The Redemption of Shares vs. Purchase of Shares

When you buy stock shares of a company, you likely have the expectation that you can hold the shares for as long as you like and sell them at a time of your choosing. That, in fact, is usually the case, but there is an exception known as “redeemable shares.” When a company issues redeemable shares, it has the right to force the shareholder to sell back the shares to the company at a set price, known as the “call price.”

Companies can also offer to repurchase shares from shareholders at or above the current selling price. It’s strictly up to shareholders to decide to take the repurchase offer.

Corporations sell stock to the public to raise money. An initial public offering, or IPO, is the corporation’s first public sale of stock. It can sell additional shares from time to time if it wants to raise more money. The corporation can set certain terms for the stock it sells, one being the right to redeem the shares later on (these are “callable” shares).

Once the corporation sells the shares, the stock trades on a stock exchange or through a network of dealers in what is called the secondary market. The corporation doesn’t collect any further money when shares are bought and sold on the secondary market, and the price of the shares vary according to supply and demand.

The “float” is the number of shares trading in the secondary market. Corporations may want to reduce the float for various reasons.

For example, corporations are often judged on their earnings per share (EPS) and their share price; reducing the float boosts EPS. In addition, reducing the supply of shares trading on the secondary market will tend to drive up the trading price of the shares because they are now relatively scarcer. Both of these effects improve the image of the corporation.

The company might also feel that the stock is trading at too low a price. By reducing the float, it can earn a tidy profit by reissuing the shares later when the price rises.

Share redemption is one way to reduce the float. It doesn’t matter whether a shareholder purchased callable stock shares directly from the corporation or on the secondary market. If the corporation redeems the shares, the shareholder will receive a set price per share which is the “call price”.

The call price will usually be around or slightly higher than the current trading price of the shares. Otherwise, shareholders would be up in arms about being rooked out of their money. Since the shareholders own the corporation, a redemption below market price might cause the shareholders to rise up and vote out the current corporate directors.

To reduce the float via a share repurchase, a corporation acts just like any other buyer on the stock exchange. Shareholders are under no obligation to sell their shares, and even if they do, they don’t know whether the buyer was the corporation or another trader. By going into the secondary market to repurchase its shares, the corporation spends some of its money on shareholders who choose to sell without forcing anyone to unwillingly give up their shares.