The shares of treasury stock are held by the issuing corporation which cannot exercise any of the rights of ownership apart from the right to sell them. With the exception of the possible impact on the amount of legal capital, these shares are in substance the same as unissued shares and should generally be accounted for under that assumption.
Reasons for acquisition
A corporation’s board of directors may decide to acquire treasury shares for various reasons. One reason for this action is to obtain shares for reissuance when all the authorized shares are issued and outstanding. By purchasing shares from stockholders, the corporation can use them, for example, as part of the compensation to executives without having to go through the legal difficulties of amending the Charter to allow additional shares to be issued.
Many corporations have acquired treasury shares as a way of investing corporate funds. For example, the board of directors may believe that the capital market has undervalued the company’s shares and decide that an investment of funds in treasury stock is sound. This practice is subject to several legal limitations.
First, the amount of treasury stock is generally limited by state law to the balance of retained earnings. Second, securities laws restrict the amount of purchases and sales by the board because of the possibilities of manipulation and reliance on insider information not available to the public. Third, the fiduciary responsibilities of the board require it to protect the interests of all creditors and stockholders such that an excessive amount of funds should not be spent to obtain shares.
Treasury stock is also acquired in order to retire the shares of one or more stockholders. At an extreme, a few influential stockholders may decide that they would like exclusive control over the corporation by buying out the others. This process of going private is often accomplished through treasury stock purchases because corporate funds are used instead of the personal resources of the surviving stockholders.
Another reason for acquiring treasury stock exists for corporations whose shares are not traded on an active basis. In these cases, the board may accommodate the stockholders by agreeing to buy their shares when they wish to liquidate their holdings.