The Debate on Stock Buybacks: Strategies, Arguments, and Controversies
Introduction
Few corporate strategies inspire as much debate as stock buybacks. Activist investors often request them as a quick way to return money to shareholders that would otherwise go to waste. Company executives argue that they’re not only a tax-efficient alternative to dividends, but they can also signal that the company is undervalued. However, critics fear that both groups are seeking to enrich themselves at the expense of workers or long-term investments in growth.
In this article, we will delve into the intricacies of stock buybacks, exploring the various arguments and controversies surrounding this practice. We will discuss the potential benefits and drawbacks, examine the academic literature on the subject, and provide unique insights into the topic.
The Benefits and Arguments for Stock Buybacks
Company executives and proponents of stock buybacks argue that they offer several benefits:
- Tax-efficiency: Buybacks are often considered a tax-efficient way to return capital to shareholders compared to dividends, as they offer potential capital gains rather than taxable dividends.
- Signal of undervaluation: By repurchasing shares, companies can signal to the market that they believe their stock is undervalued, potentially attracting more investors and increasing shareholder value.
- Flexibility: Stock buybacks offer flexibility to companies in managing their capital structure and allocating excess cash. They can adjust the pace and scale of buybacks based on market conditions.
The Concerns and Criticisms of Stock Buybacks
While stock buybacks have their proponents, they also face significant criticism and concerns:
- Impact on workers and long-term investments: Critics argue that stock buybacks prioritize short-term gains for shareholders while neglecting investments in areas such as employee wages, research and development, or capital expenditures.
- Opportunities for short-term investors: When stock prices rise after a buyback, short-term investors can capitalize on the price increase and make a profit, potentially benefiting at the expense of long-term investors.
- Earnings-per-share (EPS) manipulation: Some studies suggest that buybacks can be used strategically to meet EPS targets, artificially boosting a company’s financial performance and potentially misleading investors.
Academic Studies and Findings
Academic research on stock buybacks has produced mixed findings:
A US study concluded that 29% of companies announcing buybacks did so at a time when they would have risked missing EPS expectations without them. However, a more recent study in the UK found no link between the use of buybacks and EPS targets. Despite these mixed findings, the US government has imposed a new tax on buybacks and tightened regulations surrounding them.
The Importance of Efficient and Well-managed Buybacks
Regardless of one’s opinion on stock buybacks, it is crucial for companies to conduct these repurchases efficiently and in a well-managed manner. Here are the key considerations:
- Maximizing shares for the company’s money: Boards of directors must strive to maximize the number of shares they acquire while minimizing market risks and keeping fees reasonable.
- Complex contracts with investment banks: A recent study suggests that many companies are entering into complex contracts with investment bank brokers instead of buying shares on the open market. This raises concerns about transparency and potential inefficiencies.
- Trading strategies and risks: Accelerated stock repurchase agreements offer upfront discounts, but traders can manipulate the daily volume-weighted average price to their advantage. This can lead to brokers making substantial profits at the expense of shareholders.
Practical Examples and Implications
Examining practical examples can shed further light on the implications of stock buybacks:
Research by Joerg Osterrieder and Michael Seigne highlights how the use of complex contracts with investment banks can result in companies losing money. For instance, Royal Mail spent £200m on its buyback but ended up with just £184m of stock, with the investment bank pocketing the rest as fees.
It’s essential for companies to understand the potential risks and ensure they are not exposing themselves to unnecessary losses or inefficiencies when conducting stock buybacks.
The Growing Trend and Regulatory Changes
Stock buybacks have seen significant growth in recent years, reaching an all-time record of $1.3 trillion globally in 2022. The United States accounted for a large portion of this volume.
In response to the increasing concerns surrounding buybacks, the Securities and Exchange Commission (SEC) implemented new disclosure rules in May. These rules aim to enhance transparency and provide stakeholders with better insights into the extent of buyback activities.
Conclusion
Stock buybacks remain a highly debated corporate strategy, with proponents and critics offering contrasting arguments. While buybacks can provide tax benefits and signals of undervaluation, they also face criticism for potentially prioritizing short-term gains and manipulating financial metrics.
Companies must carefully consider the efficient and well-managed execution of buybacks to maximize shareholder value while minimizing risks and fees. The recent regulatory changes highlight the importance of transparency and understanding the implications of buyback activities.
Summary
In summary, stock buybacks continue to be a topic of controversy. Proponents argue that they are tax-efficient and can signal undervaluation, while critics raise concerns about their impact on workers, short-term investors, and possible EPS manipulation.
Academic studies offer mixed findings, with some showing a correlation between buybacks and meeting EPS targets and others finding no link. Efficient and well-managed buybacks are crucial, as complex contracts with investment banks can lead to companies losing money.
The growing trend of stock buybacks has prompted regulatory changes to enhance transparency. Investors and stakeholders should pay attention to the extent and execution of buybacks to ensure they align with long-term value creation.
By delving deeper into the controversies and strategies surrounding stock buybacks, we gain a better understanding of their implications and the need for responsible and sound decision-making in corporate finance.
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Few corporate strategies inspire as much debate as stock buybacks.
Activist investors often request them as a quick way to return money to shareholders that would otherwise go to waste. Company executives argue that they’re not only a tax-efficient alternative to dividends, but they can also signal that the company is undervalued. Everyone hopes that reducing the total ledger will increase the value the market places on each stock.
Critics fear both groups are seeking to enrich their nests at the expense of workers or long-term investments in growth. If stock prices rise after that buy back ads, which creates an opportunity for short-term investors to make a profit. And reducing the stock count should make it easier to earn earnings-per-share bonuses.
The academic literature is equivocal. A US study concluded that 29% of companies announcing buybacks did so at a time when they would have risked missing EPS expectations without them. A more recent one in the UK found no link between the use of buybacks and EPS targets. That hasn’t stopped the US from imposing a new tax on buybacks and tightening the rules surrounding them.
Whatever your opinion on buybacks, one principle should be incontrovertible. If companies intend to buy back shares, they should do so in an efficient and well-managed way. It’s not easy, as anyone who handles very large stock sales can tell you. Boards of directors must simultaneously maximize the number of shares they get for the company’s money, minimize exposure to market risk, and keep the fees they pay to a reasonable level.
A new study suggests that many companies are failing on all three fronts. Instead of buying on the open market and paying a flat fee, at least 10 percent are entering into complex contracts with the brokers of the big investment banks.
On the surface, these accelerated stock repurchase agreements look like a good deal: The broker promises upfront that the company will receive a specific discount, often as low as 0.5%, off the “volume-weighted average price” for a roughly four-month buying period. Its traders then decide exactly when to buy. While the company will still lose by getting fewer shares if the price rises sharply during the period, the bank absorbs the risk of daily swings.
Research by two Goldman Sachs alumni, Joerg Osterrieder, now a professor at the Bern Business School and the University of Twente, and Michael Seigne suggests the truth is far more complicated. He used UK data because those public disclosures are more detailed, but US companies hire the same banks.
While the daily VWAP benchmark is adjusted for volume, the average over the entire contract period generally is not. This means traders can massage it in by buying more shares on days when prices are low and just a few when they are higher. If prices start to climb steadily, they can dribble their purchases over a longer period to raise the benchmark. They can also keep VWAP up by ending purchases quickly if prices start to fall.
It is possible for brokers to lose money on these trades, and sometimes they do. But sometimes they make out like bandits. Researchers calculated that Royal Mail spent £200m on its buyback in 2022 and ended up with just £184m of stock. The stamp duty absorbed £1 million, but the rest ended up in the pockets of the investment bank, for a fee in effect exceeding 8.5 per cent.
“Companies and their boards don’t seem to understand that if the share price becomes volatile, brokers have the opportunity to make an extraordinary amount of money at the expense of shareholders,” says Seigne, now a consultant.
Royal Mail said the buyback “provided shareholders adequate value for money and met the expectations of the programme. The broker’s commission was absorbed into the total cost, which was itself capped.”
Even some seasoned bank merchants who share buybacks agree that the product sometimes fails to offer customers the best value for money. “Because you’re messing with the times, you’re not bouncing shares when they’re cheap,” one told me. “It’s not optimal.”
This is not a purely academic question. Global buybacks hit an all-time record last year of $1.3 trillion, triple the level a decade ago, according to research by Janus Henderson. Nearly $1 trillion was in the United States in a process that had been shrouded in secrecy.
The Securities and Exchange Commission changed that in May with new disclosure rules. If they survive a court challenge from business groups, it will be possible to determine how many US companies are losing their shares. Investors should want to know.
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