Buybacks and the Board: Director Perspectives on the Share Repurchase Revolution

Richard Fields is a Principal at Tapestry Networks. This post is based on the executive summary of a publication by Tapestry Networks and the IRRC Institute authored by Mr. Fields.

To learn how companies make decisions about share repurchases, Tapestry Networks interviewed 44 directors serving on the boards of 95 publicly traded US companies with an aggregate market capitalization of $2.7 trillion. The complete publication (available here) synthesizes these directors’ views and broader research on repurchase programs.

Report highlights include:

Companies are buying back shares at historically significant levels

In recent years, Standard and Poor’s 500 companies have repurchased their shares at a remarkable rate. S&P 500 companies acquired $166.3 billion of their own shares in the first quarter of 2016, more than in any other quarter since the financial crisis. In each of the last nine quarters, at least 370 S&P 500 companies repurchased shares, and over the last three years, S&P 500 companies spent over $1.5 trillion on buybacks.

Macroeconomic factors make share buybacks unusually attractive

Monetary and fiscal policies and macroeconomic forces have pushed companies to consider repurchase programs. Many directors said that they would be unlikely to find enough good opportunities to invest all their companies’ capital in today’s low-growth, low-interest-rate environment, and that it was often better to return capital to shareholders. They tend to prefer buybacks to dividends, primarily because they believe a buyback program offers greater flexibility over time.

US tax policies that discourage companies from repatriating foreign cash have also spurred buyback activity. Because creditors know that borrowers can repatriate foreign earnings at any time, some corporations are able to engage in almost costless borrowing to fund buyback programs.

Directors say that companies repurchase shares for one or more of four reasons:

  • To return capital to shareholders
  • To invest in the company’s shares
  • To offset dilution from using equity as currency
  • To alter the company’s capital structure

Success depends on the purpose of the buyback. Buybacks can only be evaluated effectively if a company is explicit about the reason or reasons for the repurchase program.

Most directors do not agree with popular criticisms of buyback programs

The two most common criticisms of buyback programs are that they jeopardize corporate growth and that they lead to large, unjust pay packages for senior managers. Some directors saw merit in these criticisms; most did not. In general:

Directors believe that buybacks do not jeopardize growth

Some research suggests that companies regularly turn down projects with positive net present value because of irrational risk aversion or excessive discounting of future cash flows. Other research correlates higher buyback activity with lower capital expenditure and revenue growth. Nonetheless, most directors think that their executives do everything they can to grow their businesses. Indeed, some embrace buybacks out of fear that companies would otherwise squander capital by chasing uneconomic growth.

Directors believe that buybacks do not unjustly enrich senior executives

Pay for top executives at major companies is almost always linked, directly or indirectly, to company share prices. Buybacks may increase executive compensation by improving the company’s performance on metrics such as earnings per share (EPS), or by causing the share price to rise, affecting total shareholder return calculations or the value of stock executives own or expect.

However, most directors said that their companies are aware of the relationship between buyback programs and compensation and that they make deliberate, informed choices to ensure that they reward executives for desired behavior rather than for financial manipulation of share prices. Anticipated buyback effects on EPS are usually factored into EPS targets, they say, and unanticipated effects can be adjusted out.

Investor and public concerns about high rewards for near-term share price growth are primarily about the risk that these incentives pose to long-term value creation. Most directors think that their companies are focused on long-term growth and that their incentive programs reward executives accordingly.

There is room to improve corporate disclosures about share repurchase programs

Few companies publicly disclose details about buyback decision-making and very few state which of the four reasons are driving any particular buyback program. Although a number of directors mentioned that their companies project how buyback activity will affect EPS and adjust targets accordingly, only 20 S&P 500 companies disclosed that they did so. Most companies and boards with robust buyback processes do not currently disclose enough to receive credit for their work.

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The complete publication is available for download here.

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