Why does this reduce capital, and why does this reduce the company’s ability to pay creditors?
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Because they’ve spent money. Capital is money. If you spend money to buy something you have less money and therefore less capital. If you have less money then that reduces your ability to pay other people, like creditors.
Let’s say I want to sell shares in a farm (the whole 100% to keep it simple). I can decide how many shares to sell, or how many pieces the ownership will be divided into.
I could divide it into 2 shares, and give my wife one. Or I could divide it into 6 shares, keep 1, give 1 to my wife, and 1 to each of the 4 kids. As the owner you decide (basically) on how much shares to offer.
Say I decide to offer 200 shares for sale that would effectively mean each share get the profit from half arce of land. So people give money to the company and receive a share of the profit.
Let’s say the farm does well and we have huge profits, the owners can decide to buy back the shares in this example they buy back 100 shares. This means they do the opposite of the initial offer, they give money to people (shareholders) and get the shares back. So less shares are now on the market, now the total shares are 100 and each share is of a full acre.
Tldr.
Share buy back is effectivly the opposite of an initial public offering.
Do purchased shares get dissolved, or does the company actually own itself and experience gains and loses on that value?
Imagine a million people each own 1 share. The company makes a million in profit this yeah so each share holder gets a dollar. Then the company buys back 500,000 shares. Next year the company also makes a million in profit but since there are only 500,000 shares outstanding each shareholder gets 2 dollars.
There’s a company worth $50, that has 10 shares each worth $5. The company ends the year with $10 in profit, so instead of giving that $10 to the shareholders as dividends (which are taxed as income), they spend that money to buy 2 of the shares. Now there are 8 outstanding shares but the company is still worth $50, so each share is worth $6.25, and the remaining shareholders have the choice of when to sell their shares and realize their gains (which are taxed as capital gains, which can often be lower).
TLDR: Like 90% of finance and accounting, its about paying less taxes.
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Market makers create naked shorts, sell into the company’s buy back, pockets all the money, and foments to drop the price before cashing in.
Oh, you thought it reduced the supply of shares and drove up the price? Bless your heart.
Overall, think of selling shares as raising money for the company. You sell a chunk of the company in return for cash, which you can use to grow the company. But now you’re successful and have a lot of cash, so you can buy some of those shares back, which really means you pay the owners off so that those shares cease to exist. This raises the value of the still outstanding shares since the value of the company is divided among fewer shares. If the company pays dividends, this also could mean less in dividends to pay.
I borrowed money from my two brothers.
I have 10 tickets to see a movie in the far future, but my big brother wants some money back. I sell 4 tickets to a friend to pay him back.
I end up having left over money so I buy two tickets back that I previously sold.
Uh oh, now my little brother wants me to pay him back, but I spent too much money buying back tickets.
If I want more money, I’ll have to sell tickets/shares.
A share is a piece of paper. It’s a contract that says you own some percentage of a company.
As the company goes along, sometimes it needs money. To get that money, it can either sell part of itself (issue shares) or borrow money. To get lots of money (there are factories that cost a billion dollars to build, and some that cost more), they issue bonds. Like shares, they’re contracts, but bonds are to simply pay interest until the maturity and then pay off the principal.
Corporations are (mostly) large. They generate lots of money every year, but they use lots of money every year. Much of the money they use comes from the money they get. But sometimes they make more money than they need. There are several things they can do with this money.
1. They can pay larger dividends to the shareholders. This makes the owners happy, but it also creates the expectation that next year the dividend should be even larger, and if it isn’t then the shareholders get mad.
2. They can use it to expand the business. Open more stores, build more factories, whatever.
3. They can save it for when they do need the money. This is dangerous because corporate raiders tend to buy companies with large cash reserves (“unused assets”) and then use the cash to pay off the loans they took out to buy the company. Just like a dragon sitting on a hoard of gold, you have to watch out for adventurers.
4. Or they can use it to buy shares on the open market, essentially giving the shareholders the choice of selling (turning their shares into cash) or holding (having a shares that are worth more). This gets rid of that juicy target for adventurers to come in and steal their gold.
When they own the shares, they become what are called treasury shares. The corporate charter says how many shares they can issue. If they just sit in the treasury, they can just choose to sell them any time they want. If they retire them, then in order to issue more they have to issue new shares, go through SEC registration, pay one of the financial banks (not commercial banks) to sell them, and so forth. Lots of work and expense.
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