introduction to buyback -...
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CHAPTER – 1
INTRODUCTION TO BUYBACK
1
CHAPTER – 1
INTRODUCTION TO BUYBACK
Financial restructuring is a decision involving use of business acumen &
knowledge of all possible financial strategies. Corporate financial strategy involves
either paying out excess cash or retaining the earnings. An important financial
decision involves choosing between retention and payout. Companies pay out their
excess cash in many different ways, either by paying dividends or by buying back
shares. The decision to buyback shares rather than using any other method involves
different considerations embarking upon the short term & long term profitability of
the concern. Their increased usage over the last few years has triggered increasing
debate over their relevance and effective usage by Indian companies.
The significance of buyback as a vital tool for financial restructuring focuses
upon understanding the major motivations underlying their usage. Various authors
have highlighted diverse motivations for corporates buying back their own shares
since the first study which was undertaken to compare usage of buyback vis-a-vis
issuance of dividends (Woods et al., 1996). Namely, the major forces motivating
corporates have been the presence of “free cash flows” which the corporates wish to
utilise in the absence of any suitable reinvestment options or to substitute dividends or
to achieve a “desired leverage ratio” so as to balance out the debt equity mix as per
shareholders’ expectations or to use it as “takeover deterrence strategy” or to use it
simply as an effective “market signalling mechanism” countering undervaluation of
shares in the markets or as a mechanism to create “managerial opportunism” or just to
cover the impact of “issuance of ESOs”.
The short term success of any financial decision depends largely upon its
adoptability by various interest groups and stakeholders. Buyback announcements as
made by companies supposedly carry strong signals to such stakeholders specially the
shareholders. Their perceived valuations (undervaluation or overvaluation) result in
strong reactions based on differential of current market price and the buyback price
announced by the company. Such reactions may translate into abnormal returns, high
liquidity values and excessive volatility for the announcing stocks, thereby making
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buyback a strategic financial instrument unfolding short term repercussions.
Expectedly, the premium offered through buyback to existing shareholders provides
the much needed support in case of perceived undervaluation besides offering an exit
window opportunity to shareholders with perceived overvaluations. Thus, it plays a
balancing act which creates strong sentiment benefitting both holding and exercising
shareholders in such scenario. In fact, the level of reactions is an effective parameter
to be utilised for testing the level of efficiency of markets in handling such news or
announcements.
The viability of any financial decision gets reflected through the changes that
are brought into respective financial statements in following years on medium term
basis. The basic parameters for performance measurement, as employed mainly by
analysts, include measurement of the resulting effect on cumulative earnings during
that financial year and on net worth employed. To capture these effects on uniform
basis, variables like Earnings Per Share (EPS) ratio and Book Value to Market Value
(BVMV) ratios are employed. With the reduction in total outstanding capital post
buyback, both these variables are expected to improve. However, sustaining such
improvements over longer time periods is absolutely necessary to reap the benefits of
buyback. Analysts considering “free cash flow” hypothesis look into the merits of
utilisation of excess cash flow to buyback shares if and only if the above benefits are
realised. Besides, achieving a particular leverage ratio leading to improvement in cost
of capital are the other desired effects to be produced by corporate undergoing
buyback.
Immortality is a basic assumption underlying formation of a public limited
company. Majority of individual investors buying stake in a company are interested in
holding shares rather than exercising buyback options (Jain, 2007). The ultimate
litmus test for financial restructuring decisions lies in understanding long term value
addition to shareholders’ wealth. For the shareholders who opt to hold rather than
exercise the buyback option, supporting “undervaluation hypothesis”, market
corrections occurring over longer terms are expected to add future value. Thus,
market efficiency plays a major role in allowing such resurgences. With markets
following a particular form of efficiency, the direct impact of buyback decisions
becomes complex to comprehend.
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The basic premise driving analysis of companies opting for particular financial
decision lies in some level of differentiation regarding financial and non financial
parameters. Understanding and identifying the underlying motivations for any type of
financial decision is dependent upon related financial characteristics. Besides, any
such differentiation provides rational basis for such decisions, thereby preparing a
checklist for identification of such companies in the future. Moreover, differentiating
buyback companies from their counterparts in similar or other industry helps in
developing ready profiles for such companies who are susceptible to take such
decisions in the future. This provides a level playing field for analysts, who are
always interested in providing valid reasons for their recommendations to investors.
1.1 HISTORY OF BUYBACK ACROSS THE WORLD Development of newer methods and techniques for raising capital, new
investment options and newer means to distribute earnings could be traced back to
developed economies and their mature markets. These concepts drift slowly to the
developing economies with improving development and strengthening of capital
markets in such economies over a period of time. However, their adoption and the
resulting changes in regulatory mechanisms for the same have to be done with due
caution.
The differential in terms of prevailing economic and business environment has
to be identified and analysed for ensuring smooth transformation. Thus, any study
undertaken to analyse the dynamics of buyback needs to carry the torchlight from the
home of buyback, i.e. USA. US markets have shown significant advances in
development and usage of buyback as corporate financial strategy since its
introduction. Besides, the extent of research work undertaken and the amount of
literature available is exhaustive and relevant to studies in any part of the world.
Keeping in mind these perspectives, the next section is devoted to documenting the
history, trends and possible explanations for development of share buyback in US
capital markets. The chronological introduction of buyback in countries across the
world outside US has been made to gain insight into its global acceptance.
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1.1.1 SHARE BUYBACK TRENDS IN US
Share buyback have been used by US companies for a long time period. The
history of share buyback being allowed can be traced back to the Federal Court ruling
of 1967 in the case of SEC vs. Georgia-Pacific (Cook et al., 2003). Under Securities
and Exchange Commission (SEC) guidelines, repurchases by US corporations can be
done in 4 different ways, namely, open market repurchases, fixed price tender offer,
Dutch auction tender offers and privately negotiated repurchase. Out of all, fixed price
tender offer and Dutch auction tender offer are the most flexible due to pro rata
allocation clause in case of higher number of offers and flexibility to extend its
duration beyond the specified date in case of under subscription. Hence, these are the
most frequently used options, followed by repurchases through open market with little
preference for privately held repurchases due to various limitations attached to it.
They are popularly known as ‘Greenmail’ used to repel an unwanted takeover threat
from a competitor. Another method which has recently evolved is Transferable Put-
Right Distributions (TPRs). Under TPRs, put options are given to each shareholder in
proportion to their shareholding in the company at a given predetermined price.
To analyse the trends of repurchases in US markets, the time period can be
divided primarily into two major categories. First is pre 1987 market crash period
starting from 1960s and second is post 1987 crash period.
A. 1960-1987
There are numerous evidences of sudden increase in volumes of share
buyback being carried out by the respective boards of US corporations during this
period. In fact,132 companies went forward to buyback more than 5% of their total
capital in 1963.The amount spent by companies was reported to be more than 30% of
the total equity raised during same period (Bierman et al.,1966). Reportedly, these
numbers went as high as $ 1.7 billion in 1964. As per the statistics available, the
challenge was to effectively utilise the excess funds generated through increasing
profitability. Increasing depreciation reserves, strict anti takeover regulations and low
corporate tax rate were quoted as the primary reasons for such high preferences for
buyback.
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As is clear from Table 1.1, the volume of share repurchase activity went as
high as up to 27% of total corporate payouts which included cash paid via mergers
and acquisitions, dividends paid during the same period and the level of share
repurchases. In fact, the amount of money spent on repurchases came quite close to
matching up with the amount spent annually on dividend. Along with this, the total
amount spent on non dividend payout easily exceeded the dividend payout from 1984
onwards.
TABLE 1.1 SHARE BUYBACK ACTIVITY IN US MARKETS (1977-87)
Source: Bagwell et al., 1989
However, the above data has to be analysed keeping in mind the fact that prior
to 1986, the tax rates for dividend were much higher than for capital gains. Still,
dividend enjoyed the top position as a part of corporate payout mechanism and firm
valuation (Grullon et al., 2002).
YEAR
CASH SPENT VIA
ACQUISITIONS
SHARE REPURCHASES
(IN MILLION DOLLARS)
DIVIDEND(IN
MILLION DOLLARS)
TOTAL PAYOUT
(IN MILLION
DOLLARS)
SHARE REPURCHA
SES AS % OF TOTAL PAYOUT
SHARE REPURCHASES AS % OF DIVIDEND
PAID
1977 4274 3361 29450 37085 9.06% 11%
1978 7228 3520 32830 43578 8.08% 11%
1979 16888 4507 38324 59719 7.55% 12%
1980 13081 4961 42619 60661 8.18% 12%
1981 29319 3973 46832 80124 4.96% 8%
1982 26427 8080 50916 85423 9.46% 16%
1983 21428 7709 54896 84033 9.17% 14%
1984 64244 27444 60266 151954 18.06% 46%
1985 69971 41303 67564 178838 23.10% 61%
1986 74522 41521 77122 193165 21.50% 54%
1987 62240 54336 83051 199627 27.22% 65%
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B. 1987-2003
The Tax Reform Act, 1986 reduced substantially the relative advantage of
capital gains tax versus dividends (Medury et al., 1992), yet on the contrary, the
volume of share repurchases for year 1987 went much higher than 1986 on yearly
basis. Considering quarterly data, the fourth quarter of year 1987 ($ 22546 million)
recorded the maximum repurchases announced in one quarter ever since its
introduction. The US markets crashed on October 19, 1987 leading to an unparalleled
rush of companies announcing share repurchases. Over the next fortnight, 598
companies (350 on NYSE & AMEX and 248 on OTC) went on a buyback spree in
contrast to 350 companies declaring buyback in first 3 quarters of 1987 (Netter et al.,
1989). The lowest prices recorded for majority of listed stocks on US bourses
motivated such announcements whereby cheaper acquisitions became possible. US
laws permit repurchased shares to be held as treasury shares at time of repurchase and
can be sold on later dates. Thus, the markets crash provided just the right opportunity
for companies to avail the benefits of treasury shares.
TABLE 1.2 SHARE BUYBACK ACTIVITY IN US MARKETS (1988-2003)
TOTAL SHARE
REPURCHASES
OPEN MARKET
FIXED PRICE
TENDER OFFER
PRIVATELY NEGOTIATED
DUTCH AUCTION TENDER OFFER
YEAR VALUE
(IN $ MILLION)
VALUE (IN $
MILLION)
VALUE (IN $
MILLION)
VALUE (IN $
MILLION)
VALUE (IN $
MILLION) 1988 44,940 30,426 2,851 3,836 7,829
1989 69,986 58,727 4,141 2,011 5,107
1990 36,910 28,973 3,139 2,864 1933.65
1991 19,833 14,981 3,304 810.01 738.05
1992 35,849 31,340 1,586 1,246 1,677
1993 37,610 33,884 1,578 851.45 1296.45
1994 63,887 58,969 1,077 2,889 950.66
1995 86,332 71,252 13,546 559.12 974.24
1996 1,54,828 1,40,415 9,015 2,606 2,792
1997 1,65,569 1,46,233 11,597 3,113 4,627
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Source: Securities Data Corporation
As evident from Table 1.2, the first wave of buyback went on till 2003 with
US Companies announcing to buyback a huge $ 1738 billion worth of stock between
1988-2003. In fact, the majority of buyback came from big companies like DuPont,
Citicorp, Chrysler, IBM, Caterpillar, American Express, Eastman Kodak, Philip
Morris and General Electric to name a few. Moreover, for the first time in US history,
US corporations spent more money on buyback in 1998 than they spent on paying
dividends (Grullon et al.,2000).
C. 2004-2010
The second phase of buyback resurgence can be attributed to The Jobs and
Growth Tax Relief Reconciliation Act of 2003 (JTRRA), whereby the tax rates on
dividends was reduced by more than 20% , i.e, from 38% to a top rate of 15%. Along
with this, the tax rates on capital gains was also brought down from 20% to 15%
thereby bringing dividend payments and buyback on same tax platform (DeAngelo et
al.,2008). This reduced substantially the tax disadvantage of dividends for all
investors. Yet, the preference for share repurchases failed to diminish even after such
a huge tax revisions. Primarily, it is the relative tax advantage still enjoyed by share
buyback as capital gains tax is calculated only on the difference in repurchase value
and historical costs. Besides, the relative flexibility of share repurchases as a
temporary distribution policy which can be easily adapted to changing investment
opportunity scenario makes it a preferred activity (Corporate Executive Board Report,
2010). The US markets crashed again in 2007 due to subprime crisis bringing an
overall global meltdown down. Consequently, that year saw a record amount of share
buyback announcements by US companies to take advantage of continuously falling
share prices.
1998 2,19,000 2,08,094 3,851 4,384 2,671
1999 1,43,631 1,35,548 2,376 1,888 3,819
2000 1,66,437 1,47,073 2,338 14,363 2,661
2001 1,55,783 1,48,339 5,316 1,643 484.74
2002 1,19,593 1,11,638 5,460 1,634 860.39
2003 93,583 87,583 2,439 1,765 1,796
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TABLE 1.3 SHARE BUYBACK ANNOUNCEMENTS IN US
POST JTRAA, 2003 (2004-2010)
Source: Securities Data Corporation
However, the recession following the meltdown affected the total repurchases
announced with the volumes touching the bottom in 2009, yet the signs of recovery
started becoming visible in last quarter of 2009. In October 2009, IBM announced a
mighty $ 5 billion repurchase plan over and above $ 2.6 billion spent by the company
in second and third quarter of 2009. Year 2010 has seen a major recovery in buyback
announcements with big names like Microsoft, Pepsico and HP announcing mighty
buyback plans. These companies have reportedly been raising cheaper debt from the
market in order to complete buyback plans.
BEYOND 2010
While announcing the above mentioned JTRRA Act, 2003, the Bush
administration had fixed a timeline for the expiry of these tax rebates by the end of
year 2010. Simultaneously, President Obama’s 2011 Budget proposal increased the
tax rate on dividends and capital gains from 15% to 20% for higher income group
individuals (earning more than $ 2,50,000). With these proposals in place, the cash
rich US companies are expected to revise their cash distribution options in favour of
buyback over dividends.
YEAR AMOUNT IN $ BILLION
2004 237
2005 349
2006 451
2007 863
2008 465
2009 125
2010 273
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1.1.2 BUYBACK IN CANADA
Canadian markets can be bestowed with the honours of utilising and
embarking on buyback for a sufficient long period till now. The wave to buyback
shares became so strong in Canada that it grew from $ 500 million in 2002 to $ 50
billion in 2004. In fact, the level of share buyback in Canadian capital markets
surpassed dividend payouts in year 2000, which is an indication of a permanently
increasing usage of buyback as payout policy in Canada (Mishra et al., 2008)
1.1.3 BUYBACK IN EUROPE, ASIA AND OTHER COUNTRIES
Following US and Canada, many countries around the world have made
amendments to allow buyback under the corporate legal framework. In most of the
European countries, these changes have occurred before the conceptualisation of
European Union and after the passing of European Union directive in 2004 under
which the regulations in respective countries have started to converge towards a
common framework (Ginglinger et al., 2008). Table 1.4 shows the respective year of
introduction of buyback in various countries around the world (both developed and
emerging markets) indicating a sudden flurry of amendments in company law
allowing buyback in almost all major economies of the world. Some countries took an
initial lead (like UK, Austria and Luxemburg) while others followed the trends (Rau
et al., 2002).
However, regulations enacted in these markets relating to level of buyback
allowed, accounting treatment, tax treatments, corporate reporting and creation of
treasury shares has been quite diverse. On the other hand, there are large numbers of
markets across the world which does not allow buyback. As per Rashid Sabri (2003),
countries like China, Jordan, Morocco, Poland, Saudi Arabia, Oman, Egypt and
Lebanon still have regulations disallowing buyback in their respective markets.
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TABLE 1.4 YEAR OF INTRODUCTION OF BUYBACK IN VARIOUS COUNTRIES
COUNTRY YEAR OF INTRODUCTION
Australia 1989
Austria 1965
Belgium 1991
Denmark 1996
Finland 1997
France 1998
Germany 1998
Greece 1995
Hong Kong 1991
Ireland 1990
Italy 1998
Japan 1995
Luxemborg 1972
Malaysia 1997
Netherlands 2001
New Zealand 1999
Norway 1999
Singapore 1998
South Africa 1999
Sweden 2000
Switzerland 1992
Taiwan 2000
United Kingdom 1981
Source: Various studies
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1.2 INTRODUCTION OF BUYBACK IN INDIA Indian economy has seen plethora of changes in economic structure, economic
systems and business processes since the introduction of globalisation and
liberalisation in 1992. In the era of liberalization and global competition, the wide
varieties of stakeholders have diverse expectations. Out of those, the shareholders are
mainly interested in efficient utilisation of assets and capital of the company. As,
many new opportunities for corporate and financial restructuring have been banging
on doors of Indian companies since opening up of the economy, these have undergone
a series of capital restructuring exercises in the last decade. This includes both internal
and external restructuring of capital and assets. Big groups like Tatas, Birlas,
Reliance, Bharti etc. have been mainly relying on mergers and acquisitions mainly on
the global front to expand their wings. Besides, there have been new financial
innovations on the home front which mainly include capital expansion through
issuance of sweat equity and Employee Stock Options (ESOs) on one side and capital
reduction through buyback on the other. Buyback is relatively a new concept in India
in comparison to developed nations and it came concurrently with introduction of
buyback in other emerging markets. It is a procedure that enables the company to go
back to its existing shareholders and offers to purchase from them the shares they hold
of that company.
Certainly, it was a big change in corporate laws as it provided another window
of opportunity to Indian companies to restructure their capital requirements enabling
better capital utilisation by all means. An amendment in Section 77A of the
Companies Act, 1956 along with fresh guidelines put in force by SEBI paved the way
for its introduction in Indian corporate scenario. In order to fully understand the
process of introduction of buyback in Indian capital markets, it is imperative to focus
upon the recommendations of various committees related to it and the corresponding
changes in legislation related to it. The different reasons have been assigned for
introducing buyback in Indian corporate scenario by different authors in their studies.
Presumably, one of the major motivations could be derived out of the fact that
majority of developing economies, specifically South Asia and South East Asia
introduced this concept in their respective countries around 1999. With Hong Kong,
Singapore and Malaysia preceding India (See Table 1.4), there was an increasing
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pressure from Indian corporate sector to allow them to use buyback for capital
reduction through usage of internal surplus cash of the company.
Along with this, another version as quoted in one of the study has been the
effect of liberalisation and corresponding entry of Trans National Corporations
(TNCs) in Indian economy. The perceived threat by many Indian companies from
such TNCs was the root cause for such companies demanding amendments in
company law to enable them to go for buyback. Thus, buyback was suggested to be
used primarily for averting threats of takeovers from either TNCs or from big players
within the same industry. Besides, it was quoted as a vital strategic tool for increasing
shareholding of management in depressing market timings while it provides an exit
opportunity for the investors creating win-win situation for both the parties. The
Indian stock markets witnessed a gradual rise in stock prices during the first half of
the year 1997-98, but thereafter the various macro economic factors both at the
national and international levels brought the valuations down again (SEBI Annual
Report, 1997-98). This created a tremendous pressure for government authorities to
create an opportunity for Indian companies to see some silver lining in an otherwise
overall black cloud scenario.
1.2.1 RESTRAINING PROVISIONS UNDER SECTION 77 OF COMPANIES
ACT, 1956
The adoption of buyback in Indian capital markets has passed through a series
of recommendations from different regulatory agencies. First and foremost, the need
was to bring changes into the basic law prohibiting buyback for Indian companies.
Under Section 77 of Companies Act, 1956, it was forbidden for companies to
purchase its own shares or give loans to anybody to purchase own shares or holding
company’s shares. However, Section 100 to 104 dealing with capital reduction
allowed such powers to board of the company under very special circumstances.
Primarily, these sections were introduced in Companies Act, 1956 to provide a
window of opportunity for such companies who are suffering from any
overcapitalisation. Certainly, the confirmation from the court was required after
passing of special resolution to make changes in articles of association of the
company for allowing such reductions. Moreover, the consent from the existing
creditors in terms of either their complete satisfaction regarding safety of their
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interests or discharge of complete debt by the company was mandatory before taking
up the case to the court for final approval. Under the provisions of section 402,
Company Law Board (CLB) can allow certain members of the company to buy shares
or interests of any member of the company by other members or by company in case
of any application filed under section 397 and 398. Such application can be filed in
case of actions of certain members being found detrimental to the interests of the
company as a whole.
1.2.2 JUSTICE DHANUKA COMMITTEE SUGGESTIONS ON WORKING
DRAFT OF COMPANIES BILL, 1997
Subsequently, the proposed bill was made public for open discussion and
suggestions. Securities and Exchange Board of India (SEBI) constituted a committee
under the chairmanship of Justice D.R.Dhanuka, former judge of the Bombay High
Court to examine, inter alia, the provisions of the Companies Act, 1956 and make
recommendations for amendments in the Companies Act in order to enable SEBI to
better regulate issue of capital, listing of securities, transfer of securities and to protect
the interests of investors. The committee in its final report suggested modifications in
draft bill for company law amendments. Various suggestions from the committee can
be summarised as follows.
A. The provision for buyback should be restricted to shares only.
B. The companies should not be allowed to utilise proceeds of “prior issue” for
purpose of buyback.
C. The companies should be allowed to re-issue the shares which are bought
back, subject to safeguards and stipulations which may be laid down.
D. Implications relating to insider trading to be considered.
1.3 REGULATORY PROVISIONS GOVERNING BUYBACK IN
INDIA Presently, there are two different regulations governing buyback in India, that
is, Companies Act, 1956 as amended in 1999 and SEBI Buy Back of Securities
Regulation, 1998. These stipulate conditions for allowing Indian companies to
buyback their own shares. The SEBI Buy Back of Securities (Amendment)
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Regulations, 2012 has also been covered in the following pages which has introduced
a few significant changes in buyback guidelines regulating Indian companies.
1.3.1 COMPANIES AMENDMENT ACT, 1999
The Indian parliament enacted the Companies Amendment Act, 1999 which
came into effect from 31st October, 1998. This is the main legislation which
introduced buyback in India in its present form. Primarily, this Act inserted 3 new
sections namely, 77A, 77AA and 77B in order to regulate the process of buying back
of securities by Indian companies. Looking closely, it can be observed that although
this Act was in synchronisation with the recommendations of working group, the
suggestions of Justice Dhanuka Committee were also fully incorporated. The main
provisions of the Act related to buyback are stated below:-
A. SOURCES OF CASH
A company is allowed to buyback its shares or specified securities using any
of the following sources:-
1. Free Reserves;
2. Securities Premium Account;
3. Proceeds of any shares or other specified securities;
However, the earlier proceeds of same shares as bought back or any other specified
securities cannot be used for this purpose.
B. PROCEDURE
The buyback should be authorised by the articles of the company and a special
resolution is to be passed in the general meeting of the company for this purpose.
Besides, the total amount of buyback in one financial year should not be more than
25% of the total paid up share capital of the company in that financial year. The
notice of the meeting at which special resolution is proposed to be passed shall be
accompanied by an explanatory statement stating:-
1. A full and complete disclosure of all material facts.
2. The necessity for the buyback.
3. The class of security intended to be purchased under the buyback.
4. The amount to be invested under the buyback.
5. The time limit for completion of buyback.
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The total process of buyback should be completed within 12 months of passing the
special resolution in this regard.
C. CONDITIONS TO BE FULFILLED PRE BUYBACK
A company willing to undergo buyback has to fulfil underlying conditions
before starting the procedure for it.
1. The ratio of the debt owed by the company is not more than twice the capital
and its free reserves after such buyback.
2. All the shares or other specified securities for buyback are fully paid-up.
3. The buyback of the shares or other specified securities listed on any
recognised stock exchange is in accordance with the regulations made by the
Securities and Exchange Board of India in this behalf.
4. The company has to file with the Registrar and the Securities and Exchange
Board of India a declaration of solvency in the form as may be prescribed and
verified by an affidavit to the effect that the board of directors has made a full
inquiry into the affairs of the company as a result of which they have formed
an opinion that it is capable of meeting its liabilities and will not be rendered
insolvent within a period of one year of the date of declaration adopted by the
board of directors. This affidavit has to be signed by at least two directors of
the company, one of whom shall be the managing director.
D. METHODS FOR BUYBACK The buyback can be made using any of the following methods:-
1. From the existing security-holders on a proportionate basis.
2. From the open market.
3. From odd lots, that is to say, where the lot of securities of a public company
whose shares are listed on a recognised stock exchange, is smaller than such
marketable lot, as may be specified by the stock exchange.
4. By purchasing the securities issued to employees of the company pursuant to a
scheme of stock option or sweat equity.
The company is supposed to extinguish and physically destroy the securities so
bought-back within seven days of the last date of completion of buyback.
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E. CONDITIONS TO BE FULFILLED POST BUYBACK 1. Where a company completes a buyback of its shares or other specified
securities, it is not allowed to make further issue of the same kind of shares or
other specified securities within a period of twenty four months except by way
of bonus issue or in the discharge of subsisting obligations such as conversion
of warrants, stock option schemes sweat equity or conversion of preference
shares or debentures into equity shares,
2. The company has to maintain a register of the securities so bought, the
consideration paid for the securities bought back, the date of cancellation of
securities, the date of extinguishing and physically destroying of securities,
3. The company, after the completion of the buyback has to file with the
Registrar and the Securities and Exchange Board of India, a return containing
such particulars relating to the buyback within thirty days of such completion.
F. NON COMPLIANCE
If a company makes default in complying with the provisions of any of the
relevant sections or any rules made there under, the company or any officer of the
company who is in default shall be punishable with imprisonment for a term which
may extend to two years, or with fine which may extend to fifty thousand rupees, or
with both.
G. PROHIBITION OF BUYBACK UNDER CERTAIN CIRCUMSTANCES
No company shall directly or indirectly purchase its own shares or other
specified securities:-
1. Through any subsidiary company including its own subsidiary companies
2. Through any investment company or group of investment companies; or
3. If a default, by the company, in repayment of deposit or interest payable
thereon, redemption of debentures or preference shares or payment of
dividend to any shareholder or repayment of any term loan or interest payable
thereon to any financial institution or bank, is subsisting.
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1.3.2 SEBI REGULATIONS, 1999
The Securities and Exchange Board of India (Buyback of Securities)
Regulations, 1999 is the main governing law for regulation of procedures related to
buyback in India.
A. APPLICABILITY
These regulations are applicable to buyback of shares or other specified
securities of a company listed on a stock exchange, however, a company listed on a
stock exchange shall not buyback its shares or other specified securities so as to delist
its shares or other specified securities from the stock exchange.
B. METHODS
1. A company may buyback its shares or other specified securities by any one of
the following methods: -
a. From the existing shares or other specified securities on a
proportionate basis through the tender offer.
b. From open market through –
(i) book-building process, (ii) stock exchange.
c. From odd-lot holders.
2. A company shall not buyback its shares or other specified securities from any
person through negotiated deals, whether on or off the stock exchange or
through spot transactions or through any private arrangement.
3. Any person or an insider shall not deal in securities of the company on the
basis of unpublished information relating to buyback of shares or other
specified securities of the company.
C. SPECIAL RESOLUTION
1. For the purposes of passing a special resolution, the explanatory statement to be
annexed to the notice for the general meeting shall contain disclosures as
specified in Schedule I. (details of Schedule I has been covered under
Appendix 2)
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2. A copy of the resolution passed at the general meeting shall be filed with SEBI
and the stock exchanges where the shares or other specified securities of the
company are listed, within seven days from the date of passing of the
resolution.
D. BOARD RESOLUTION
1. A company should be authorised by a resolution passed by the board of
directors at its meeting to buyback its shares or other specified securities
subject to the following conditions:
a. Before making a public announcement, a public notice shall be given in at
least one English national daily, one Hindi national daily and one regional
language daily, all with wide circulation at the place where the registered
office of the company is situated.
b. The public notice shall be given within 2 days of the passing of the
resolution by the board of directors.
c. The public notice shall contain the disclosures as specified in Schedule I.
2. A copy of the resolution, passed by the board of directors at its meeting
authorising buyback of its shares shall be filed with SEBI and the stock
exchanges where the shares of the company are listed, within two days of the
date of the passing of the resolution.
E. BUYBACK THROUGH TENDER OFFER
A company may buyback its shares or other specified securities from its
existing shareholders on a proportionate basis in accordance with the various
provisions as outlined.
1. ADDITIONAL DISCLOSURES
The explanatory statement annexed to the public notice shall also contain the
following disclosures;
a. The maximum price at which the buyback of shares shall be made and
whether the board of directors of the company are being authorised at the
general meeting to determine subsequently the specific price at which the
buyback may be made at the appropriate time.
19
b. If the promoter intends to offer their shares,
i. The quantum of shares proposed to be tendered.
ii. The details of their transactions and their holdings for the last six months
prior to the passing of the special resolution for buyback including
information of number of shares acquired the price and the date of
acquisition.
2. FILING OF OFFER DOCUMENT
a. The company which has been authorised by a special resolution or a resolution
passed by the board of directors at its meeting shall before buyback make a
public announcement in at least one English National Daily, one Hindi
National Daily and one regional language daily all with wide circulation at the
place where the Registered office of the company is situated and shall contain
all the material information as specified in Schedule II.(details of Schedule II
has been covered under Appendix 2)
b. The public announcement shall specify a date, which shall be the `specified
date’ for the purpose of determining the names of the security holders to
whom the letter of offer shall be sent.
c. The specified date shall not be later than thirty days from the date of the public
announcement.
d. The Company shall within seven working days of the public announcement
file with SEBI a draft-letter of offer containing disclosures as specified
in Schedule III through a merchant banker who is not associated with the
company.(details of Schedule III has been covered under Appendix 2)
e. The draft letter of offer shall be accompanied with fees specified in Schedule
IV. (details of Schedule IV has been covered under Appendix 2).
f. The letter of offer shall be dispatched not earlier than twenty one days from its
submission to SEBI.
g. Provided that if, within twenty one days from the date of submission of the
draft letter of offer SEBI specifies modifications, if any, in the draft letter of
offer, the merchant banker and the company shall carry out such modifications
before the letter of offer is dispatched to the shareholders.
h. The company shall file along with the draft letter of offer, a declaration of
solvency in the prescribed form
20
3. OFFER PROCEDURE
a. The offer for buyback shall remain open to the members for a period not less
than fifteen days and not exceeding thirty days.
b. The date of the opening of the offer shall not be earlier than seven days or later
than thirty days after the specified date.
c. The letter of offer shall be sent to the shareholders so as to reach them before
the opening of the offer.
d. In case the number of shares offered by the shareholders is more than the total
number of shares to be bought back by the company, the acceptances
per shareholder shall be equal to the acceptances tendered by the shareholders
divided by the total acceptances received and multiplied by the total number
of shares to be bought back.
e. The company shall complete the verifications of the offers received within
fifteen days of the closure of the offer and the shares lodged shall be deemed
to be accepted unless a communication of rejection is made within fifteen days
from the closure of the offer.
4. ESCROW ACCOUNT
a. The company shall as and by way of security for performance of its
obligations under the regulations deposit in an escrow account on or before the
opening of the offer an amount as determined by the following manner;-
i. If the consideration payable does not exceed Rs.100 crores - 25% of the
consideration payable.
ii. If the consideration payable exceeds Rs. 100 crores – 25% up to Rs. 100
crores and 10% thereafter.
b. The escrow account shall consist of either of the following:-
i. Cash deposited with a scheduled commercial bank.
ii. Bank guarantee in favour of the merchant banker.
iii. Deposit of acceptable securities with appropriate margin with the
merchant banker.
iv. A combination of (i), (ii) and (iii) above.
21
c. Where the escrow account consists of deposit with a scheduled commercial
bank, the company shall, while opening the account, empower the merchant
banker to instruct the bank to issue a banker’s cheque or demand draft for the
amount lying to the credit of the escrow account, as provided in the
regulations.
d. Where the escrow account consists of bank guarantee, such bank guarantee
shall be in favour of the merchant banker and shall be valid until thirty days
after the closure of the offer.
e. The company shall, in case the escrow account consists of securities, empower
the merchant banker to realise the value of such escrow account by sale or
otherwise and if there is any deficit on realisation of the value of the securities,
the merchant banker shall be liable to make good any such deficit.
f. In case the escrow account consists of bank guarantee or approved securities,
these shall not be returned by the merchant banker till completion of all
obligations under the regulations.
g. Where the escrow account consists of bank guarantee or deposit of approved
securities, the company shall also deposit with the bank in cash a sum of at
least one percent of the total consideration payable, as and by way of security
for fulfilment of the obligations under the regulations by the company.
h. On payment of consideration to all the shareholders, who have accepted the
offer and after completion of all formalities of buyback, the amount, guarantee
and securities in the escrow, if any, shall be released to the company.
i. SEBI, in the interest of the shareholders may in case of non-fulfilment of
obligations under the regulations by the company forfeit the escrow account
either in full or in part. The amount forfeited may be distributed pro rata
amongst the shareholders who accepted the offer and balance, if any, shall be
utilised for investor protection.
22
5. PAYMENT TO SHAREHOLDERS
a. The company shall immediately after the date of closure of the offer open a
special account with a bankers to an issue registered with SEBI and deposit
therein, such sum as would, together with ninety percent of the amount lying
in the escrow account make-up the entire sum due and payable as
consideration for buyback in terms of these regulations and for this purpose,
may transfer the funds from the escrow account.
b. The company shall within seven days of the expiry of fifteen days of receiving
offers make payment of consideration in cash to those shareholders whose
offer has been accepted or return the shares to the shareholders.
6. EXTINGUISHMENT OF CERTIFICATE
a. The company shall extinguish and physically destroy the security certificates
so bought back in the presence of a registrar to issue or the merchant banker
and the statutory auditor within fifteen days of the date of acceptance of the
shares. Provided that the company shall ensure that all the securities bought
back are extinguished within seven days of the last date of completion of
buyback.
b. The company shall furnish a certificate to the Board certifying compliance as
duly certified and verified by-
i. The registrar and whenever there is no registrar by the merchant banker.
ii. Two directors of the company one of whom shall be a managing
director where there is one.
iii. The statutory auditor of the company
c. The certificate required shall be furnished to SEBI and to the stock exchanges
where the shares are listed on a monthly basis by the seventh day of the month
succeeding the month in which the securities certificate are extinguished and
destroyed.
7. ODDLOT BUYBACK
The provisions pertaining to buyback through tender offer as specified above
shall be applicable mutatis mutandis to odd lot shares.
23
FIGURE 1.1 BUYBACK PROCESS AS PER SEBI GUIDELINES, 1998
(TENDER OFFER)
Public announcement in at least one English national
daily, one Hindi national daily and one regional daily
specifying a specified date for the purpose of determing the
names of the shareholders
File with SEBI a draft letter of offer containing disclosures as specified in Schedule III along with decleration of solvency
in the prescribed form
The offer should remain open for a period not less than 15 days and not exceeding 30
days
In case of number of shares of shares offered by the
shreholders is more than the total number of shares to be
bought back by the company, a system of proportionate
allocation will be used
Company shall open an escrow account by way of
security for performance of its obligations
Company shall make payment to the shareholders whose shares have been accepted
within 15 days of closure of offer
Company shall extinguish all the share certificates within 15
days of the acceptance & should not delay it for a
period more than 7 days of the closure of the offer
After extinguishment, it is required to provide a
certificate to this effect to SEBI and to stock exhange by
the 7th of each succeeding month
24
F. BUYBACK FROM OPEN MARKET The buyback of shares from the open market may be in any one of the
following methods:-
1. Through stock exchange
2. Book building process
1. BUYBACK THROUGH STOCK EXCHANGE
A. PURCHASE PROCESS
1. The special resolution or the resolution passed by the board of directors
at its meeting shall specify the maximum price at which the buyback
shall be made.
2. The buyback of the shares shall not be made from the promoters or
persons in control of the company.
3. The company shall appoint a merchant banker and make a public
announcement to this regard.
4. The public announcement shall be made at least seven days prior to the
commencement of buyback.
5. A copy of the public announcement shall be filed with SEBI within
two days of such announcement along with the fees as specified
in Schedule IV.
6. The public announcement shall also contain disclosures regarding
details of the brokers and stock exchanges through which the buyback
of shares would be made.
7. The buyback shall be made only on stock exchanges having nationwide
trading terminals.
8. The buyback of shares shall be made only through the order matching
mechanism except ‘all or none’ order matching system.
9. The company and the merchant banker shall submit the information
regarding the shares bought back to the stock exchange on a daily
basis and publish the said information in a national daily on a
25
fortnightly basis and every time when an additional five per cent of the
buyback has been completed.
10. The identity of the company as a purchaser shall appear on the
electronic screen when the order is placed.
B. EXTINGUISHMENT OF CERTIFICATES
1. The company shall extinguish and physically destroy the security
certificates so bought back in the presence of a registrar to issue or the
merchant banker and the statutory auditor within fifteen days of the
date of acceptance of the shares or other specified securities. Provided
that the company shall ensure that all the securities bought back are
extinguished within seven days of the last date of completion of
buyback.
2. The company shall furnish a certificate to SEBI certifying compliance
as duly certified and verified by:-
a. The registrar and whenever there is no registrar, by the merchant
banker.
b. Two directors of the company one of whom shall be a managing
director where there is one.
c. The statutory auditor of the company.
d. The certificate required shall be furnished to SEBI and to the stock
exchanges where the shares are listed on a monthly basis by the
seventh day of the month succeeding the month in which the
securities certificate are extinguished and destroyed.
e. The company shall complete the verification of acceptances within
fifteen days of the payout.
26
FIGURE 1.2 BUYBACK PROCESS AS PER SEBI GUIDELINES, 1998
(OPEN MARKET OFFER)
The special resolution or the resolution passed by the board of directors at its
meeting shall specify the maximum price at which the
buy-back shall be made
The public announcement shall be made at least seven
days prior to the commencement of buy-back
A copy of the public announcement shall be filed with the Board within two days of such announcement along with the requisite fees
The buy-back shall be made only on stock exchanges
having nationwide trading terminals
The company shall file with SEBI the information
regarding shares bought back on daily basis and get it
published in a national daily on fortnight basis
Company shall extinguish all the share certificates within 15 days of the acceptance &
should not delay it for a period more than 7 days of the completion of buyback
After extinguishment, it is required to provide a
certificate to this effect to SEBI and to stock exhange
by the 7th of each succeeding month
27
2. BUYBACK THROUGH BOOK BUILDING
A. PURCHASE PROCESS
1. The special resolution or the resolution passed by the board of directors
at its meeting shall specify the maximum price at which the buyback
shall be made.
2. The company shall appoint a merchant banker and make a public
announcement;
3. The public announcement shall be made at least seven days prior to the
commencement of buyback.
4. The provisions related to deposit of money in escrow account will be
followed as specified in earlier sections. Besides, the deposit in the
escrow account shall be made before the date of the public
announcement. Moreover, the amount to be deposited in the escrow
account shall be determined with reference to the maximum price as
specified in public announcement.
5. A copy of the public announcement shall be filed with SEBI within
two days of such announcement along with the fees as specified
in Schedule IV.
6. The public announcement shall also contain the detailed methodology
of the book building process, the manner of acceptance, the format of
acceptance to be sent by the shareholders pursuant to the public
announcement and the details of bidding centres.
7. The book building process shall be made through an electronically
linked transparent facility.
8. The number of bidding centres shall not be less than thirty and there
shall be at least one electronically linked computer terminal at all the
bidding centres.
9. The offer for buyback shall remain open to the shareholders for a
period not less than fifteen days and not exceeding thirty days.
28
10. The merchant banker and the company shall determine the buyback
price based on the acceptances received.
11. The final buyback price, which shall be the highest price accepted shall
be paid to all holders whose shares have been accepted for buyback.
12. The company shall complete the verifications of the offers received
within fifteen days of the closure of the offer and the shares lodged
shall be deemed to be accepted unless a communication of rejection is
made within fifteen days from the closure of the offer.
2. EXTINGUISHMENT OF CERTIFICATES
The provisions of regulations mentioned earlier for buyback through stock
exchanges pertaining to extinguishment of certificates shall be applicable mutatis
mutandis.
G. GENERAL OBLIGATIONS
1. The company shall ensure that:-
a. The letter of offer, the public announcement of the offer or any other
advertisement, circular, brochure, publicity material shall contain true,
factual and material information and shall not contain any misleading
information and must state that the directors of the company accept the
responsibility for the information contained in such documents.
b. The company shall not issue any shares including by way of bonus till
the date of closure of the offer made under these regulations.
c. The company shall pay the consideration only by way of cash.
d. The company shall not withdraw the offer to buyback after the draft
letter of offer is filed with SEBI or public announcement of the offer to
buyback is made.
e. The promoter or the person shall not deal in the shares of the company
in the stock exchange during the period the buyback offer is open.
f. No public announcement of buyback shall be made during the
pendency of any scheme of amalgamation or compromise or
arrangement pursuant to the provisions of the Companies Act.
29
2. The company shall nominate a compliance officer and investors service centre
for compliance with the buyback regulations and to redress the grievances of
the investors.
3. The particulars of the share certificates extinguished and destroyed shall be
furnished by the company to the stock exchanges where the shares of the
company are listed within seven days of extinguishment and destruction of the
certificates.
4. The company shall not buyback the locked in shares and non
transferable shares till the pendency of the lock in or till the shares become
transferable.
5. The company shall within two days of the completion of buyback issue a
public advertisement in a national daily, inter alia, disclosing:-
a. Number of shares bought.
b. Price at which the shares bought.
c. Total amount invested in buyback.
d. Details of the shareholders from whom shares exceeding one-per cent
of total shares bought back.
e. The consequent changes in the capital structure and the shareholding
pattern after and before the buyback.
6. The company in addition to these regulations shall comply with the provisions
of buyback as contained in the Companies Act and other applicable laws.
1.3.3 SECURITIES AND EXCHANGE BOARD OF INDIA (BUYBACK OF
SECURITIES) (AMENDMENT) REGULATIONS, 2012
Major changes made in SEBI Guidelines for buyback of shares are as follows:-
A. The company which has been authorised by a special resolution or a resolution
passed by the board of directors at its meeting shall make a public
announcement within two working days from the date of resolution in at least
one English national daily, one Hindi national daily and one regional language
daily all with wide circulation at the place where the registered office of the
company is situated and shall contain all the material information.
30
B. A copy of the public announcement along with the soft copy shall also be
submitted to SEBI simultaneously through a merchant banker.
C. A company making a buyback offer shall announce a record date for the
purpose of determining the entitlement and the names of the security holders,
who are eligible to participate in the proposed buyback offer.
D. The letter of offer along with the tender form shall be dispatched to the
security holders who are eligible to participate in the buyback offer, not later
than five working days from the receipt of communication of comments from
SEBI.
E. The date of the opening of the offer shall be not later than five working days
from the date of dispatch of letter of offer.
F. The offer for buyback shall remain open for a period of ten working days.
G. The company shall accept shares or other specified securities from the security
holders on the basis of their entitlement as on record date. The shares proposed
to be bought back shall be divided in to two categories:-
1. Reserved category for small shareholders, whereby, “small
shareholder‟ means a shareholder of a listed company, who holds
shares or other specified securities whose market value, on the basis of
closing price of shares or other specified securities, on the recognised
stock exchange in which highest trading volume in respect of such
security, as on record date is not more than two lakh rupees.
2. The general category for other shareholders and the entitlement of a
shareholder in each category shall be calculated accordingly.
H. After accepting the shares or other specified securities tendered on the basis of
entitlement, shares or other specified securities left to be bought back, if any in
one category shall first be accepted, in proportion to the shares or other
specified securities tendered over and above their entitlement in the offer by
security holders in that category and thereafter from security holders who have
tendered over and above their entitlement in other category.
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1.4 TRENDS OF BUYBACK IN INDIAN CAPITAL MARKETS TABLE 1.5
BUYBACK ANNOUNCEMENTS IN INDIAN CAPITAL MARKETS
FINANCIAL YEAR
NUMBER OF BUYBACK ANNOUNCEMENTS
AMOUNT OF CONSIDERATION PAID
(IN RS. CRORE) 1998-1999 1 1.39 1999-2000 12 159.07 2000-2001 15 341.60 2001-2002 29 451.68 2002-2003 35 391.59 2003-2004 17 44.59 2004-2005 13 370.96 2005-2006 11 259.14 2006-2007 7 74.64 2007-2008 10 2668.41
2008-2009 45 2275.48
2009-2010 25 332.81
2010-2011 13 3710
Source: www.sebi.gov.in , www.bseindia.com
Since its introduction in 1999, the number of buyback announcements and the
amount of funds to be used for the same has grown tremendously. With just one
announcement made in 1998-99, it has grown to 45 in the year 2008-2009. The
numbers have diminished since 2008-09, yet the amount of reserves used for the
purpose of buying back shares has increased to a whopping 3710 crores for the
financial year 2010-2011. It is beyond doubt that Indian companies have repeatedly
adopted buyback as a mechanism for payouts in last one decade. Looking at the
details of the buyback firms, a few entities like Reliance, Salem Exploration, Godrej,
ICI India and Finolex etc. have repeatedly gone for adoption of buyback route. Thus,
buyback has been a favourite choice of many such firms who plan to undertake
buyback for capital restructuring.
Looking at the trends, a few middle years, i.e. 2001 to 2005 of the decade have
got a good number of buyback announcements. With a fall in numbers in following
years, the next wave is visible around 2008-2009 when the number of announcements
32
have reached unprecedented levels at 45. Thus, the year of subprime crisis in USA has
evoked the response with large number of buyback undertaken in that very year itself.
With undervaluation being considered as primary reason for announcing buyback, the
figures substantiate the findings whereby, an overall declining trend in stock markets
motivates firms to buyback its own shares from the market. Falling share prices in
markets with substantial reserves available for buyback induce such firms to adopt
buyback strategy. Most of buyback firms have been found to be showing better
financial results vis-a-vis industry standards which also explains the presence of
sufficient reserves to undertake the activity. Thus, with ready motivations supported
by spirit to provide temporary jumps in share prices, buyback strategy becomes a
perfect solution for such troubled times. Although stability in prices have reduced the
number of announcements after 2008, yet strong financial motivations have persuaded
companies to utilise more and more funds for buyback.
TABLE 1.6 CLASSIFICATION OF BUYBACK ANNOUNCEMENTS IN INDIAN
CAPITAL MARKETS AS PER METHOD OF BUYBACK
Source: www.sebi.gov.in, www.bseindia.com
YEAR TOTAL BUYBACK ANNOUNCEMENTS OPEN MARKET TENDER OFFERS
1998-1999 1 0 1
1999-2000 12 1 11
2000-2001 15 3 12
2001-2002 29 23 6
2002-2003 35 17 18
2003-2004 17 6 11
2004-2005 13 8 5
2005-2006 11 10 1
2006-2007 7 6 1
2007-2008 10 7 3
2008-2009 45 41 4
2009-2010 25 23 2
2010-2011 13 8 5
TOTAL 243 153 80
33
Open market purchases and tender offer are the two most widely used methods
for share buyback by Indian companies. Out of the two methods, tender offer has been
an equally popular method till 2008 with an equal number of open offer and tender
offer buyback announcements being made in all the years prior to 2008.The balance is
clearly tilted towards open offer method being adopted by companies from 2008
onwards. With big names like Bosch, Hindustan Unilever Limited, Reliance
Infrastructure, Patni Computers, Panacea Biotec, India Infoline and GTL announcing
buyback worth more than 100 crores each during this period, the numbers have been
showing the growing preference for buyback.
With no major changes in tax rates or any significant change in legislature
related to buyback as observed during all these years, no definite trending pattern can
be built up for such changes in preferences of one method over the other. With recent
changes in guidelines, whereby, buyback announcing companies have to make a
public announcement within two days of passing the board resolution authorising the
buyback rather than no time period fixed earlier for such announcements, the
popularity of buyback as an effective tool for providing short term boost to demand
for such shares is expected to go higher in coming days.
34
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