that the demand of share
of a particular company is increasing then they would like to invest, otherwise they might not
want to invest in the company. Because they might now think that the demand of shares are
increasing which means that the company will make huge profits in the future and by
investing in this company they would like generate more profit which they cant generate by
investing in the other company.

National Law School of India University Page 8

Graph-1

INCREASE IN PRICE OF SHARES

When a company buyback its share, then It would affect the price of share in the market. It is
due to shifting of demand curve. The reason behind shift in demand curve is due to increase
in utility. It is because when company buyback the number of shares in the company will
decrease and due to which there will be more dividend for each share holder and the
satisfaction of the shareholders will increase. So it would increase the utility of shareholders.
Dividend is the amount of money paid to shareholders from the profit, given to share holder
as a part of the company. But as the dividend will increase the more number of investors are
willing to invest in the company.10 Due to increase in demand of shares the demand curve will
shift outwards and the supply of the shares will decrease so the supply curve will shift
inwards. Thus according to the economic principle of demand and supply the price of shares
will increase.11

10 Share Buy Back: What You Need To Know, available at http://www.suredividend.com/share-buybacks/ (Last
visited on August 28)

National Law School of India University Page 9

 INCREASE IN VALUE OF SHARE AND CONTROL OVER THE COMPANY

Tabl
If a company is having excess cash resource then it would like to buy back the shares from
market instead of paying more dividends. Before buy back of shares there are more number
of shares in the market so the supply in market of shares is high so the price is less and after
share buyback there are less number of shares in the share market so the price of shares are
high. Due to share buyback the number of shareholders decreases and the companys value
remain in the hand of fewer shareholders that are available, and now the each share shows a
bigger ownership and the value of each share will be more. As now the percentage of share of
a company is more than the earlier situation, therefore the control over the company is more.

INCREASE IN EARNING PER SHARE

The term earning per Share tells us that how much money each share of the companys stock
earned for the company. So in order to increase earing per share company buy back share and
when no of shareholders will decrease then earning per share will increase. So when earning
11 J.Victor, Dividend vs Bonus, SHARE MARKET SCHOOL, (October 28,2011) available at
http://www.sharemarketschool.com/dividends-vs-bonus/ (Last visited on September 1)

National Law School of India University Page 10

per share is higher, then the stock price is higher and now the satisfaction of the investors are
higher than the earlier situation in which there are more number of shares. The Earning per
share is calculated by the given formulae,

EPS = (Net Income Preferred Dividends)/ Number of Common shares outstanding.12

So as the number of shares in the market is decreased then each shareholder will get high
earning per share even though the benefit of the company remains the same after and before
the buyback of shares.

12 Supra note, at 10

National Law School of India University Page 11

 Table:1.13

13 Id

National Law School of India University Page 12

STABILISATION OF MARKET DUE TO SHARE BUYBACK
There are many reasons why a company buys back its shares. One of the most important
reasons for this is stabilisation of market. Since a company going in loss for a long time due
to many reason such as ineffective management and lack of other facilities which is needed to
improve the operation of company, so in such a scenario company comes in to market and
buy back their own share. Company start buying back their share because now it is the
responsibility of company to establish the confidence of the investors which can be done by
investing in the company and to ensure to existing shareholder by producing wealth in
company during the crisis and at the time when company is not performing well in the
market. And by doing this company is able to stabilise the market. By this type of co-
operation the morale of the investors will boost and make them connect with the financial
market.14

14 M.C. Sekhar and A.A. Khan, Share Buyback A Way To Stabilise Indian Financial Markets,
FORBES INDIA, (March 28, 2016) available at http://forbesindia.com/article/special/share-
buybacks-a-way-to-stabilise-indian-financial-markets/42787/1 (Last visited at August 26,
2016)

National Law School of India University Page 13

CHAPTER: 3

BUY BACK OF SHARES BY PSUS

DISINVESTMENT IN PUBLIC SECTOR UNIT

Disinvestment means selling or liquidating an asset. There are minority disinvestment,
majority disinvestment and complete privatisation. In minority disinvestment government
retains the majority stake in the company and thus having control power with them. In
majority disinvestment the government after the disinvestment retains minority stake in
company. In complete privatisation there is a majority disinvestment in which complete
control i.e. 100% given to the buyer.15 There could be many reasons for disinvestment in
public sector unit by government. The one reason may be that due to government failure in
public sector unit .Many public sector unit failed in earning profit when remains in the hand
of government and which eventually waste the government resources. Government might
want to bring foreign companies to invest in public sector unit in order to make public sector
unit more efficient. When foreign companies will in public sector units they want to generate
as much profit as they can which can be done by utilising proper sources and in proper and
efficient way and So when private entity come they will bring all kind of technological skills
as well as managerial skills to improve the level of operation of which will bring a company
on the path of growth. When the private ownership in introduced into the company the
functioning of enterprise will increase. By disinvesting in public sector unit government can
meet their financial demand and can reduce financial burden on government.16

15 S.S.Koner and J.Sarkhel, Disinvestment of Public sector in India, 3(6) IOSR JOURNAL OF
ECONOMICS AND FINANCE 48 (May, 2014)

16 S.Verma, To Boost Capital Availability: Govt in Talks to Buy Back 25% Shares Of BEL,
THE INDIAN EXPRESS, (July 17, 2016) available at
http://indianexpress.com/article/business/market/bel-shares-government-buy-back-capital-
availability-boost-market-2918595/ (Last visited on August 29, 2016)

National Law School of India University Page 14

National Law School of India University Page 15
 Table:2 Disinvestment By Government For Decreasing Fiscal Deficit.17

Year Centers Gross Disinvestment Disinvestment as % of

Fiscal Deficit Proceeds Fiscal Deficit
1991-92 36323 3038 8.36
1992-93 40173 1913 4.76
1993-94 60257 0 0
1994-95 57703 4843 8.4
1995-96 60243 362 0.60
1996-97 66733 380 0.57
1997-98 88937 902 1.01
1998-99 113349 5371 4.74
1999-00 104717 1829 1.50
2000-01 118816 1870 1.37
2001-02 140955 5632 3.99

REASONS FOR GOVERNMENT ASKING PSUs TO BUYBACK SHARES

Share buyback is a smart way for government in order to raise their resource. When public
sector unit is buy backing shares then from the side of government it is disinvesting in the
PSU and if a public sector unit is buying back share then due to which there will be an inflow
of cash to government. And at the time when the larger public sector unit is buying back
share s then the cash flow will be larger. Since government is already struggling in many
ways to meet their financial demand. So share buyback is a better option with them because it
provides an option of raising resources without diluting the shares of private shareholders.
The reason for it is to provide financial support to the government. And these resources must
be provided to the social sector such as public health, education etc. So government can use
these resources by releasing them which are locked up in the public sector unit. Demand of
both in the state as well as in the centre is increasing.18

So buy back for public sector unit is necessary because by buyback there is more
privatization in the public sector unit and the private sector ownership leads to better use of
resources and in an efficient manner. Only a very-2 small section of the country is working in
public sector unit. So to provide work to more number of people, growth is necessary in

17 V.Pradhan, Disinvestment of Public Sector Enterprises In India:Need or Compulsion?, (2010) available at

http://s3.amazonaws.com/academia.edu.documents/37009797/Refresher_Paper (Last visited on August 31)

18 Id, at 12

National Law School of India University Page 16

public sector unit. In the table given below we can see that the private sector performs better
than the public sector in majority of cases.19

Table: 3 Price Earning Ratios of Public and Private sector.20

Public sector Firms PER Private Sector Firms PER

IDBI 6 ICICI 18.63

GAIL 15.3 Gujarat Gas 21.39

BHEL 13.71 ABB 266.7

IOC 10.26 RIL 11.8

ONGC 12.47 Castrol 25.69

So when PSU buyback share then there is disinvestment for the government and by this the
government is able to reduce the fiscal deficit.

CONCLUSION

In conclusion, the researcher would like to state that though the government was facing
problems in the private sector enterprise past two and half decade but now government is able
to control the decline in public sector by disinvesting and allowing PSU to buyback share and

19 Id, at 8-9

20 Id, at 5

National Law School of India University Page 17

privatizing the PSU. Buy backing of shares by PSU can help the government to meet their
financial demand which can be used for funding in various social sector schemes like
Mahatma Gandhi National Rural Employment Guarantee Scheme, Indira Awas Yojana,
Jawaharlal Nehru National Urban Renewal Mission and at many more places and for
companies share buyback program is a way to remain in the market at the time when the
company is not performing well.

Apart from all this the researcher argues that, there is an incentive for the companies to buy
back their shares as it increases the value of the shares and increases the satisfaction of the
investors and while PSU buying back the shares the government should be clear in deciding
and convincing the concerned PSUs to starts the proceeds of disinvestment because it is not
the only and last way to remove the problem of fiscal deficit and now the problem of fiscal
deficit is not like that as it was during the 1990s. So it should be done not only for the
problem likes fiscal deficit but for increasing the efficiency of the PSUs.

National Law School of India University Page 18

 BIBLIOGRAPHY

ARTICLE

1) S.S.Koner and J.Sarkhel, Disinvestment of Public sector in India, 3(6) IOSR

JOURNAL OF ECONOMICS AND FINANCE 48 (May, 2014)
2) S.Verma, To Boost Capital Availability: Govt in Talks to Buy Back 25% Shares Of
BEL, THE INDIAN EXPRESS, (July 17, 2016) available at
http://indianexpress.com/article/business/market/bel-shares-government-buy-back-
capital-availability-boost-market-2918595/ (Last visited on August 29, 2016)
3) V.Pradhan, Disinvestment of Public Sector Enterprises In India:Need or
Compulsion?,(2010) available at
http://s3.amazonaws.com/academia.edu.documents/37009797/Refresher_Paper (Last
visited on August 31)
4) M.C. Sekhar and A.A. Khan, Share Buyback A Way To Stabilise Indian Financial
Markets, FORBES INDIA, (March 28, 2016) available at
http://forbesindia.com/article/special/share-buybacks-a-way-to-stabilise-indian-
financial-markets/42787/1 (Last visited at August 26, 2016)
5) S. Whyte, The Reason For Disinvestment, KAIETEUR NEWS, (May 21, 2012),
available at http://www.kaieteurnewsonline.com/2012/05/21/the-reasons-for-
divestment/ (Last visited on August 27)
6) S. Whyte, The Reason For Disinvestment, KAIETEUR NEWS, (May 21, 2012),
available at http://www.kaieteurnewsonline.com/2012/05/21/the-reasons-for-
divestment/ (Last visited on August 27)
7) J.Victor, Dvidend vs Bonus, SHARE MARKET SCHOOL, (October 28, 2011) available at
http://www.sharemarketschool.com/dividend-vs-bonus/(last visited on September 1)

WEBSITES

1) http://www.suredividend.com/share-buybacks

2) http://financetrain.com/what-is-share-repurchase-and-methods-of-share-repurchase

3) http://www.livemint.com/Money/IoBGW70rsPWDyhCO1wySWL/Tax-rules-tilt-

scales-in-favour-of-buybacks-versus-dividends.html

4) https://www.scribd.com/doc/33399516/Buyback-of-Shares

5) https://blog.religareonline.com/2016/06/22/psu-share-buyback/

National Law School of India University Page 19

National Law School of India University Page 20