The UK government has commissioned research into share buybacks with a particular focus on whether some companies are repurchasing their own shares to artificially inflate executive pay.
The government has appointed consultants PricewaterhouseCoopers to undertake the research into share buybacks and this will be supported by Professor Alex Edmans, an academic at the London Business School. The findings will be published later this year.
The government said the study formed part of the government’s corporate governance reforms and wider industrial strategy as well as its aim to the public’s trust in big business and corporate standards. This research will help to understand how companies use share buybacks and whether any further action is needed to prevent them from being misused, the government said.
A share buyback is when a company repurchases its own shares from the marketplace, reducing the number of
shares in issue. Repurchased shares are typically either held in Treasury or cancelled. As a recent Manifest research paper noted over the last couple of decades share repurchase activity has experienced an extraordinary growth globally.
Manifest’s report stated that the argument in favour of share buybacks are:
- A sign of management confidence -repurchases are seen as an indication that the company’s management thinks the shares are undervalued and want to signal management confidence in the company’s future prospects.
- Lack of investment opportunities – buybacks as a method to return cash to shareholders should be favoured
during times where there are no better opportunities for investment.
- EPS and share price boost – by repurchasing shares the number of shares in issue is reduced and therefore
earnings per share and the market value of the remaining shares are increased.
However, as the paper’s author Thomas Bolger noted buybacks as a way for companies to use extra cash is not without its critics. Academic research from the US published in 2015 suggested companies that conduct buybacks subsequently tend to reduce employment and investment in capital.
Meanwhile, Andrew Haldane, Bank of England’s chief economist, has suggested that the rise of buybacks over
recent years could be connected with a rise in corporate and shareholder short-term thinking which focuses on
shareholder returns irrespective of profitability in favour of investment.
From this perspective, Bolger stated, rather than signalling management confidence buybacks could be a sign that management has run out of ideas for sources of long-term growth. The strategic rationale for buybacks, as well as a company’s capital allocation policy, should be considered by shareholders, Bolger suggested.
Additionally, when assessing the value of a company, shareholders needed to be careful about relying on earnings per share as a measurement of performance because it can be manipulated. Ideally other performance metrics need to be considered by investors. At the same time when considering share repurchases and impact on earnings per share, shareholders needed to be mindful that earnings per share is a frequently used performance metric in incentive pay-plans.
If a buyback results in increased earnings per share, which then results in executives receiving a higher payout
under an incentive plan, there is a clear conflict between executive self-interest and their authority to make
share repurchases. Bolger suggested that if incentive pay plans use any share-price related performance metrics, such as earnings per share, the company should provide explicit assurance to shareholders that incentive pay performance targets will be adjusted to reflect the impact of any share buybacks.
Meanwhile, a recent Lex report in the Financial Times (FT, 30th January) questioned whether, when US companies were still not investing in research and development at their pre-2008 levels, the continuing high levels of share buybacks made sense. The FT reported that US firms are due to have more cash because of changes to the country’s tax regime which is expected to trigger a repatriation of profits that have been held offshore for years.