Why do companies buy back their own shares?
In: Economics
The point of being a shareholder in a company is so that you will earn an income based on the profit of that company despite having done no work for the company. There are two ways the company can transfer that profit to its shareholders:
1) The company can pay a dividend in which all shareholders get a fixed amount of money per share that they own. Dividends usually provide a small but predictable, passive income and are historically what most stock investors were looking for. More modernly, large institutions with fixed payment obligations, such as pension funds, like to invest in companies that pay a decent dividend due to the predictable nature of the income.
2) The company can buy back shares. This will cause a short term increase in the demand for the company’s shares and a long term decline in the supply of the company’s shares. The result of this is that shareholders who want to cash their shares out are able to do so at a higher than normal price, while shareholders who want to hold onto their shares see the paper value of the shares increase.
The modern stock market has seen a shift towards speculative, gambling based investment. IE, the Wallstreetbets mentality is becoming more widespread, particularly among investors under the age of 35. Investors who are doing so by gambling don’t want a small but predictable return on their investment. They want large, unpredictable returns and the possibility of a large stock buyback better satisfies that investment strategy.
Something to keep in mind is that the shareholders of a company are the *owners* of that company and the company’s management is supposed to do what the shareholders want. If a significant percentage of the shareholders have invested in the company hoping for a large stock buyback so they can cash out, then that’s what the company is going to do.
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