Treasury shares are the shares which are bought back by the issuing company, reducing the number of shares outstanding on the open market.
All companies have an authorized amount of equity capital that it can issue legally. Of this amount, the total number of shares owned by investors, including the officers and insiders of the company, are called outstanding shares. The amount of equity which is available to the public for sale and purchase on the stock market is known as float. Treasury shares are the shares which were ones part of the float and outstanding shares, but were subsequently bought back by the company.
The shares which have been bought back by a company can either be canceled or held for reissue. Technically speaking, the repurchased shares are a company's own shares that have been bought back after having been issued and fully paid. Treasury share do not pay any dividends and they do not have any voting rights. The possession of these shares does not give the company the right to either receive any assets on company liquidation, or to exercise pre-emptive rights as a shareholder.
They should not be included in the calculations of outstanding shares. The amount of treasury shares can not exceed the maximum proportion of total capitalization specified by laws and regulations.
In essence, the treasury shares are the same as unissued equity capital. They are not classified as an asset on the balance sheet, because assets should have probable future economic benefits. These shares simply reduce ordinary share capital. They are usually presented under the equity capital in balance sheet as a negative number.
When the shares are bought back, they have a positive effect on the earning per share ratio and price earnings ratio because the number of outstanding shares is reduced. Although these ratios improve but the value of shares do not change because there is an equal increase in the market risk.
Shares buy back is a good way of distributing cash to the shareholders instead of dividends because it is tax efficient. They are also bought back to protect the company from hostile takeovers. If the shares are undervalued, some companies buy back their shares to benefit the shareholders.