Risk & Compliance

Share Buybacks: Who Really Benefits?

Corporations should exist for a greater purpose than maximizing value to shareholders — and executives.
Sviatoslav Rosov and Kurt SchachtJanuary 5, 2018
Share Buybacks: Who Really Benefits?

This is the second of two articles examining the value of share buybacks amid their diminishing volume over the past two years. Read the first here.

Kurt Schacht

Kurt Schacht

The issue of share buybacks by public companies is a complex one. It encompasses questions of company growth and investment opportunities, interest-rate policy, macroeconomic dynamism and employment, management compensation — and even philosophical questions about a firm’s purpose.

Share buybacks stem from the assumption that the job of management is to maximize shareholder value, a concept promoted by Milton Friedman in the early 1970s. Therefore, the thinking goes, whenever management cannot find investment opportunities whose return exceeds the cost of capital, that management should instead return the capital to its shareholders.

The real questions, though, are whether share buybacks are the best tool for returning capital, and whether they’re sometimes used for the less-wholesome reasons of management entrenchment or enrichment.

In some cases, management may feel that the company’s share price is undervalued and fairly decide that the best return on investment would come from buying its own shares. This idea has lately been extended even further, with some companies now borrowing money to repurchase shares.

However, with public shares at record levels, swapping in debt for equity is less clear-cut. Such a swap might have darker motivations, such as leveraging-up the balance sheet when the company is anticipating a potential takeover bid. Here the buyback becomes part of a management entrenchment move, which is far different from a return of investor capital.

In fact, some activist investors have argued for special dividends as the preferred mechanism for return of capital. They present it as a more direct and transparent mechanism, despite the taxability of dividends.

The most commonly heard criticism of share buybacks is that, in practice, they are used mainly for improving reported earnings per share (EPS) by reducing the number of shares outstanding. This, critics argue, is simply a way to manipulate EPS and, in the process, benefit executive compensation formulas. Not only is that hardly a return of capital, it’s particularly upsetting to those that subscribe to the stakeholder model of corporate behavior — that is, the corporation must exist for greater purpose than just maximizing profit to benefit executives and shareholders.

The issue of share buybacks has become a concern for the broader economy as well. If the theoretical reason for buying back shares is a dearth of corporate investment opportunities, and share buybacks are occurring across a wide swath of publicly listed firms, then it is unclear where this liberated shareholder capital is being redeployed.

The combination of significant workforce layoffs, reduced expenditures on research and development, and soaring executive compensation is difficult to portray in a positive light in an environment featuring “secular stagnation” and flatlining real wages for the middle class.

One thing is certain: The current practice of management share buybacks has fewer and fewer defenders outside of public companies’ C-suites.

Kurt Schacht is managing director of standards and advocacy at the CFA Institute. Sviatoslav Rosov is an analyst in the institute’s capital markets policy group.