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Equity capital is always an important source of finance in business. It has provided upward adjustment in capital structure in the form of increase in authorized capital and capitalization of profit (Bonus issue). but before 1999 there was no flexibility in reduction of capital only way to reduce capital of company was capital reduction scheme. Rajagopalan and Shankar (2012) referred to as share re-purchase in western literature, buy-back of shares, a process through which companies get back their equity which has already been issued to the public and are traded in exchanges.
In 1998 an amendment was passed under section 77A, 77AA and 77B of previous company law 1956 which allowed companies in India to repurchase their own shares up to twenty-five per cent of their net worth out of the free reserves or securities premium account or proceeds of an earlier issue other than a fresh issue made specifically for buy-back purposes. The Articles of Association of the company must authorize the buyback and a special resolution must be passed in the general meeting of the company (CA report, 2018). But if the amount of buyback is less than 10% of the paid-up capital and free reserves of the company, than the buyback decision can be made by a board resolution. The ratio of the debt owed by the company should not be more than twice the aggregate of capital and its free reserves after such a buy-back, i.e. not more than 2:1.
Shares buy-back is getting popular from that time only. Buyback of shares is considered as the most liberal system which allows any company to repurchase its own shares. Moreover, it is also a financial strategy which involves restructure of share capital (e.g. Benhamouda & Watson,2010; Thirumalvalavan & Sunitha, 2006), takeover defensive mechanism (e.g. Denis, 1990; Ginglinger & L'her, 2006; Liang et al 2012), It also in increase EPS of company by distribution of excess cash (e.g. Benhamouda & Watson, 2010) most important reason for buy-back is undervaluation of shares (Ha, Hong & Lee, 2011). Signalling theory says that when a firm frequently issues buy-back to disclose undervaluation of their shares, moreover it’s a tactic to give signal to market that they are bullish (Jagannathan & Stephens, 2003). Manifestly most of the earlier research has documented a positive return around buy-back announcement (Comment & Jarrell, 1991; Gonzālez & Gonzālez, 2004; Hyderabad, 2009, Ikenberry et al 1995;).
There are two perspectives regarding buyback. One perspective among the investors is that the company is buying its shares back because it does not have investable opportunities in real assets and does not plan at this point of time to expand or diversify. This being the case the company is returning the money in part or full to the investors so that he may deploy these funds to more profitable ventures. This move is on lines of maximizing investors wealth. The other view is that the company is buying its shares back because it wants to invest in its own shares and does not find better opportunity to invest elsewhere.