Generally, the announcement of a buy back deal will raise share prices as the market responds to the expected increase in earnings per share and increase in return on net worth resulting from a lower equity. Further, buy backs are usually at a substantial premium over the market price which is an indicator that the company expects a sharp buy back, like bonus shares, is a means to reward shareholders.

However, in a recessionary market where companies are not cash rich and not in a position to reward their shareholders with a premium over that paid at par, the buyback provisions cannot be expected to stimulate the capital markets. In fact, the buy back provisions cannot be expected to stimulate the capital markets.

In fact, the buy back provisions have been promulgatedalong with provisions facilitating issue of discount shares and the Ordinance does not preclude a buy back of shares at which backs may be made. This belies any expectation even by the authorities that the buybacks are intended to reward shareholders and thus increase market prices. Instead, the buy back provisions have another purpose altogther.

A buy back enables management to repurchase part of the outstanding capital from the existing shareholders on a proportionate basis. Although a company was previously allowed to repurchase its shares in the context of a reduction of capital, now a company no longer has to obtain court approval in order to purchase its own shares and no long has to call a meeting of the creditors.

If an acquirer makes an offer to the shareholders, under the new provisions, the existing management can try to prevent the takeover by making a repurchase offer to the shareholders. Therefore, a promoter can prevent a takeover of his company and have the company itself bankroll thedefensive mechanism.

According to press reports, the Justice P.N. Bhagwati committee set up by SEBI to review the takeover code has decided that a buyback of shares will be excluded from the Takeover Code. A buyback will be permitted while a hostile or friendly bid is made for substantial acquisition of shares of the company. The exclusion of buy backs from the Takeover Code means that the buy back will not be considered as a competitive bid and will not be subject to the restrictions on timing and quantity of shares applicable to competitive bids.

The committee has further clarified that the Takeover Code will provide for an adequate time frame for companies to make a buy back offer to counter any takeover offer. Therefore, the buy back provisions are intended to help existing managements to prevent takeovers and have the company finance the repurchase.

The provisions in the Ordinance on issue of discount shares also support the view that the drafters' intention was, first, to provide existingmanagement defensive mechanisms against takeovers. Under the new provisions, "sweat equity share" may be allotted at a discount or for consideration other than cash. Instead of contributing cash, persons may contribute their intellectual property rights or make "value additions." Although shares could be issued at a discount under the existing law, the Ordinance has removed the requirement that approval be obtained from the Company Law Board (CLB) as well as the maximum rate of discount (10 per cent) which may be approved by the CLB.

Under the new provisions on sweat equity shares, the company may issue shares to certain persons thereby increasing the relative equity holdings of a particular group of shareholders even if such persons do not have the cash to finance the purchase. Like the provisions on buy back, the creation of sweat equity shares will enable existing managements to stave off hostile takeovers or acquisitions by foreign companies as the company may allot shares to friendly persons even ifthey cannot make the cash contributions at par.

Second, the issuance of discount shares may help a company finance a buy back of shares. The Ordinance provides for three methods by which a buy back may be financed by the company: 1) free reserves, 2) securities premium account or 3) the proceeds of an earlier issue. A public issue of shares at a discount is a quick way to pump cash into the company in cases where the market is not responsive to the shares prices at par or at a premium. Importantly, the Ordinance does not prohibit a buy back at a discount.

The issuance on discount shares may also help promoters of financially troubled companies to consolidate shares in the hands of financial institutions which, in turn, may serve to dilute the shareholding of the foreign investor in the company or stave off a takeover. Promoters can request financial institutions to convert their loans into equity at a discounted price thereby offering a chunk of the share capital of the company. The resulting reduction ofthe debt and the interest costs should facilitate recovery of the company. Moreover, the financial institution will have a larger chunk of shares than if the same was purchased at par thereby protecting the company from an unwanted takeover.

The use of buy backs as a defensive mechanism against takeovers and to dilute the stakes of foreign investors is further supported by the provisions on intercorporate loans and investments in the Ordinance. The ceiling on intercorporate loans and investments which may be increased from 30 per cent of the subscribed capital and reserves of the lender/ investor company to either 60 per cent of the paid up share capital and reserves of 100 per cent of the free reserves of the lender/investor company whichever is higher. The restriction that only up to 30 per cent of the paid up capital and reserves of the investee company could be acquired without Central Government approval has also been deleted.

Accordingly, promoters can now use a much larger percentage of the sharecapital of one company to acquire the shares of another company and the limit on the percentage of share capital acquired no longer exists. Although the same investments could be effected earlier by dividing them among several investor companies, the Ordinance has provided greater flexibility and reduced transaction costs by removing the need to spread the acquisition or the financing over several companies in order to avoid transgressing the 30 per cent limit. Accordingly, in the event of a hostile takeover, a related company can now make a competing offer to the shareholders in an amount up to 100 per cent of its free reserves. Also a promoter can now bring in much more funds with fewer administrative hurdles from a related company in order to buy out a foreign investor.

In sum, the provisions in the Ordinance on buy back of shares, discount shares and intercorporate loans and investments are a three pronged tool designed to facilitate defensive measures by companies faced with a takeover threat and toenable companies to buy out their foreign joint venture partners. As for revival of the capital markets, it will likely remain elusive as a myth, a metaphor.