Chartered Financial Analyst Level 2
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20 Which of the following is most likely a motivation for a company using share repurchases rather than cash dividends to distribute earnings to shareholders?
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A
To decrease the company's financial leverage
B
To signal that the company's prospects are positive
C
To create the expectation of future share repurchases
Explanation:
Explanation
Share repurchases are often used by companies to signal positive future prospects to the market. When a company announces a share repurchase program, it typically indicates that management believes the company's shares are undervalued and that the company has sufficient cash flow and confidence in its future earnings to return capital to shareholders.
Key points:
- Option B (Correct): Share repurchases can signal management's confidence in the company's future prospects and that they believe the stock is undervalued
- Option A: Share repurchases actually decrease equity, which typically increases financial leverage rather than decreasing it
- Option C: While share repurchases can create expectations, this is not the primary motivation compared to signaling positive prospects
Share repurchases provide flexibility to management and can be viewed as a more tax-efficient way to return capital to shareholders in some jurisdictions.
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