On Wednesday this week WPP, one of the world’s largest marketing and advertising companies, suspended a £950m buyback announced last year. A day later Adidas, a global sports brand announced postponement of a €1bn buyback.
Throwing buybacks into stasis is just the latest act in a succession that has cast a shadow over the capital management tool. Buybacks were already the focus of debate, but the Covid-19 crisis has brought a fresh wave of scrutiny. What are their prospects going forward?
That buybacks have become a subject of hot debate in the crisis should not surprise. The process of companies buying back their shares from stockholders has been a hot button issue in recent years. On one side are those that argue they are wasteful and used to artificially inflate executive pay through boosting stock prices. On the other side are those who argue that buybacks are an efficient way of recycling capital to shareholder and then on to companies who need it more.
So controversial are buybacks in the US they became the subject of policy declarations by Democrat hopefuls seeking the nomination for the US presidential election. Public concern in the UK prompted a government review which investigated whether there was a relationship between buybacks and the “earnings per share” (EPS) measure used to calculate executive remuneration.
When the subject of state aid to big corporates arose there was a clamour from many that a condition should be no more buybacks. Indeed, when the US recently launched its $2trn stimulus, companies were told that buybacks could not happen while they were receiving government cash. Some companies, especially airlines, came under fire for seeking federal government support after spending vast sums on buybacks. There was further criticism as it emerged that companies were using debt to carry through with buybacks.
In the UK, Pirc, an adviser to shareholders—in particular local government pension funds—has said buybacks make financial analysis of a company impossible and should only be approved when there is good reason.
The European Central Bank has called on banks to suspend buybacks for six months, while many companies listed in London and Europe have called a halt to their buyback plans.
There are obvious reasons now to freeze buybacks. Suspension enables a company to hold to much needed reserves to handle the crisis, or avoid taking on more debt.
But despite claims from many sources before the crisis that buybacks were a problem, the UK government did not move to condemn them. Indeed, the study found “some evidence of a correlation between executive incentives and repurchases but not evidence of a systematic causal relationship”.
The report concluded: “Our econometric analysis found no significant relationship between share repurchases and either the existence of an EPS condition or the proportion of an incentive award linked to that condition within executive pay incentives and share repurchases.”
Buybacks vs dividends
Many believe buybacks are legitimate, if you exclude repurchases made with debt. They argue they are a good use of capital if a company is over capitalised, the stock is undervalued and there is nothing better to do with company cash.
Some experts believe current cancellations offer an argument in favour of buybacks. Alex Edmans, professor of finance at London Business School, says the buybacks have a key advantage over dividends in that they are “flexible”: dividends must follow year on year and if they are cut stock prices fall.
Buybacks are less predictable so stock prices, Edmans says, are less sensitive and the consequence less severe.
“The flexibility of buybacks—the fact that they have been cancelled—demonstrates their main advantages, and should lead to them being more popular, not less. The criticism of buybacks is crazy as it would just lead to returning capital to shareholders via dividends which are less flexible.”
As the Covid-19 crisis wears on, both buybacks and dividends are being cut. When the situation stabilises, boards will face tough questions on how to offer returns to shareholders. Buybacks may be an answer.