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The Price Effects of Australian Structured Share Buybacks Keith Woodward and Graham Partington, 2016 Tax advantages of Off-market Buybacks Price In America the buyback price is usually higher than the market price. In Australia the buyback price is usually less than the market price. This is because the after-tax The aftertax value of the buy-back offer value of the buyback is greater than the market price of the share. The two tax benefits of the buyback are the: franking credits attached to the franked dividend portion of the buyback price, and the Actual Market Price Price Price Value of franking credits Tax on dividend component Franking Credits and the 45-day Rule After-Tax Value of Buy-Back Offer = Actual Market Price After-Tax Value of Buy-Back Offer Tax on ‘gross-up' Buyback price capital loss due to the capital portion of the buyback price being only a fraction of the market share price. Actual Market Price After-tax value of capital loss Franking credits provide a significant part of the after tax Dividend component value of shares successfully tendered in the buyback. To be able to use the franking credits, shares must be held ‘True’ Market Price Capital component by domestic investors for at least 45 days before the buy- ‘True’ Market Price 0 back price announcement date (and scale back). 0 Time Announcement Date Franking Credit Drop-Off Date Ex-Buy-Back Date 0 Time Announcement Date Franking Credit Drop-Off Date Ex-Buy-Back Date Before Arbitrage Before Arbitrage After Arbitrage After Arbitrage Buyback Price Floor set by ATO The after-tax value of the buy-back offer The ATO designates the maximum tender discount in an off-market buyback to be 14% of the VWAP prior to the buyback announcement. Domestic tax-advantaged investors, particularly super funds, would tender shares below this amount if allowed. This is because the after-tax value of the buyback is often significantly higher than the nominal cash buyback price. The maximum 14% discount acts as a price floor, and tax-advantaged super funds are expected to bid up the market price of the stock as they Market price Gain per share accepted into the buy-back Market price = New market price After-tax value of the buy-back offer Buy-back price Price Gain per share accepted into the buy-back Buyback price Price compete for the tax benefits of the buyback. 0 Buy-back announcement date 0.14 0.12 0.1 Actual and estimated daily abnormal returns Ann actual return Ann estimated return 0.08 Franking Credit Drop-off date 0.04 0.02 Actual and estimated daily abnormal returns FCD actual return FCD estimated return 0 0.06 0.04 = After-tax value of the buy-back offer Buy-back price which cannot fall below minimum tender price (Pfloor) Buy-back price which cannot fall below minimum tender price (Pfloor) 0 Abnormal Returns due to ATO Price Floor Buyback announcement day positive abnormal return Super funds may bid up the stock price on the buyback announcement date due to the price floor. But this effect is difficult to separate from the other signaling effects. -0.02 0.02 -0.04 0 -0.02 Franking credit drop off date negative abnormal return -0.06 -0.04 On the earlier of the ex-buyback date or 45 days before the buyback tender price and scale back anPPT'11 JBH'11 CXP'05 WOW'01 CAA'00 STO'07 CCL'07 IAG'04 CML'06 CXP'07 STO'01 AWC'07 WBC'04 SGB'05 BHP'06 TLS'03 BHP'11 RIO'05 FGL'07 CML'05 TLS'04 BHP'04 WBC'05 BHP'07 CBA'04 WOW'10 WOW'03 BSL'05 BLD'08 STO'08 -0.08 PPT'11 BLD'08 CXP'07 JBH'11 STO'08 STO'07 BHP'07 AWC'07 WOW'03 CXP'05 STO'01 IAG'04 CML'06 BSL'05 BHP'11 SGB'05 CCL'07 TLS'03 WBC'05 WOW'10 CBA'04 BHP'06 TLS'04 BHP'04 CAA'00 WOW'01 RIO'05 CML'05 WBC'04 FGL'07 -0.06 nouncement, the franking credits detach from the buyback offer. This should correspond to a price fall over the night before. The size of the fall depends on the franking credit value and the share price premium above the 'true' market price.