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

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HOW TO EXECUTE YOUR SHARE REPURCHASE PROGRAM

Companies that bought back their own shares have subsequently posted returns between two and 12 percentage points above the market average, which is billions of dollars in shareholder value.9 However, not all buybacks are created equal.

A poorly designed share repurchase can be damaging. For example, in May 1998, Samsonite announced a fixed tender offer for about one half of all outstanding shares, at a 30 percent premium over market, to increase leverage and allow a financial sponsor to exit. Investors did not believe that Samsonite’s operating performance justified such a large increase in financial leverage and read the investor exit as a negative signal. The size and premium of the buyback worked against the company with the share price initially plunging 50 percent and another 50 percent over the summer. The transaction transferred $200 million of wealth from nontendering to tendering shareholders and was subsequently the target of considerable litigation.

Generally, any time a corporation transacts in its own shares there is no taxable event. Internal Revenue Service (IRS) Section 1032 exempts gains or losses from taxation. However, if an equity transaction does not benefit from Section 1032 exemptions, gains and losses may be taxable as expenses associated with executing the transaction will generally be deductible. For a traditional buyback, the accounting impact is reflected in the equity account and cash account as of the settlement ...

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