Share buybacks do not inflate executive pay or crowd out investment
Regular readers of Governance and Compliance may recall a debate in these pages in November 2015 about share buybacks. According to one view, they are frequently more concerned with boosting a company's financial indicators or executive remuneration packages rather than enhancing value for shareholders and demonstrate a lack of initiative on the part of a company which is unable to find investment opportunities for cash sitting in the balance sheet.
Conversely, there is a view that there are good reasons why a company may undertake a share buyback, including: the execution of a capital allocation model agreed with shareholders; to consolidate ownership to reduce the cost of capital by paying less in dividends; to take advantage of market undervaluation; to avoid investor dilution by repurchasing to offset shares issued under share plans; and to make the shares more attractive to investors by boosting earnings per share (EPS) or the price/earnings ratio. Buyback proposals are often popular with investors. This is not least because their impact on EPS and return on assets are usually at least as positive for investors as they are for managers. One of the reasons why investors like to see EPS and total shareholder return (TSR) as common metrics for executive remuneration schemes is that they directly link executive remuneration to shareholder interests. But a vocal minority continued to argue that share buybacks were tantamount to fraud and, in January 2018, the Government announced new research to address concerns that companies may be repurchasing shares to artificially inflate executive pay.
That research, undertaken jointly by Professor Alex Edmans of London Business School and a team from PwC led by Nick Forrest and Tom Gosling, has now been published. According to the LBS press release, The research aimed to answer two main questions. The first is whether buybacks are used to inflate executive pay. Perhaps the most striking finding was that, over the 10 years studied, not a single FTSE 350 firm successfully used share buybacks to meet an EPS target. Specifically, there was no firm that ended up above its EPS target that would have been below had it not repurchased shares. Moreover, firms that ended up above their EPS target bought back fewer shares than those that ended up below - inconsistent with concerns that they hit the target through buybacks.
That seems a...