I do not get how direct negotiation share repurchase would increase transfer wealth from the average shareholder to the wealthiest shareholder.
Shouldn’t everyone get richer because a share repurchase would reduce the shares outstanding, thus increasing the stock price and making equity investors richer?
Repurchasing shares costs money.
There are fewer shares, but there’s less equity.
Since less shares are outstanding for the company, wealth becomes more concentrated towards the ones who own the most shares?
And those who just got a payoff.
At market value.
Which may be higher than book value.
Sounds good. I have a followup question (related to share repurchases):
When computing book value for a company after a share repurchase, why do subtract the repurchase amount to compute book value after a share repurchase?
For example, if a company has $200 million book value on its B/S, and it decides to purchase back $15 million of shares, why do we subtract 200 - 15? I thought under perfect capital market assumption (I learned this in school) that the equity value for a company does not change in a perfect world scenario with a share repurchase?
You spend $15 million in cash to buy the shares, so your assets are reduced by $15 million. That means that either your liabilities or your equity is reduced by $15 million.
You liabilities haven’t changed.
But isn’t there a specific assumption where total value of the firm does not change with a share repurchase, or am I wrong about this?
You’re wrong about this.
As another followup question, when we are calculating a BV per share after a share repurchase, why is the reduction of shares outstanding based upon the market value instead of the book value for the stock.
Because the company has to pay market price to buy back the shares, just like everyone else.
In direct negotiation, company pay premium price to the market price, to the stock seller.
Any price paid by company above market price is waste to existing shareholder. This will result in less distributable fund/shareholders’ fund to be distributed among shareholders.
To the question of direct negotiation and wealth transfer - let’s assume the intrinsic value of the shares were $5 million (you can for simplicity assume that the shares are fairly priced, so market value is intrinsic value).
If the company buys back the shares in direct negotiation, it’s often done because they want the shareholder to go away (i.e. think of offering greenmail to an activist investor). To do so, they offer them a premium over intrinsic value - say $7 million. In this case, the company has effectively made a negative NPV decision - their inflows are $5MM, and their outflows are 7MM, so the company has lost $2MM. Remember - the firm’s shareholders have the residual claim, so they gain from value-creating decisions and lose from value-destroying ones
Likewise, the selling shareholder has gained $2MM in value.
Put those tow facts together, and you have a $2MM weath transfer.