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In light of the Covid-19 crisis, my country's banks have seen their shares' prices drop. Last week, the banks announced that they will doing a share buyback, and this week, the prices of the shares have increased...

Is there any reason why the banks are buying their own shares at a crisis like this?

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  • Hi and welcome to PF&M stack overflow. This is likely to be closed as an economics question but it is borderline so I won't vote to do so. The most useful change that you could make is to add a tag with your country information to the question as it is hard to give you an answer without knowing which country you are talking about!
    – MD-Tech
    Commented Mar 25, 2020 at 11:41
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    @MD-Tech There are borderline economics implications, but understanding the flow of corporate funds is an important thing for a personal investor to understand. Commented Mar 25, 2020 at 13:42

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Assume there is a corporation that makes spoons, with $10M in cash. Its single factory is already pumping out as many spoons as it can. There is also no need to open a new factory, because our market research team has determined that no one will buy the new spoons from the new factory. Our R&D team doesn't know how to make anything but spoons.

So, what does the company do with the cash? It could (1) sit on it, and earn basically nothing. Or it could (2) invest it in something completely unrelated to the spoon business. Or, it could (3) send it back to the shareholders. Let's look at each option:

(1) If the company just keeps the cash in the bank account, then it will earn basically no interest, and the investors who own shares in the corporation will be unhappy to get such little returns on corporate assets. If they wanted to have a low-risk cash portfolio, they would do that with their own money, they wouldn't want their spoon-making-investment to make that decision for them.

(2) If the company invests in non-spoon related things, then perhaps it will get into trouble by making foolish business decisions. Buying a fork-making factory could lead to trouble - why what if our spoon scientists forget to make the tines, and just makes the whole thing rounded, based on what worked for them in spoon making?? Again, if a company steps outside of its area of expertise, it is deciding, on behalf of its shareholders, to diversify its portfolio. But the shareholders could make that decision themselves, and doesn't necessarily want the corporation to make this decision. Note that some companies do successfully diversify, but it is typically part of an overarching plan that makes sense together, or else it often fails.

(3) If the company returns the cash to the shareholders they can decide for themselves what to do with the cash. Some will invest in low-risk things like government bonds or simple savings accounts earning minimal interest. Some will invest in competing spoon-makers, and some might invest in new fork-making ventures. But the decision on how to invest goes back to the individual shareholders.

Buying back stock is just one way to get money back to shareholders. The other common way would be to pay out a dividend. In financial theory, there are basically 3 differences between a share buy-back and a dividend: (A) A buyback is optional, meaning only the shareholders looking to sell their shares, will have shares bought by the company; (B) A buyback happens relative to the current share price in the market, meaning that part of the decision to make a buyback could be based on whether the company believes itself to be undervalued; and (C) the tax implications are different [In general, most countries tax capital gains on selling your shares, at a lower rate than corporate dividends].

So, why would a bank do a share buyback right now? Probably because interest rates are at a historic low, meaning that the bank has a limited ability to invest its capital to earn what it feels are good returns. So instead, it is leaving the choice to its shareholders how to invest - and because the bank probably feels its shares are undervalued, it is preferential to do this instead of paying a dividend. For the shareholders who remain in the company, the increase in share price is an indication that the decision made by the bank was one that benefited them.

Quick note on the political aspect hinted at here: The main reason it is contentious to do a share buy-back in times like this, is that a government could give a stimulus package to a business, with the goal of having that business invest in itself, hire workers, etc.; if instead of investing in itself it just pays out the cash to shareholders, the government has effectively 'bailed out' the relatively wealthy individuals who own shares, rather than the working class who they were attempting to get jobs for.

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  • I know the theory, but would like to know if you have any practical insights. Theoretically "you buy a piece of the company", in practice I have the feeling that a stock isn't worth anything besides the dividend and selling it for more money (unless you bought a significant piece of all shares). I also assume that the stock price isn't increasing linearly in relation to the buy-backs. So will the stock price increase permanently after buy-backs or is it a short term effect because of the news? Is there any data on this?
    – user27411
    Commented Mar 25, 2020 at 20:01
  • @chris Having the right to receive dividends is 'owning a piece of the company'. The only other sense of it is that if you buy $10 of GM stock you own one of the door handles on one of the factories - what other sense of 'ownership' is important to you except the legal right to the value it creates? And yes if a company has $10M in cash and $30M in other assets less $5M of debt, it would be worth ~$35M, and if it had 1,000 shares outstanding worth $35,000 each, and used the $10M cash to buy out ~285 shares, there would be 725 shares remaining owning a company worth ~$25M. Commented Mar 25, 2020 at 20:04
  • @Chris The math on it basically means that if you didn't sell your shares to the company, you are left with a bigger piece of a smaller pie, worth the same net amount as if you did nothing - except that the share price may rise reflecting a change in the market opinion based on how the company acted - this part is not necessarily permanent. Commented Mar 25, 2020 at 20:05
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Because they have money and stocks are cheap. The more company own itself the less it have to share profit with others.
Having less dividend to pay out means more profit for the bank in the coming years.
Bank don't look at the situation as "crysis like this". They look at low price of their shares. They don't care about the reason (in very layman terms and to some extention), they look at best possible outcome for few next years possible decades.

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    The company doesn't "own itself". Shareholders still own the company, only now it is a smaller group of shareholders. This is a common but important distinction. Commented Mar 25, 2020 at 13:10

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