" DIVIDEND POLICY "

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The earnings of a company is equal to the sum of dividend and retained earnings. Hence,

E = D + R

where R represents the retained earnings. In the above model if E is replaced with (D + R),

P =

= m

The model thus gives 4 times more weightage to dividends in relation to retained earnings. It may be noted that the weightages are subjective and are not derived from any empirical data. While the weightages assigned are debatable, the essence of the theory is that the market is overwhelmingly in favor of liberal dividend pay-out. The dividend policy has a critical impact on the market valuation of the firm.

Illustration 9.1

Alpha Ltd. has recorded an EPS of Rs.6 for 1998-99. The company follows a fixed dividend pay-out ratio of 75%. If the multiplier for the industry is 12, compute the expected market price for the share based on the Graham-Dodd Model.

Solution

The dividend per share is Rs.6 ´ 0.75 = Rs.4.50

Based on the Graham-Dodd Model, the expected market price would be

P = m (D + E/3)

= 12 (4.50 + 6/3)

= Rs.78 per share.

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Walter Model

The model devised by Prof. James Walter considers dividend as one of the factors determining the market valuation. It also considers the returns earned by the firm on its retained earnings vis-a-vis the cost of capital of the firm. The model says that the market price of a share is the sum of the present value of the future stream of dividends and the present value of the future stream of returns from the retained earnings.

The model makes the following assumptions:

1. The firm is a going concern and has a perpetual life span.

2. The only source of finance available to the firm is retained earnings. The firm does not have any alternative means of financing.

P = m

=m

3. The cost of capital and the return on investment are constant throughout the life of the firm.

According to the model, the market valuation of its shares is

where,

P is the market price per share

D is the dividend per share

E is the earnings per share

r is the return on investments

k is the cost of capital

The model implies that a firm should have 100% dividend pay-out if the IRR on its investments is less than its cost of capital. Conversely, a firm which is able to generate higher IRR on its investments in relation to its cost of capital, should retain its entire earnings and no dividends should be declared. The dividend policy of a firm is irrelevant if the IRR is equal to its cost of capital.

Illustration 9.2

Beta Ltd. paid a dividend of Rs.4 per share for 1998-99. The company follows a fixed dividend pay-out ratio of 50%. The company earns a return of 18% on its investments. The cost of capital to the company is 12%. Determine the expected market price of the share using the Walter model.

Solution

The EPS of the company is

EPS = =

= Rs. 8.00 per share

According to the Walter model

P = =

= Rs. 83.33 per share

Gordon Model

The Gordon model values the share by capitalizing its future stream of dividends. Myron Gordon maintains that the growth rate of a firm is a product of its retention ratio and the return on its investments. The assumptions of the model are similar to those of the Walter model:

1. The firm is a going concern and has a perpetual life span.

2. The only source of finance available to the firm is retained earnings. The firm does not have any alternative means of financing.

3. The cost of equity and the return on investment are constant throughout the life of the firm.

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1. The cost of equity is greater than its growth rate.

The model is expressed as:

P₀ =

where,

P₀ is the market price per share at the beginning of Year 0

Y₀ is the expected earnings per share for Year 0

b is the retention ratio (retained earnings/total earnings)

r is the return on investments k is the cost of equity

The following implications can be drawn from the model:

· When the cost of equity exceeds the return on investment, the pay-out ratio should rise to increase the market price;

· When the cost of equity equals the return on investment, the changes in the pay-out ratio will have no impact on the market price;

· When the cost of equity is less than the return on investment, the pay-out should be reduced to increase the market price.

Illustration 9.3

Gamma Ltd. follows a policy of fixed dividend pay-out of 75%. The EPS for 1998-99 is Rs.4 per share and the same is expected to grow by 25% during 1999-2000. The firm earns a return of 20% on its investment. The cost of equity of the company is 15%. Compute the value of the share as on 31.03.2000 using the Gordon Model.

Solution

The expected EPS for 1999-2000

Rs.4.00 x 1.25 = Rs.5.00 per share

The retention ratio of the firm

Retention Ratio = 1 - Pay-out Ratio

= 1 - 0.75

= 0.25

According to the Gordon Model the expected value of the share is

P₀ =

=

= Rs. 37.50 per share

Modigliani-Miller Position

Franco Modigliani and Merton Miller propound that the dividend pay-out is an irrelevant factor in the market valuation of firms. They assert that the value of shares is solely determined by "real" considerations i.e. the earning power of the'firm and its investment policy. The distribution of earnings in the form of dividends has no bearing on the valuation of the firm. The proportion in which the earnings are split between dividends and retained earnings has no affect on the wealth of the shareholders.

Assumptions

The MM hypothesis is constructed on the assumptions of an ideal economy. An ideal economy is characterized by perfect capita! markets, rational behavior and perfect certainty.

Perfect Capital Markets has a large number of issuers and investors. The transactions of no single participant can have an appreciable impact on the market prices. Information is costless and is equally accessible to all.

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There are no transaction costs in the form of brokerage fees, transfer taxes, etc. for buying and selling of securities. There are no flotation costs like issuing costs and underpricing, to the issuer, for the issue of new securities. There are not a differentials between distributed and undistributed profits or between dividends and capital gains.

Rational Behavior means that investors always prefer more wealth to less. Further they are indifferent as to whether a given increment to their wealth takes the form of dividend flow or an increase in the value of their shares. Modigliani and Miller extended the usual postulate of rational behavior by introducing the concept of symmetric market rationality. The Symmetric Market Rationality hypothesis is based on the premise that every investor also imputes rationality to the market. He assumes that all other investors are rational and they, in turn, also impute rationality to the market. This concept not only covers the choice behavior of individuals but also their expectations of choice behavior of others. The symmetric market rationality cannot be deduced from individual rational behavior. If an ordinarily rational investor has good reasons to believe that other investors would not behave rationally, then it might be rational for him to adopt a strategy he would have otherwise rejected as irrational. This hypothesis thus rules out the possibility of "speculative bubbles", wherein an otherwise rational investor buys an overpriced security (too expensive in relation to its expected long-term return to merit its addition to his portfolio) in the expectation that he can resell it at an even more inflated price before the bubble bursts. Thus Symmetric Market Rationality hypothesis extends the concept of rationality to the market as a whole.

Perfect Certainty means complete assurance on the part of every investor as to the future investment program and the future profits of all the firms. It is latter proved that MM approach holds good even when this assumption is dropped.

Dividends and Market Valuation

The substance of the MM approach is that the dividend payments has no impact either on the valuation of the firm or the wealth of the shareholders. When a firm declares dividends it foregoes retained earnings to the extent of the dividend amount. As the investment needs of a firm are taken as a constant, the firm finances the amount of retained earnings foregone, by issuing new shares. MM assets that the sum of discounted value of the shares after the financing and the amount of dividends paid is exactly equal to the market value of the share before the payment of dividends. In other words the fall in the stock price offsets the amount of dividends received. There is no change in the overall wealth of the shareholders. The shareholders are therefore indifferent between dividend payments and retained earnings. Further, while the market price of each share may decline, the number of shares outstanding increases due to the fresh issue of equity. Therefore the market capitalization of the firm remains constant. Hence dividend policy of a firm is irrelevant.

The current market price of a share is the sum of the present values of the dividend paid and the market price at the end of the investment horizon tl. The market price can be represented as

P₀ = ……..9.1

where,

P_o is the market price per share at the beginning of Year 0

D₁ is the expected dividend per share for Year 1

P₁ is the market price per share at the end of Year 1

p is the capitalization' rate for the firms in that risk class

If m is the number of shares issued at the end of the period at a price of P1 (the prevailing market price), the above equation can be rewritten as

nP₀ = ……..9.2

where n is the number of shares at the beginning of the period.

The above equation signifies that the total valuation of the firm at the beginning of the period (t0) is the sum of present value of the dividend and the market value of the outstanding shares at t₁ less the total value of the new shares issued.

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The total value of the new shares issued is

mP₁= I - (X - nD₁) ….Eq. 9.3

where

I is the value of the total investments

X is the earnings of the firm during the period t.

By substituting the value of mP₁ in the equation 9.2

nP_{0 = ………}Eq.9.4

It may be noted that the term Ds does not appear in the above equation. Further all other variables in the equation are independent of Dj. Thus it can be concluded that the dividend decision has no bearing on the valuation of the firm. Hence there is nothing like an optimal dividend policy.

MM Hypothesis Under Conditions of Uncertainty

The hypothesis continues to remain valid even if the assumption of perfect certainty is dropped. The condition of uncertainty implies that the values of dividends and "the expected future share price are uncertain. Hence they are treated as 'random variables from the point of view of the investors. These variables will, therefore, not assume definite value but a probability distribution of possible values.

The solution is that individual investors can replicate the pattern of any stream of dividends. Let us assume that the investors require a certain desired pay-out to "compensate" for the uncertainty. If the actual dividends are less than the target pay-out, the investors can sell a. part of their holdings to generate the desired amount of cash. The investors can thus generate "home-made" dividends to obtain the required pay-out. Conversely, if the actual dividends are more than the target pay-out, the investors can invest the surplus cash into buying more shares of. the company. Thus dividend payment would be a matter of irrelevance even under conditions of uncertainty.

MM Hypothesis and Market Imperfections

The assumption of perfect capital market is abandoned. However there is no unique set of circumstances that constitute "imperfection". There can be a multitude of possible departures from strict market perfections, either singly or in combinations.

Tax differentials exist in the real world, where substantial advantages are accorded to capital gains as compared to dividends. This can be countered by pointing out that the tax structure on dividends is generally progressive while that on capital gains is a flat rate. Therefore for the investors in lower tax bracket may have no differentials or even negative differentials (when dividend income attracts lower tax rate than capital gains). The investors in higher tax brackets have significant tax differentials. Hence it is difficult to generalize the tax implications of dividend policy on the investors. The advantages and disadvantages of various classes of investors generally tends to get canceled out. It is further argued that if the tax structure is significantly tilted in favor of capital gains vis-à-vis dividends, then companies which have zero to minimal pay-outs should command a premium over companies with high pay-outs. In this context, it is paradoxical that other dividend theories emphasize on liberal pay-outs to increase the firm valuation. From the corporate taxation angle, most countries do not have tax differentials between distributed and undistributed profits. (India is, however, a notable exception due to imposition of 10% tax on distributed profits).

The transaction costs have an impact on the arbitrage opportunities to generate cash flows which can replicate the dividend streams of any target policy. The existence of brokerage and transfer taxes hinder the arbitrage process. Investors preferring high pay-out incur transaction costs in selling their shares to increase their current cash flow. On the other hand, investors preferring low to zero pay-outs have such costs as a deterrence in buying further shares of the company. Thus transaction costs have equal impact on both sides and have no directional implications on the dividends versus retained earnings debate. However flotation costs like issue expenses and underpricing results in dilution of the wealth of the existing shareholders.

Hitherto, it was assumed that firms would issue equity to the extent of retained earnings foregone. It was argued that firms can issue debt or a combination of equity and debt to finance the same. The MM position on

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The total value of the new shares issued is

mP₁= I - (X - nD₁) ….Eq. 9.3

where

I is the value of the total investments

X is the earnings of the firm during the period t.

By substituting the value of mP₁ in the equation 9.2

nP_{0 = ………}Eq.9.4

It may be noted that the term Ds does not appear in the above equation. Further all other variables in the equation are independent of Dj. Thus it can be concluded that the dividend decision has no bearing on the valuation of the firm. Hence there is nothing like an optimal dividend policy.

MM Hypothesis Under Conditions of Uncertainty

The hypothesis continues to remain valid even if the assumption of perfect certainty is dropped. The condition of uncertainty implies that the values of dividends and "the expected future share price are uncertain. Hence they are treated as 'random variables from the point of view of the investors. These variables will, therefore, not assume definite value but a probability distribution of possible values.

The solution is that individual investors can replicate the pattern of any stream of dividends. Let us assume that the investors require a certain desired pay-out to "compensate" for the uncertainty. If the actual dividends are less than the target pay-out, the investors can sell a. part of their holdings to generate the desired amount of cash. The investors can thus generate "home-made" dividends to obtain the required pay-out. Conversely, if the actual dividends are more than the target pay-out, the investors can invest the surplus cash into buying more shares of. the company. Thus dividend payment would be a matter of irrelevance even under conditions of uncertainty.

MM Hypothesis and Market Imperfections

The assumption of perfect capital market is abandoned. However there is no unique set of circumstances that constitute "imperfection". There can be a multitude of possible departures from strict market perfections, either singly or in combinations.

Tax differentials exist in the real world, where substantial advantages are accorded to capital gains as compared to dividends. This can be countered by pointing out that the tax structure on dividends is generally progressive while that on capital gains is a flat rate. Therefore for the investors in lower tax bracket may have no differentials or even negative differentials (when dividend income attracts lower tax rate than capital gains). The investors in higher tax brackets have significant tax differentials. Hence it is difficult to generalize the tax implications of dividend policy on the investors. The advantages and disadvantages of various classes of investors generally tends to get canceled out. It is further argued that if the tax structure is significantly tilted in favor of capital gains vis-à-vis dividends, then companies which have zero to minimal pay-outs should command a premium over companies with high pay-outs. In this context, it is paradoxical that other dividend theories emphasize on liberal pay-outs to increase the firm valuation. From the corporate taxation angle, most countries do not have tax differentials between distributed and undistributed profits. (India is, however, a notable exception due to imposition of 10% tax on distributed profits).

The transaction costs have an impact on the arbitrage opportunities to generate cash flows which can replicate the dividend streams of any target policy. The existence of brokerage and transfer taxes hinder the arbitrage process. Investors preferring high pay-out incur transaction costs in selling their shares to increase their current cash flow. On the other hand, investors preferring low to zero pay-outs have such costs as a deterrence in buying further shares of the company. Thus transaction costs have equal impact on both sides and have no directional implications on the dividends versus retained earnings debate. However flotation costs like issue expenses and underpricing results in dilution of the wealth of the existing shareholders.

Hitherto, it was assumed that firms would issue equity to the extent of retained earnings foregone. It was argued that firms can issue debt or a combination of equity and debt to finance the same. The MM position on

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Flotation Costs: Issue of securities to raise capital in lieu of retained earnings involve flotation costs. These costs include fees payable to the merchant bankers, .underwriting commission, brokerage, listing fees, marketing expenses, etc. Moreover smaller the size of the issue, higher will be the flotation costs as a percentage of amounts mobilized. Further there are indirect flotation costs in the form of underpricing. Normally issue of shares is made at a discount to the prevailing market price. The cost of external financing has an influence on the dividend policy.

Corporate Control: Further issue of shares (unless done through rights issue) results in dilution of the stake of the existing shareholders. On the other hand, reliance on retained earnings has no impact on the controlling interest. Hence companies vulnerable to hostile takeovers prefer retained earnings rather than fresh issue of securities. In practice, this strategy can be a double edged sword. The niggardly pay-out policy of the company may result in low market valuation of the company vis-à-vis its intrinsic value. Consequently the company becomes a more attractive target and is in the danger of being acquired.

Investor Preferences: The preference of the shareholders has a strong influence on the dividend policy of the firm. A firm tends to have a high pay-out ratio if the shareholders have a strong preference towards current dividends. On the other hand, a firm resorts to retained earnings if the shareholders exhibit a clear tilt towards capital gains.

Restrictive Covenants: The protective covenants in bond indentures or loan agreements often include restrictions pertaining to distribution of earnings. These conditions are incorporated to preserve the ability of the issuer/borrower to service the debt. These covenants limit the flexibility of the company in determining its dividend policy,

Taxes: The incidence of taxation on the firm and the shareholders has a bearing on the dividend policy. India levies a 10% tax on the amount of distributed profits. This tax is a strong fiscal disincentive on dividend distribution. These dividends are totally tax-free in the hands of the shareholders. The capital gains (long-term) are taxed at 20%.

Dividend Stability: The earnings of a firm may fluctuate wildly between various time periods. Most firms do not like to have an erratic dividend pay-out in line with their varying earnings. They try to maintain stability in their dividend policy. Stability does not mean that the dividends do not vary over a period of time. It only indicates that the previous dividends have a positive correlation with the current dividends. In the long run, the dividends have to be invariably adjusted to synchronize with the earnings. However the short-term volatility in earnings need not be fully reflected in dividends.

Corporate Dividend Behavior

John Lintner made an empirical study on the corporate dividend behavior. He developed a quantitative model to express the dividend behavior.

Dt = cr EPSt + (1 - c) Dt - 1

where

Dt is the dividend per share for the time period t;

c is the weightage given to current earnings by the firm;

r is the target pay-out rate;

EPSt is the earnings per share for the time period t;

Dt-1 is the dividend per share for the time period t-1;

The Lintner model states mat the current dividend of a firm depends on its current earnings and its past dividends. The degree of dividend stability can be deduced from the weightage in the model. A conservative firm which prefers a high level of dividend stability will assign relatively insignificant value to c in the above equation. On the other hand, an aggressive firm which does not attach much significance to past dividends would give a high value to t: in the equation. The dividends of such firms would be more reflective of their current earnings. He concludes that "On the evidence so far available, it appears that our basic model incorporates the dominant determinants of corporate dividend decisions, that these have been introduced properly and that the resulting parameters are reasonably stable over long periods involving substantial changes in many external conditions."

Bonus Issues and Stock Splits

Bonus issue (also called as stock dividend) involves capitalization of reserves by issuing new shares to the existing shareholders. A part or the whole of the reserves are capitalized. The new shares (bonus) are issued to the existing shareholders pro rata to their existing holdings. The proportional stake of the shareholders in the firm remains unchanged though the size of their individual holdings may be significantly different. Hence bonus issue has no implications on the controlling interests. From the accounting point of view, the paid up equity capital of the company increases and the size of the reserves decreases. The overall quantum of the

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shareholders funds (net worth) remains constant but there is a change in its composition. Thus a bonus issue essentially represents a recapitalization of the company. It aligns the share capital with the total shareholders funds.

Stock splits involve increase in the number of shares outstanding through a decrease in the par value of the share. The total size of the share capital remains the same. For example, the recent reduction in the face value of the shares of ACC from Rs. 100 to Rs. 10. Each shareholder will be given 10 shares with a par value of Rs.10 each in lieu of every old share of Rs. 100 each. This move of ACC is called as 10-to-l stock split. Stock splits like bonus issues have no implications on the proportion of individual stakes in the company. Conversely a company might want to reduce the number of outstanding shares. It can accomplish this through a reverse stock split. A new share with a higher par value is created in exchange of the old shares with lower par values. Reverse stock splits are generally employed to increase the market price of its shares. Market reacts negatively to reverse stock splits and hence firms are generally disinclined to undertake this exercise.

Signaling through Stock Dividends and Stock Splits

Researchers have been surprised over the role of stock splits and stock dividends in the valuation of the company. Theoretically, stock splits and stock dividends should have no impact on the wealth of the shareholders. They were puzzled that companies engage in these transactions at all and even more so because stock prices rise when these transactions were announced. The significant positive announcement effects led to the hypothesis that firms signal information about their future earnings or valuation through these decisions. Practitioners have long contended that the purpose of stock splits and stock dividends is to the firms share price into the "optimal trading range". The trading range hypothesis is anchored on the arguments that there exists informational asymmetry between the management and the investors. Hence the stock splits and stock dividends have information content about the future earnings or firm valuation and the market reacts to the same by revising the valuation. They also pointed that the lower share prices (post-split or post-bonus) enhances the liquidity of the scrip in the market.

Financial Signaling and Information Asymmetry

Maureen McNichols and Ajay Dravid carried out a study to assess the empirical validity of signaling through stock splits and stock dividends. The central theme of the study was to verify whether firms that announce these distributions signal favorable information about their future earnings and the impact of the distribution factor as the signal. The earnings forecast by professional analysts was taken as a surrogate for market information. The management private information about the earnings was proxies by the earnings forecast error of the analysts. The information asymmetry was measured as a percentage difference between the annual earnings reported after the distribution and the median pre-distribution forecast of the firm's earnings by the analysts. The study concluded that firms resort to stock splits and stock dividends to bring to a specific price range. The study also found significant positive correlation between the split factor and the earnings forecast error suggesting that managements use unpublished information about future earnings in determining the size of the split. The study also found evidence that investor's inferences about the valuation of the firm corresponds to the choice of the split factor. The investors interpret stock splits and stock dividends as signals about future earnings.

Share Repurchases as a Mode of Earnings Distribution

Dividends are increasingly losing their status as the primary vehicle of earnings distribution. Firms are often adopting a strategy of share repurchases as a method to reward the shareholders. The share repurchase plan has benefits to the shareholders. The buy-back provides liquidity to the scrip and presents an exit opportunity (often at a premium to the prevailing market price) to the investors who wish to offload their holdings. The shareholders who continue to hold the shares are benefited by better market valuation of their shares after the repurchase program. There are three principal methods of share repurchase:

Open Market Repurchases: A firm purchases its own shares like any other investor on the stock exchange. Normally the repurchase program is carried on over an extended period of time. The firm gradually accumulates the required block of shares. The price of the shares rises in the market due to the increased demand for the shares. Such repurchase programs have to comply with stringent norms of the regulatory bodies to prevent their abuse for rigging up the market.

Fixed Price Tender Offers: This mode of repurchase involves making an offer to the shareholders to buy their shares at a certain predetermined price. Such an offer is in the nature of a reverse rights issue. The advantage of fixed price tender offer is that it provides equal opportunities to all the shareholders to participate in the repurchase program. The shareholders can either tender the shares at the stated price or turn down the offer and continue to hold them. The tender offer is kept open for a specified period of time. If the shareholders tender more shares than originally specified, the firm has the discretion to purchase the whole or a part of the excess shares.

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shareholders funds (net worth) remains constant but there is a change in its composition. Thus a bonus issue essentially represents a recapitalization of the company. It aligns the share capital with the total shareholders funds.

Stock splits involve increase in the number of shares outstanding through a decrease in the par value of the share. The total size of the share capital remains the same. For example, the recent reduction in the face value of the shares of ACC from Rs. 100 to Rs. 10. Each shareholder will be given 10 shares with a par value of Rs.10 each in lieu of every old share of Rs. 100 each. This move of ACC is called as 10-to-l stock split. Stock splits like bonus issues have no implications on the proportion of individual stakes in the company. Conversely a company might want to reduce the number of outstanding shares. It can accomplish this through a reverse stock split. A new share with a higher par value is created in exchange of the old shares with lower par values. Reverse stock splits are generally employed to increase the market price of its shares. Market reacts negatively to reverse stock splits and hence firms are generally disinclined to undertake this exercise.

Signaling through Stock Dividends and Stock Splits

Researchers have been surprised over the role of stock splits and stock dividends in the valuation of the company. Theoretically, stock splits and stock dividends should have no impact on the wealth of the shareholders. They were puzzled that companies engage in these transactions at all and even more so because stock prices rise when these transactions were announced. The significant positive announcement effects led to the hypothesis that firms signal information about their future earnings or valuation through these decisions. Practitioners have long contended that the purpose of stock splits and stock dividends is to the firms share price into the "optimal trading range". The trading range hypothesis is anchored on the arguments that there exists informational asymmetry between the management and the investors. Hence the stock splits and stock dividends have information content about the future earnings or firm valuation and the market reacts to the same by revising the valuation. They also pointed that the lower share prices (post-split or post-bonus) enhances the liquidity of the scrip in the market.

Financial Signaling and Information Asymmetry

Maureen McNichols and Ajay Dravid carried out a study to assess the empirical validity of signaling through stock splits and stock dividends. The central theme of the study was to verify whether firms that announce these distributions signal favorable information about their future earnings and the impact of the distribution factor as the signal. The earnings forecast by professional analysts was taken as a surrogate for market information. The management private information about the earnings was proxies by the earnings forecast error of the analysts. The information asymmetry was measured as a percentage difference between the annual earnings reported after the distribution and the median pre-distribution forecast of the firm's earnings by the analysts. The study concluded that firms resort to stock splits and stock dividends to bring to a specific price range. The study also found significant positive correlation between the split factor and the earnings forecast error suggesting that managements use unpublished information about future earnings in determining the size of the split. The study also found evidence that investor's inferences about the valuation of the firm corresponds to the choice of the split factor. The investors interpret stock splits and stock dividends as signals about future earnings.

Share Repurchases as a Mode of Earnings Distribution

Dividends are increasingly losing their status as the primary vehicle of earnings distribution. Firms are often adopting a strategy of share repurchases as a method to reward the shareholders. The share repurchase plan has benefits to the shareholders. The buy-back provides liquidity to the scrip and presents an exit opportunity (often at a premium to the prevailing market price) to the investors who wish to offload their holdings. The shareholders who continue to hold the shares are benefited by better market valuation of their shares after the repurchase program. There are three principal methods of share repurchase:

Open Market Repurchases: A firm purchases its own shares like any other investor on the stock exchange. Normally the repurchase program is carried on over an extended period of time. The firm gradually accumulates the required block of shares. The price of the shares rises in the market due to the increased demand for the shares. Such repurchase programs have to comply with stringent norms of the regulatory bodies to prevent their abuse for rigging up the market.

Fixed Price Tender Offers: This mode of repurchase involves making an offer to the shareholders to buy their shares at a certain predetermined price. Such an offer is in the nature of a reverse rights issue. The advantage of fixed price tender offer is that it provides equal opportunities to all the shareholders to participate in the repurchase program. The shareholders can either tender the shares at the stated price or turn down the offer and continue to hold them. The tender offer is kept open for a specified period of time. If the shareholders tender more shares than originally specified, the firm has the discretion to purchase the whole or a part of the excess shares.