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Strategic Corporate Finance: Applications in Valuation and Capital Structure by Justin Pettit

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HOW LARGE SHOULD YOUR BUYBACK PROGRAM BE?

The optimal size of shares repurchased in a buyback depends in part on the amount of excess capital, stock float, other company-specific factors, and in part, on the purpose of the buyback.

Capital Efficiency

In cases where a company wants a mechanism to distribute excess capital, a small, steady signal-neutral open market program may well be its most appropriate choice. The program can be turned on and turned off without the worry of sending unintended signals to the market.

Beyond simple cash management, a secondary objective common to such programs is to offset the equity dilution of equity-related compensation schemes. Therefore, these share repurchase programs are typically calibrated to maintain flat to slightly rising cash balances, with flat to slightly declining share counts. These programs typically amount to roughly 1 to 2 percent of shares outstanding annually. A quarterly budget is generally set to achieve these goals for cash and share count, but execution is often opportunistic with respect to market pricing.

In practice, so many companies announce open market share buyback authorizations that there is generally little signaling effect from authorization alone. Open market repurchases are often signal-neutral, making them more flexible than dividends for residual cash distribution.

Signaling

If the primary goal is to send a signal to investors, one yardstick for deciding the size of a signaling buyback is its materiality ...

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