Share Repurchases on Trial: Large-Sample Evidence on Market Outcomes, Executive Compensation, and Corporate Finances

Nicholas Guest is an Assistant Professor of Accounting at Cornell University Johnson Graduate School of Management; S.P. Kothari is the Gordon Y Billard Professor of Accounting and Finance at MIT Sloan School of Management; and Parth Venkat is an Assistant Professor of Finance at the University of Alabama Culverhouse College of Business. This post is based on their recent paper.

Related research from the Program on Corporate Governance includes Short-Termism and Capital Flows (discussed on the Forum here) by Jesse Fried and Charles C. Y. Wang; and Share Repurchases, Equity Issuances, and the Optimal Design of Executive Pay (discussed on the Forum here) by Jesse Fried.

Many in politics and the media question the economic efficacy and ethical provenance of share repurchases, a ubiquitous corporate financial activity. Most recently, the federal government’s proposed 2022 budget disclosed their aims to curb repurchase activity with a one percent tax on all repurchases and to bar executives from selling shares for three years after a repurchase (see recent coverage by the New York Times). Our key question is whether evidence supports the critiques used to justify these and other anti-repurchase initiatives.

Our primary contribution is large-sample evidence on the trends and effects of share repurchases by US corporations. Specifically, we document trends in repurchases, and compare trading volume, share price performance, CEO pay, and corporate financial activities (e.g., investment and profitability) of firms in three groups: those that intensively repurchase shares, those that do so sparingly, and those that do not at all. We also provide a brief outline of the common economic rationale for and criticisms of share repurchases. However, our goal is not to rehash the numerous conceptual rationales in defense of share repurchases, nor argue that there are no cases when repurchases could be misused. Instead, we provide large-sample evidence on whether repurchases are systematically abusive, as suggested by some proponents of significant regulation.

There are several reasons why corporations might prefer using share repurchases instead of or in addition to dividends, including (i) maintaining flexibility in determining the amount of cash returned to shareholders, (ii) an ability to award repurchased shares to employees as equity compensation, (iii) a modest tax advantage to shareholders (that became less pronounced after the 2003 dividend tax cut), and (iv) the ability to send a credible signal of the firm’s (good) prospects.

Multiple safeguards are already in place to limit improper repurchase behavior. For example, securities regulations mandate that firms disclose the amount and approximate timing of intended repurchases. Such disclosure enables investors to update share prices on the basis of their own assessment of the impact of the repurchase on the firm’s economic prospects vis-à-vis managements’ announced intentions. Armed with this knowledge, investors can choose to sell their shares back to the firm, perhaps because they hold a less favorable view of the firm or to satisfy liquidity needs. However, shareholders are not coerced into selling their shares. Share repurchases represent arm’s length transactions at current market prices between willing participants. Ex post, firms must also disclose repurchase activity in quarterly reports or face SEC enforcement and class action lawsuits.

Nonetheless, share repurchases remain a frequent target of critics, who typically offer the following criticism:

  • Share repurchases have grown inappropriately quickly and inappropriately large (e.g., Roosevelt Institute, Reuters).
  • Share repurchases enable firms to manipulate the market either by increasing the demand for and price of shares or by tricking naïve investors through EPS inflation (e.g., CNBC).
  • Share repurchases enable insiders to benefit through compensation contracts or the sale of shares at inflated prices (e.g., Harvard Business Review).
  • Share repurchases crowd out investment and thus sacrifice innovation and long-term economic growth (e.g., BlackRock, CNBC, Institute for New Economic Thinking).

Our large-sample evidence refutes these alarming claims. Instead, the evidence shows that repurchases are a mainstream corporate financial activity that returns several hundred billion dollars of capital to shareholders annually. At an aggregate level, we find that this activity neither creates nor destroys much wealth (i.e., share price changes). In addition, while repurchases are associated with higher profitability, they are not associated with excessive CEO pay or underinvestment. Each of these findings is consistent with economic theories of payout policy (e.g., the irrelevance theorem of Miller and Modigliani, 1961, and the chapter on payout policy in the well-known corporate finance textbook by Brealey, Myers, and Allen).

This large-sample evidence is highly relevant to academics, practitioners, policymakers, and regulators alike. In the context of share repurchases, we complement the evidence from carefully selected anecdotes or small samples with the purpose of testing economic theories (e.g., signaling vs. earnings manipulation). For example, detractors have accused the airline industry (especially American Airlines) of abusing repurchases, particularly for using almost all of their spare cash to buy back shares at the expense of their financial security and investment (see recent coverage by MarketWatch and the BBC). In rebuttal, proponents could cherry pick Google, which has repurchased tens of billions of dollars of its stock over the past few years, and Amazon, which only recently (in 2022) started repurchasing its stock, as examples of firms that can engage in large repurchases and still have plenty of profits and cash left available for investment and related initiatives. While these individual cases may be instructive, it is important to keep in mind that thousands of firms repurchase their shares, and aggregate repurchases have exceeded $500 billion annually for the past five years, comparable in magnitude to dividends paid. Therefore, any regulation governing repurchases should take into account the potential effects on the entire corporate sector, as opposed to isolated examples of firms identified as potential abusers of the freedom to repurchase shares.

The complete paper is available for download here.

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One Comment

  1. Newcavendish
    Posted Wednesday, August 3, 2022 at 11:39 am | Permalink

    This is interesting, but overlooks at least one important issue: buybacks are inherently unfair to buy-and-hold investors, who derive little benefit from their ephemeral effects, in contrast to executives and active traders. Buy-and-hold investors are much better off with dividends, which provide actual cash that can be reinvested or spent.There are therefore substantial policy arguments to favor dividends over buybacks. The argument that dividends are less flexible is obviously specious as it relates only to a common opinion and not to any legal or policy constraint. Long-term investing should be encouraged: this is sufficient reason in itself to penalize buybacks.