What is Treasury Stock and Why Do Companies Buy Back Their Shares?

A share buyback occurs when a listed company purchases its own shares on the market. This type of transactions involving treasury shares are regulated by the Spanish Corporate Enterprises Act (LSC), approved by Royal Legislative Decree 1/2010, and by Regulation 596/2014 of the European Parliament on market abuse.

The repurchased shares are recorded on companies’ balance sheets as treasury stock, which implies that they lose their economic rights (dividends) and political rights (the right to vote at meetings). In many cases, these shares are subsequently redeemed, meaning they are removed from the share capital. Once redeemed, the shares cease to legally exist and cannot be sold or used again.

This process directly affects earnings per share (EPS): as the number of shares outstanding decreases, if earnings are maintained or increased, EPS increases. However, it should be remembered that these operations imply a cash outflow for the company, which may impact its future investment capacity.

According to financial literature, there are several reasons behind buybacks:

• Increase earnings per share (EPS)
• Cash distribution of surpluses
• Indicate that the share is undervalued
• Fund employee stock incentives
• Adjust the capital structure

Buybacks offer flexibility when it comes to modulating shareholder remuneration of listed companies and are presented as an additional element of management and capital allocation with the capacity to generate shareholder value.

A recent study analyzed S&P 500 companies and Spanish banks in order to answer three key questions:

1. Do they create shareholder value?
2. Do they affect investment capacity and competitiveness?
3. Can they be considered a form of market manipulation?

The main conclusions were:

• Buybacks create value when they achieve a sustained increase in EPS.
• They are not responsible for the increase in debt or the decline in investment but rather reflect greater corporate conservatism in the post-2008 crisis era.
• Their effect on the stock price impact is generally positive in the short term, although this impact tends to be diluted in the long term.

In Spain, it has been observed that buyback programs are usually followed by a rebound in the stock market reaction to buybacks, because they are perceived as a positive sign about the company’s future. However, this effect disappears in the long term.

One of the most frequently cited reasons for buybacks is their ability to provide flexibility in shareholder remuneration. Unlike dividends, which investors tend to regard as stable and expect their payments on scheduled dates, buybacks may be suspended or not carried out without generating such a strong negative reaction in the market.

Furthermore, although from a financial point of view dividend vs buyback are equivalent, buybacks allow shareholders who retain their shares to increase their relative stake in the company.

Since the mid-1980s, share repurchase and stock buyback practices have been gaining ground in the United States, but in Europe, the phenomenon has intensified more recently. In Spain, they gained momentum from 2021 when the European Central Bank lifted the recommendation against distributing dividends during the pandemic.

In this context, many institutions, especially banks, took advantage of excess liquidity and low returns on investments to reward their shareholders through buyback shares and repurchase of shares.

From a legal standpoint, buyback regulations and corporate governance and buybacks have also attracted particular attention from the legislator. The main concern is preventing the treasury shares acquired by the company – whether originally or through derivatives – from being used in a way that distorts the corporate balance or leads to an excess of power on the part of the directors, to the detriment of other shareholders.

In this regard, the legislation provides for the suspension of voting rights and the redistribution of economic rights proportionally to the remaining shares outstanding. The only exception is the right to receive free shares through processes such as bonus share issues, which are not redistributed.

However, even though they do not grant voting or economic rights, they are still considered part of the total issued capital.

This legal treatment seeks to ensure that holding treasury shares does not alter the rules of the game or grant disproportionate advantages within the corporate structure, thus maintaining equity among shareholders and transparency in management.

The maximum limit on treasury stock for non-listed companies is set at 20% of the subscribed capital, while for listed companies it may not exceed 10% of the subscribed capital, reflecting the legal limits on treasury shares and buyback restrictions in Europe.

Share buybacks are neither good nor bad in and of themselves. They are, above all, a capital management tool that can generate shareholder value if used responsibly, transparently and at the right time.

Although the debate remains open, it is true that an increasing number of companies are resorting to this formula to remunerate the shareholder, especially in a context of excess liquidity, high interest rates and markets that demand efficiency.