The Hindu Business Line : What's the rationale behind share buyback?

There seems to be some confusion. Section 77 of the Companies Act does not allow a company to buy its own shares but the subsequent Section 77A permits buyback subject to certain conditions. What is your view on this?

Tara Ramachandran, Chennai

To start with, the company law in India frowned upon a company trading in its own shares in common with the US and the UK.

It was rightly considered that any freedom in this regard would whittle down the priority given to creditors vis-à-vis the shareholders, the fundamental principle of company law being shareholders as risk takers should be the last to be serviced by a company with the first ones to be served being the creditors both while a company is a going concern and also when it is under liquidation.

The US was first to relax this rigour. Soon the UK also brought a thaw in its law. And when these two role models diluted their concern for the creditors, India couldn't resist the temptation of following suit.

But to the credit of the UK and India it must be said that buyback in these two countries are for immediate cancellation and not for chronic tinkering which permitting buyback for treasury operations, as is the case in the US, implies.

Be that as it may, the rationale for buyback is when a company has excess capital it should be allowed to boost its earnings per share by chopping off the dead wood.

While this is supposed to be what that triggers buyback in the US, in our country experience shows that buyback has often been done with an non-altruistic motive — to allow promoters to get a better hold on the company.

To wit, if the existing promoters in the saddle are having 20 per cent of the shares and the company announces a 20 per cent buyback in which obviously the promoters will not participate, the bottomline would be their stake now going up to 25 per cent (20 divided by 80).

There cannot be a simpler and less expensive way of beefing up one's control in a company. In fact the promoters gain at the expense of the company whose cash is used in bankrolling this exercise.

(ASK! Send in your queries on accounting, auditing, corporate law and taxation to ask@thehindu.co.in.)

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S. Murlidharan

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