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In the U.S., Jack creates a C-corporation and funds it with $100, receiving 100 shares in return. Greg, a passive investor, then gives the company $900 in exchange for 900 newly issued shares. The bank account of the company now contains $1000, and the 1000 issued shares each have a value of $1.

Immediately after investing, Greg gets cold feet and wants out. The company buys back his 900 shares for $900. The company—rather than canceling the received shares—retains them as an asset, and values them at $900. So the value of the company still stands at $1000: $100 in cash + $900 in stock.

So, to review, the book value of the company has grown from $100 to $1000 merely as the result of one investor coming and going. No company business or anything else occurred to account for this increase in book value. Meanwhile, it seems intuitively clear that the "actual" value of the company is just $100.

Are private and public companies legally permitted, by 10b-18 or other statutes, to do buybacks like this (as this article might be taken to suggest)? If so, why doesn't this allow the financial data of the company (such as total assets, shareholders' equity, and so on) to be wildly misleading to investors?

Here are several online references—encountered after posting—that partially address the above questions (without citing relevant law, SEC guidance, or court precedents):

This Forbes article states that: "It's important to understand that once a company has bought back its own shares, they are either canceled—thereby permanently reducing the number of shares outstanding—or held by the company as treasury shares. These are not counted as shares outstanding, which has implications for many important measures of a company’s financial fundamentals."

Additionally, this Wikipedia article on treasury shares states that: "The possession of treasury shares does not give the company the right to vote, to exercise preemptive rights as a shareholder, to receive cash dividends, or to receive assets on company liquidation. Treasury shares are essentially the same as unissued capital, which is not classified as an asset on the balance sheet, as an asset should have probable future economic benefits. Treasury shares simply reduce ordinary share capital."

(The bolding above is mine, and included for clarity.)

Finally, this Investopedia gives at least a partial explanation of how the accounting of treasury stock is supposed to work.

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A company cannot own it’s own shares

As soon as the company acquired the shares, they are cancelled and the balance sheet reads Cash $100, Owner’s Equity $100.

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  • Wow, is it really this simple? How do we reconcile this answer with the content of this article: investopedia.com/ask/answers/05/retiredstock.asp ? Could there be a difference between U.S. and Australian law in this area?
    – SapereAude
    Apr 16, 2022 at 5:10
  • @George Thanks for the comment. I at least agree with your second sentence. The above answer suggests that there is only one alternative: canceling the shares, while the article seems to suggest two alternatives: (a) canceling the shares and (b) retaining them as treasury stock. My belief is that Dale is basically using "cancel" to signify both (a) and (b), and that under (b) the repurchased shares are effectively omitted from the company assets (more precisely, their value is subtracted from shareholders' equity) until they are resold. Is this correct?
    – SapereAude
    Apr 16, 2022 at 7:17
  • Sorry I only read the first part of the linked article. Deleted my comment.
    – George White
    Apr 16, 2022 at 14:26
  • This answer cites no source, and esp no law or reg.. It seems to contradict the above article, which says that a company can retain shares for sale, or distribute them as employee compensation, at once or later. What the article does not mention is the effect of retained shares on a company's book value, so I am not yet downvoting. If the article is wrong, the answer should specifically say so, and cite a source. If the shares can in fact be retained and later reissued, but have no value until reissued (which i suspect is the true answer) the answer should say that, which it now does not.
    – David Siegel
    Apr 16, 2022 at 14:55

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