Many people will want to reach for the pitchforks as they watch fee-charging, space-squeezing airlines get a chunk of taxpayer money as part of the COVID-19 stimulus package, with few strings attached. Particularly so after a decade of airlines implementing huge share buyback programs.
As a result, the debate on buybacks may focus on the airline industry — but hopefully the very concept of the buyback will get a closer look.
In our work, we spend quite a bit of time thinking about long-term value creation; the concern being that incentives and short-term time horizons produce poor long-term outcomes — for corporates, investors, and citizens. Buybacks aren’t intrinsically short term or inherently suspect (and they can be an efficient means of recycling capital), but current practice and rationale seem laden with problems.
Buybacks should be a tool for balance sheet management. Following a major divestment, a buyback might be the most efficient tool for returning a portion of the proceeds to shareholders without having to disrupt the dividend trajectory. The narrative around dividends is important and, for some companies, definitional. So this approach seems reasonable. Some leading executives have said that this is how they think about buybacks — for example, Mark Schneider of Nestle at our CEO Investor Forum.
But the practice of buybacks has diverged from the stated intent.
First, “buy when the stock is underpriced” — but corporations have been buying at the peak. Second, buy back because there’s too much excess cash to reinvest. But many companies have levered up, delivering more in buybacks than net cash flow; borrowing to ship it straight out the door, without investing in the business to enable it to carry a higher debt load. Even outside those extreme cases, the volume of buybacks, given concerns over investment levels of public companies, seem to have been at the expense of reinvestment in the business.
All this implies shoddy thinking around buyback timing, pricing, and rationale. Connected to these issues of sound capital deployment, we’re seeing ostensibly successful companies that at the end of an 11-year bull market have distressed-like debt to EBITDA ratios, a crazy situation for some of America’s leading companies to have managed their way into.
Buybacks interact with incentives to create bad outcomes. We know from the literature that executives announce buybacks that enable them to hit earnings targets that would otherwise have been missed and resulted in lower pay — so buybacks are already distorting the time horizon and capital-allocation decisions of corporations. In the best-case scenario for the executive, he or she may get a trifecta from the buyback: hit the earnings-per-share target (“What a competent manager!”), sell following the buyback announcement (more cash right now, as the stock goes up after the announcement), and have future compensation based on a better EPS multiple (even more cash later).
Buybacks shouldn’t really be a tool to juice the stock. Ensuring the stock is fairly priced is the role of investor relations officers (the good ones, worth their weight in gold). That involves the careful work of constructing a compelling value narrative that the market understands and finds credible; building relationships with your investors; attracting committed investors that support your long-term strategy; and using the reporting ecosystem to ensure that your prospects and performance are well understood. A solid investor relations program might be one of the best investments a firm makes. The primary rationale for buybacks should not be juicing the stock. To focus on the long term, we want stock prices to be a reflection of fundamentals — cash flows, margins, patent book, ESG performance, customer loyalty, and employee engagement — not market timing.
Buybacks and dodgy distributional outcomes: Our economy has produced poor distributional outcomes since the late 1970s. Real wages have stagnated. Inequality has skyrocketed. The federal minimum wage hasn’t budged in over a decade. American workers lack many basic employment rights that much of the developed West considers essential to a civilized, non-Hobbesian life. As such, buybacks do represent part of a distributional picture that has inflamed a crisis of confidence in capitalism rarely seen in America. Now, it isn’t the Securities and Exchange Commission’s job to indulge in social policy, given its disclosure remit. If people want a higher minimum wage, the federal government has to raise it (following local and union-led initiatives). If Americans are to get better rights at work, collective bargaining has to make a comeback. But on the subject of disclosure . . .
Buybacks should be accompanied by more rigorous disclosure: I’m not sure imposing essentially arbitrary limits on buybacks would have positive effects; that looks like politics untethered from how capital markets function. But corporations ought to have much more to say about why they are doing them: why now, why at this price, what is the basis connected to strategy and long-term value creation, why a buyback rather than reinvestment, implications for balance sheet resilience, and whether executives intend to sell following the announcement.
Such disclosure, in prescribed and comparable form, might at least allow investors to fully assess the picture (the structurally long-term ones should want to). In 2018, former SEC commissioner Robert Jackson wrote about how we can at least create more fulsome disclosure around buybacks (as part of implementing unfinished Dodd-Frank rule-making) without closing off the safe harbor. A no-cost move — unlike bailing out the airlines.
Brian Tomlinson is the global head of research for Chief Executives for Corporate Purpose.
