UNDERSTANDING THE EFFECTS OF UNIVERSAL BASIC BUYBACKS ON FINANCIAL STATEMENTS AND RESIDUAL INCOME VALUATION

Abstract

Share repurchases, also known as buybacks, have been a source of controversy due to misperceptions about their impact on firms and shareholders. This paper examines the economic effects of share repurchases and establishes the theoretical underpinnings and accounting mechanics of these transactions. Contrary to popular belief, share repurchases do not increase a company's share prices but do reduce market value, increase financial leverage and certain profitability metrics, and increase the equity cost of capital. The paper uses financial statement analysis and a residual income valuation (RIM) approach to demonstrate the economic effects of these transactions. The focus of the paper is to debunk some of the common myths and misperceptions surrounding the effects of share repurchases and provide a sound basis for evaluating these transactions. The paper contends that returning surplus capital to shareholders for external investment opportunities is historically considered sound corporate governance