Stock Prices, Clifford P.

Historically, companies took a common sense approach toward share repurchases, reducing them when stock prices were high and stepping them up when prices were low. After the stock market crash of October 19, 1987, for example, 400 companies announced new buybacks over the next 12 days alone-while only 107 firms had announced buyback programs in the earlier part of the year, when stock prices had been much higher. See Murali Jagannathan, Clifford P. Stephens, and Michael S. Weisbach, “Financial Flexibility and the Choice Between Dividends and Stock Repurchases,” Journal of Financial Economics, vol. 57, no. 3, September, 2000, p. 362.

The stock options granted by a company to its executives and employees give them the right (but not the obligation) to buy shares in the future at a discounted price. That conversion of options to shares is called “exercising” the options. The employees can then sell the shares at the current market price and pocket the difference as profit. Because hundreds of millions of options may be exercised in a given year, the company must increase its supply of shares outstanding. Then, however, the company’s total net income would be spread across a much greater number of shares, reducing its earnings per share. Therefore, the company typically feels compelled to buy back other shares to cancel out the stock issued to the option holders.