Rules for Buyback of Shares

Abstract

Share buybacks have become a popular strategy among Indian companies, often used to return surplus capital to shareholders and reshape their capital structure. While they can signal strong financial health, buybacks also raise questions around fairness, transparency, and long-term value creation. The SEBI (Buyback of Securities) Regulations, 2018, have been central in regulating this practice for listed companies in India. This paper takes a close look at how these regulations impact shareholder value, help guard against potential price manipulation, and promote good corporate governance. It also reflects on global practices, recent trends, and what more can be done to ensure that buybacks serve their intended purpose without being misused.

Over the past decade, share buybacks have emerged as a significant feature of India’s capital markets. Prominent corporations across sectors—ranging from technology leaders such as Infosys to industrial conglomerates like Larsen & Toubro—have increasingly employed buybacks as a strategic financial instrument. At its essence, a buyback involves a company repurchasing its own shares from existing shareholders or the open market, resulting in a reduction of outstanding shares. This reduction can lead to an enhancement of key financial metrics, such as earnings per share (EPS) and return on equity (ROE), while also serving as an indicator of management’s confidence in the company’s future prospects.

The motivations underpinning buybacks are diverse. Companies often use them to optimize their capital structure, distribute surplus cash, and provide an alternative to dividend payments, which may be less tax-efficient for certain shareholders. From a market signaling perspective, buybacks are generally interpreted as a positive development, suggesting that management perceives the shares as undervalued. In the context of India’s evolving corporate governance landscape, buybacks have thus become an attractive mechanism for companies seeking to manage market perceptions and shareholder expectations.

Nonetheless, the increased prevalence of buybacks has also raised several concerns. When improperly timed or strategically misused, buybacks can have adverse implications. There is a risk that companies might undertake buybacks at inflated valuations, ultimately harming long-term shareholder value. Furthermore, buybacks may be exploited by promoters to facilitate an exit at advantageous prices, or to manipulate share prices in a manner that misleads the broader market. Such practices, if left unchecked, can erode investor confidence and distort true assessments of a company’s financial health.

In light of these risks, the Securities and Exchange Board of India (SEBI) initiated a comprehensive overhaul of the regulatory framework governing buybacks. The SEBI (Buy-Back of Securities) Regulations, 2018 introduced a range of reforms designed to enhance transparency, ensure fair treatment of all shareholders, and promote market integrity. Key measures included stricter post-buyback debt-to-equity ratio requirements, limitations on permissible sources of funding, and enhanced disclosure obligations regarding the objectives, modalities, and effects of buyback transactions.

This article seeks to critically examine the evolution and impact of SEBI’s regulatory framework on buybacks, with a particular focus on the 2018 reforms. It evaluates how these changes have influenced corporate behavior, affected shareholder value, and contributed to improved governance standards. Drawing upon empirical examples and regulatory commentary, the analysis highlights both the strengths and limitations of the current regime. In doing so, the article provides a nuanced understanding of buybacks as a complex financial strategy situated at the intersection of corporate finance, investor protection, and regulatory oversight in India’s dynamic capital markets.

The Regulatory Basis

The legal authority for companies in India to undertake share buybacks is derived from three principal sources:

• The Companies Act, 2013 (Sections 68 to 70)
• The SEBI (Buy-Back of Securities) Regulations, 2018
• The SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (for continuous disclosures)

Collectively, these legal instruments delineate the permissible methods, purposes, and limits associated with buybacks. Section 68 of the Companies Act, 2013 stipulates that companies may fund buybacks through their free reserves, the securities premium account, or the proceeds from a fresh issue of shares or other specified securities, provided that the proceeds from a similar class of securities are not utilized for repurchasing those very securities. This framework ensures that buybacks are conducted using legitimate and sustainable sources of funding, thereby safeguarding the financial health of the company and protecting shareholder interests.

Key Thresholds and Statutory Limits

The SEBI (Buy-Back of Securities) Regulations, 2018 impose important thresholds and limitations on buyback activities to maintain market stability. Notably, a buyback is restricted to 25% of a company’s paid-up capital and free reserves as per its latest audited financial statements. Furthermore, post-buyback, the company’s debt-to-equity ratio must not exceed 2:1, although certain exemptions are available for financial institutions and non-banking financial companies (NBFCs) due to the nature of their operations.

The procedural requirements vary depending on the size of the buyback. Shareholder approval via a special resolution is mandatory for larger buybacks exceeding 10% of the total paid-up equity capital and free reserves. In contrast, for buybacks up to this threshold, board approval suffices. These measures aim to ensure both procedural rigor and shareholder oversight in significant capital restructuring activities.

Capital Structure Optimisation

One of the primary motivations for companies to undertake buybacks is to optimise their capital structure. By reducing the number of outstanding shares, companies can enhance financial metrics such as earnings per share (EPS) and return on equity (ROE). These improved ratios are often perceived positively by investors and market analysts, potentially leading to a higher market valuation. Thus, buybacks serve as a strategic lever to align a company’s financial profile with shareholder expectations and market standards.

Signalling Undervaluation

Another important rationale behind buybacks lies in market signaling. Management may initiate a buyback to convey its belief that the company’s shares are undervalued by the market. Such a signal is typically interpreted as a vote of confidence in the company’s future prospects, thereby fostering positive investor sentiment. Even in the absence of significant financial restructuring, the announcement of a buyback can have a favorables impact on the share price in the short term.

Efficient Deployment of Surplus Cash

Companies often accumulate substantial cash reserves beyond their immediate operational and strategic needs. In such circumstances, conducting a buyback can represent a more shareholder-friendly and tax-efficient method of returning excess capital compared to distributing dividends. This was particularly attractive during periods when dividend distribution taxes (DDT) were applicable, making direct cash returns less favourable for shareholders.

By returning capital through buybacks, companies not only enhance shareholder value but also prevent the erosion of returns that may arise from holding under-utilised cash on their balance sheets.

Defensive Measure Against Hostile Takeovers

Buybacks also serve as an effective defense mechanism against hostile takeover attempts. By reducing the public float—the number of shares available for trading—companies can make it significantly more challenging for an external entity to acquire a controlling stake. This strategic use of buybacks allows companies to maintain greater control over their ownership structure and defend against unsolicited acquisition bids.

Managing Employee Stock Option Plans (ESOPs)

In companies with active Employee Stock Option Plans (ESOPs), buybacks are often used to mitigate the dilutive effects that arise from the exercise of stock options. Through buybacks, companies can maintain a stable capital base and ensure that equity incentives do not unduly alter the ownership structure. This approach helps balance the twin objectives of rewarding employees while protecting the interests of existing shareholders.

Permissible Routes for Buybacks

The SEBI (Buy-Back of Securities) Regulations, 2018 recognize two primary modes through which companies may undertake buybacks:

Each route carries its own set of procedural obligations and strategic considerations, with companies choosing based on factors such as speed, cost, shareholder composition, and regulatory impact.

Enhancing Transparency and Investor Confidence

Transparency is a cornerstone of the 2018 regulations. Companies are required to make detailed public announcements prior to initiating a buyback, disclosing the rationale, size, funding sources, and timeline of the transaction. Offer documents must be filed with SEBI, and in cases involving open market purchases, companies must disclose daily buyback activities, including the number of shares purchased and the aggregate value.

Additionally, companies must deposit a prescribed portion of the buyback amount into an escrow account before commencing the buyback process. This requirement ensures that the company has the necessary financial commitment to complete the buyback, thereby minimising the risk of incomplete or misleading transactions.

Key Restrictions to Prevent Abuse

The regulations also impose several critical restrictions to prevent misuse of buybacks:

These measures are designed to protect the integrity of the market, ensure fair treatment of all shareholders, and prevent companies from engaging in opportunistic practices that may undermine investor trust.

Short-Term Gains

In the short term, share buybacks often yield tangible benefits for shareholders. Announcements of buyback programs typically generate positive market reactions, leading to an immediate uplift in share prices. This response is primarily driven by two factors: heightened investor optimism regarding the company’s future prospects and the reduction in the overall supply of shares, which can mechanically boost earnings per share (EPS). Additionally, with a reduced shareholder base, the dividends paid per share may increase over time, providing a further incentive for investors to view buybacks favourably.

Long-Term Implications

However, the long-term impact of buybacks is more nuanced. When buybacks are funded through debt or are primarily executed to artificially enhance financial ratios rather than to reflect genuine undervaluation, the strategy can undermine the company’s financial stability. Excessive leveraging to finance buybacks increases risk, particularly in volatile market conditions. Moreover, while buybacks can temporarily mask underlying weaknesses, they cannot substitute for the need for sustained revenue growth, innovation, and operational excellence. Investors must, therefore, assess whether a buyback is being used as a value-creation tool or merely as a cosmetic financial manoeuvre.

Retail Versus Institutional Investors

The effectiveness and fairness of buybacks can vary depending on the method used. In tender offers, where shares are repurchased proportionally from all shareholders who opt to participate, retail and institutional investors are generally treated equitably. Conversely, in open market buybacks, institutional investors often enjoy a significant advantage due to their ability to trade in larger volumes and respond more rapidly to market movements. Retail investors, by contrast, may be disadvantaged by information asymmetries, slower reaction times, and a lack of awareness about the ongoing buyback process.

Artificial Demand Creation

One of the major criticisms of share buybacks is their potential to artificially inflate share prices without any corresponding improvement in a company’s underlying performance. By reducing the number of shares available for trading, companies can create artificial scarcity, which may drive prices upward temporarily. This concern is particularly acute in the case of open market buybacks, where individual purchases are dispersed and less transparent, making it difficult for regulators and investors to distinguish between genuine market activity and company-driven price support.

Insider Trading Risks

Buybacks also raise concerns regarding insider trading. Corporate insiders, who possess access to material non-public information, may time buybacks strategically to benefit from forthcoming positive developments, or avoid impending negative news. Such practices undermine market integrity and erode investor trust. Given the opaque nature of many open market transactions, there is a heightened need for vigilant regulatory oversight to detect and deter potential abuses related to insider trading.

SEBI’s Regulatory Response

Recognizing these risks, SEBI has progressively strengthened its surveillance and enforcement mechanisms. Measures introduced include monitoring unusual trading patterns around buyback periods, imposing restrictions on price bands within which buybacks can be executed, and mandating cooling-off periods to separate corporate actions from insider information leaks. In addition, SEBI leverages technology-driven analytical tools to identify anomalous trading behaviors linked to buybacks, thereby enhancing its ability to maintain market fairness and integrity.

Role of the Board of Directors

Corporate governance plays a critical role in ensuring that buybacks serve the interests of all shareholders, rather than advancing narrow or short-term objectives. The board of directors is responsible for evaluating the rationale, timing, and financial implications of any proposed buyback. Independent directors, in particular, are expected to exercise enhanced vigilance, scrutinizing whether the buyback is truly in the best interest of the company and its broader shareholder base. Effective board oversight is essential to ensure that buybacks are not used opportunistically by management or controlling shareholders.

Promoter Advantages and Concerns

Despite regulatory requirements mandating disclosure of promoter participation in buybacks, practical concerns persist regarding disproportionate benefits accruing to promoters. In cases where retail investor participation is limited, promoters may find opportunities to consolidate their holdings or exit at favorable prices. This dynamic highlights the need for continued vigilance and potential regulatory refinements to ensure that buybacks operate on a level playing field and do not unduly advantage insiders at the expense of minority shareholders.

The Case of Larsen & Toubro

A notable example of SEBI’s regulatory assertiveness was the blocking of Larsen & Toubro’s proposed buyback in 2020. SEBI determined that the buyback would violate the post-buyback debt-to-equity ratio threshold, thereby contravening the statutory framework. This decision sent a clear signal that regulatory approval of buybacks is not automatic, and that SEBI will enforce compliance rigorously. The L&T case serves as a reminder that regulatory scrutiny is an essential safeguard against potential corporate overreach in the use of buybacks.

India’s regulatory framework for share buybacks seeks to balance flexibility with necessary safeguards. While companies enjoy the freedom to undertake buybacks, detailed disclosure requirements, debt-equity ratio restrictions, and shareholder approval mechanisms ensure that such transactions are subjected to robust scrutiny. SEBI has demonstrated a willingness to adapt the framework in response to market developments and observed abuses, reflecting a dynamic and evolving approach rather than a static regulatory regime.

Compared to the relatively laissez-faire environment in the United States, where companies operate under the safe harbour provisions of SEC Rule 10b-18, India’s approach places greater emphasis on transparency and shareholder protection. At the same time, India’s regime is less restrictive than that of the United Kingdom, where solvency concerns impose significant procedural hurdles on buybacks.

Overall, India’s regulatory model aspires to facilitate efficient capital management by companies while simultaneously safeguarding market integrity and protecting minority investors.

Limited Monitoring Capacity

Despite SEBI’s robust regulatory framework, practical limitations remain in monitoring buybacks—particularly those executed via the open market route. Real-time oversight of all buyback transactions is resource-intensive, and in a dynamic, high-volume market like India’s, certain practices may escape immediate scrutiny. This creates a risk that companies could exploit regulatory blind spots, undermining investor confidence.

Loopholes in Funding Mechanisms

While regulations discourage debt-funded buybacks, companies sometimes employ creative structures to circumvent these restrictions. Techniques such as intra-group loans, related-party transactions, or complex financing arrangements can indirectly facilitate buybacks without technically violating rules. Such practices challenge the spirit of the regulations and call for more comprehensive and nuanced oversight.

Passive Retail Investor Participation

Retail investors, who form a substantial portion of India’s shareholder base, often remain passive or uninformed regarding buyback processes. Due to limited financial literacy and lower access to timely information, many small shareholders neither reap the full benefits of buybacks nor challenge those perceived as value-destructive. Their limited participation can skew the equitable distribution of buyback advantages, inadvertently favoring institutional investors and insiders.

Vague and Complex Disclosures

Another persistent challenge lies in the nature of corporate disclosures surrounding buybacks. Often couched in technical language or presented without sufficient context, these disclosures can obscure rather than illuminate the true rationale and impact of a buyback program. This opacity hampers informed decision-making by investors and raises concerns regarding transparency and accountability.

Post-Pandemic Surge in Buybacks

Following the COVID-19 pandemic, an increasing number of companies, buoyed by large cash reserves and facing constrained growth opportunities, turned to buybacks as a strategic deployment of surplus capital. Notable among these are major corporations such as Tata Consultancy Services (TCS), Infosys, and Wipro, all of which executed significant buyback programs between 2020 and 2023. The trend underscores the continued relevance of buybacks in corporate financial management strategies.

Phasing Out the Open Market Route

Recognizing the transparency challenges inherent in the open market method, SEBI announced plans to phase out open market buybacks by 2025. The shift reflects a policy preference for the tender offer route, which offers greater fairness and inclusivity, particularly for retail shareholders. By eliminating the open market route, SEBI aims to minimizeprice manipulation risks and enhance investor trust.

Embracing Technology for Market Surveillance

In response to the complexities of modern market behavior, SEBI is increasingly integrating artificial intelligence (AI) and advanced data analytics into its surveillance systems. These tools enable the detection of unusual trading patterns, flagging potential instances of manipulation or insider activity more swiftly than traditional methods. Technology-driven monitoring is poised to become a cornerstone of SEBI’s regulatory approach in the coming years.

Simplified and Transparent Disclosures

To foster informed investor participation, companies should be encouraged—or required—to present buyback-related disclosures in a clearer, more accessible format. Key details, such as the rationale for the buyback, funding sources, and potential impacts on financial metrics, should be communicated in plain language without sacrificing rigor.

Shareholder Involvement in Large Buybacks

Introducing a mandatory shareholder vote for buybacks exceeding a certain threshold, even if they technically fall within the board’s approval limits, would enhance accountability. Such a measure would ensure that significant capital deployment decisions reflect a broader consensus rather than solely boardroom discretion.

Incentivising Tender Offer Routes

Given the greater transparency and fairness associated with tender offers, SEBI could consider offering procedural or regulatory incentives to companies that opt for this method. Streamlining compliance processes or providing certain flexibilities could encourage wider adoption of tender offers over the open market route.

Strengthening Market Surveillance

Continued investment in sophisticated surveillance infrastructure is essential to monitor buyback activities effectively. Expanding SEBI’s technological capabilities will enable faster responses to potential violations and maintain a level playing field for all investors.

Enhancing Financial Literacy

Investor education campaigns focused specifically on buybacks—their mechanics, implications, and participation procedures—can empower retail investors. Enhanced financial literacy would enable more equitable participation in corporate actions and contribute to a healthier, more resilient capital market ecosystem.

Buybacks, in themselves, are neutral financial instruments; their ultimate impact depends on how—and why—they are used. When deployed prudently, share buybacks can enhance shareholder value, optimize capital structures, and signal management’s confidence in the company’s future prospects. However, when misused, they can serve as tools for manipulation, erode investor trust, and mask underlying weaknesses.

The SEBI (Buy-Back of Securities) Regulations, 2018, represent a significant advancement in bringing structure, transparency, and fairness to buyback processes in India. Yet, as markets evolve and corporate strategies become increasingly sophisticated, the regulatory framework must remain dynamic. Continuous refinement, informed by market realities and emerging risks, is essential.

SEBI’s recent initiatives—phasing out the open market route, embracing technology, and promoting transparency—are positive steps in the right direction. Going forward, a greater emphasis on investor protection, governance, and education will be crucial to ensure that buybacks fulfill their intended purpose: enhancing genuine shareholder value in a fair and transparent manner.

Ultimately, the goal should not be to discourage buybacks, but to ensure they are conducted responsibly, equitably, and in alignment with the broader interests of all stakeholders in India’s capital markets.

References

 1.​ SEBI (Buy-Back of Securities) Regulations, 2018

2. ​Companies Act, 2013 – Sections 68–70

3.​ SEBI Annual Report 2023–24

4.​ Consultation Paper on Buyback Reforms, SEBI (2023)

5.​ Larsen & Toubro Ltd. Buyback Rejection Case (2020)

6.​ OECD Corporate Governance Factbook, 2023

7.​ Bhattacharya, U., & Jacob, J. – Corporate Buybacks and Earnings Management in India

8.​ Business Standard, Economic Times, and SEBI Press Releases