Dilution, Disclosure, Equity Compensation, and Buybacks

Bruce Dravis is Chair of the Corporate Governance Committee of the Business Law Section at the American Bar Association. This post is based on his article, recently published in The Business Lawyer. Related research from the Program on Corporate Governance includes  Short-Termism and Capital Flows by Jesse Fried and Charles C. Y. Wang (discussed on the Forum here)  and Share Repurchases, Equity Issuances, and the Optimal Design of Executive Pay, by Jesse Fried (discussed on the Forum here).

Buybacks and equity compensation are two sides of a single coin. In a buyback, a company spends cash to repurchase its own shares, reducing its total outstanding share count. In the case of equity compensation, a company issues shares, receiving cash and tax benefits, increasing its total outstanding share count.

The two kinds of transactions—buybacks and equity compensation—are complementary, but their connection is obscured by the asymmetries in the timing, approval processes, and securities and financial disclosures for each. The article Dilution, Disclosure, Equity Compensation, and Buybacks (published The Business Lawyer, Vol. 74, 631-658, Summer 2019) describes those differences, and quantifies the share-denominated and dollar-denominated effects of buyback and equity compensation transactions over a 10-year period for selected Fortune 100 companies.

In the sample, approximately one-third (36.9%) of the repurchased shares reversed share count dilution created by equity compensation issuances. Approximately one-fifth of the cash spent on buybacks (22.7%) was offset by cash inflows from option exercises and tax benefits.

In any period, the influence of the two types of transactions is not equal, either in the aggregate or on a company by company basis. The two types of transactions pull in opposite directions, with equity compensation issuances increasing share count and cash flow, and buybacks reducing share count and cash flow.

Notwithstanding that companies do not undertake equity compensation transactions and buyback transactions at the same times, or for the same reasons, or using the same governance processes, or subject to the same disclosure obligations, buybacks and equity compensation transactions each represent hundreds of billions of dollars of public company activity each year.

The huge dollar amounts dedicated to buybacks and to equity compensation evidence the importance both types of transactions to corporate America, and recognizing and understanding their interaction is important as well. That relationship is not widely acknowledged or discussed, and the relationship is complex.

Because of that complexity, appeals to eliminate buybacks might not include a full consideration of potential unintended consequences, particularly on equity compensation plans that produce significant income and wealth for the employees of public companies who are the beneficiaries of billions of dollars of equity compensation annually.

The complete article is available for download here.

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