Share buybacks have earned themselves an unenviable reputation in recent years. And now they—and the executives who use them—are under attack again.
Analysts this week unveiled a new scoring system—the bluntly named Executive Action for Self-Enrichment scale—which they claim shows whether corporate decision-making is associated with “short-term enrichment of executives or long-term business goals”.
The process uses a factor regression model to score companies on a scale of 0 to 100, zero being short-termist and 100 being long term.
The analysts, Bryan Williams and Chris Graham of Novatero Investments, a shareholder advisory business, say that increasing corporate debt is often tied to share buybacks which in turn relates to the sale of stock by executives.
“Executives and management at a majority of major public companies derive the bulk of their compensation from equity. Share buybacks inflate share price, thereby inflating management’s stock-based compensation under the guise of ‘giving back to shareholders’.”
Even more damning, they say, is when executives sell their stock back to the company as part of the buyback process. The pair use their scoring method to lambast the big American airlines who they claim asked for bailouts during the pandemic after years of buybacks and rising debt, while the best-performing companies have low levels of buybacks and low levels of debt.
Buybacks and state aid
The article could stir the buyback debate with fresh controversy. Buybacks became a big issue during the pandemic as companies sought state aid to help survive. In the end the White House made a suspension of buyback activity a condition of state aid. A slew of companies in the UK and Europe announced buyback postponements while they grappled with fall out from the pandemic.
When UK government aid was offered, through loans of up to £200m, it came on condition of no buybacks.
Last month the Financial Times reported that the value of US buybacks in the second quarter had dropped to their lowest level for eight years.
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 recent postponements offer an argument in favour of buybacks.
However, other academics argue for open market buybacks to be banned. Writing in the Harvard Business Review researchers from the US, UK and France rail, in particular, against buybacks funded by debt.
“It can make sense for a company to leverage retained earnings with debt to finance investment in productive capabilities that may eventually yield product revenues and corporate profits,” they write.
“Taking on debt to finance buybacks, however, is bad management, given that no revenue-generating investments are made that can allow the company to pay off the debt.”
They also agree that buybacks are driven by executives attempting to optimise the sale of their own shares because the majority of their income come from stock options and awards.
Buybacks remain a controversial issue. The pandemic certainly saw governments turn against them. But that does not mean the change in attitude is permanent.