Corporate Governance and Regulatory Impact on Mergers and Acquisitions

10

Share buybacks, institutional

investors, and corporate control

Paul U. Ali

Abstract

Corporations routinely use buybacks to return excess capital to their shareholders,

manage their capital structures, and convey signals to the market about the cor-

poration’s financial performance. These are the publicly disclosed motivations for

the vast majority of buybacks that occur in the Australian market. This chapter

examines how buybacks can be used by Australian corporations to achieve those

aims as well as undisclosed objectives such as consolidating management’s control

of the corporation and creating a deterrent to takeover bids.

10.1 Introduction

Australian corporations, in common with their counterparts in markets such as

the United States, routinely make use of share buybacks to channel excess cap-

ital to their shareholders, reorganize their capital structures by contracting the

corporation’s equity base, or provide a boost to a flagging or stagnant share

price. However, compared to U.S. corporations, the rate at which Australian

corporations have resorted to buybacks can be described as “pedestrian”

(Mitchell and Robinson, 1999), with dividends remaining the dominant means

by which Australian corporations make cash distributions to their shareholders.

Despite the low rate of take-up of buybacks by Australian corporations, buy-

backs in the Australian market, in line with markets displaying far greater buy-

back activity, have evolved beyond their original role.

Foremost among these newer uses of buybacks is their employment as a defen-

sive measure against takeovers (Bagnoli, Gordon, and Lipman, 1989; Hunt,

2004). The boost to a target corporation’s shares provided by a buyback can

make it considerably more expensive to acquire a corporation and erode the fea-

sibility of a hostile takeover bid. Moreover, the removal of potentially hostile or

disloyal shareholders from the corporation’s share register has the effect of reduc-

ing the free float of shares that can potentially be sold into a hostile takeover bid,

and by so doing consolidates control of the corporation by interests supportive of

the incumbent management who have not participated in the buyback.

The role of buybacks in the market for corporate control has received wide-

spread attention following the recent contest for control of Arcelor Steel, the