What Is Capital Reduction?

Capital reduction is the process of decreasing a company's shareholder equity through share cancellations and share repurchases, also known as share buybacks. The reduction of capital is done by companies for numerous reasons, including increasing shareholder value and producing a more efficient capital structure.

Understanding Capital Reduction

After a capital reduction, the number of shares in the company will decrease by the reduction amount. While the company's market capitalization will not change as a result of such a move, the float, or number of shares outstanding and available to trade, will be reduced.

The act of capital reduction may also be enacted in response to a decline in a company's operating profits or a revenue loss that cannot be recovered from a company's expected future earnings. In some capital reductions, shareholders will receive a cash payment for shares canceled, but in most other situations, there is minimal impact on shareholders.

A company is required to reduce its share capital using a set of specific steps. First, a notice must be sent out to creditors of the resolution of the capital reduction. Second, the company has to then submit an application for entry of the reduction of share capital no earlier than three months after publication of the initial notice. Share capital reduction is then expected to be paid to shareholders no earlier than three months after the entry of reduction in the commercial register.

Example of Capital Reduction

Many companies decide to reduce capital through repurchase agreements (buybacks). For example, Sirius XM Radio, an American broadcasting company that provides ad-free satellite radio services, announced on January 29, 2019 that its Board of Directors had approved an additional $2 billion common stock repurchase. The additional $2 billion repurchase in 2019 will bring the company's buyback authorizations to $14 billion in total since 2013. Sirius XM will fund the repurchase through cash on hand, future cash flow from operations, and future borrowings.