Share buybacks and conspiracy theories
As part of its corporate governance reforms and wider industrial strategy, and in line with its desire to build the public’s trust in big business and corporate standards, on Sunday the government announced new research to address concerns that companies may be repurchasing shares to artificially inflate executive pay.
As the government announcement puts it: ‘While there are a number of valid reasons why a company would use these schemes, there are concerns that a minority of companies are using them to inflate executive pay and that they can crowd out investment.’
Of course the central problem is that share buybacks do influence the share price – that is their point – and consequently they do, in many cases, drive executive pay.
The government press release notes that this work ‘is part of the broader package of corporate governance reforms announced in August 2017 to address concerns that executive pay can sometimes be disconnected from company performance.’
The two most common performance measures driving executive pay are earnings per share (EPS) and total shareholder return (TSR). Both these measures are popular with investors exactly because they link pay to performance and, consequently, align executive and investor interests. EPS is calculated by dividing net income (less preferred dividends if any) by the number of shares in issue.
There are many ways to calculate TSR but, fundamentally, it can be simplified as the change in share price during a period, plus dividends paid, divided by the share price at the start of the period. A share buyback reduces the number of shares in issue and therefore increases EPS. It is also likely to increase the share price and so increase TSR.
There are all kinds of reasons why companies may buy back shares. For example, the company may wish to consolidate ownership to reduce the cost of capital by paying less in dividends; to take advantage of market undervaluation; to maintain issued share capital at a constant level by repurchasing to offset shares issued under share plans and thereby avoid investor dilution; or to make the shares more attractive to investors by boosting EPS or the price/earnings ratio.
Buybacks are popular with many investors and are often viewed as a demonstration of the receptiveness of management to shareholder sentiment. When Glencore announced the 2014 share buyback the share price rose, and Barclays mining analysts said: ‘Finally, someone is listening to shareholders.’
Some American investors, in particular, expect companies to buy back shares whenever they have a significant cash pile for which no other specific purpose has been identified. However, for several years there have been claims that the inflation of executive pay is the main reason why companies launch share buyback programmes.
Those who make these claims believe in them absolutely; those who do not regard them as the ravings of conspiracy theorists. There is probably at least a little truth in both views, but establishing this is the target of this research.
Unfortunately, unless the researchers are able to track down secret recordings of the conversations of evil executives, sniggering into their moustaches as they plot how to inflate their pay through a share buyback, they will be in the unfortunate position of having to prove a negative.
They will be trying to identify the reason for a decision that is likely to have, among its outcomes, the very result of which complaints are being made. But that decision may have been made for totally different (and entirely sensible) reasons.
The involvement of Alex Edmans, professor of finance at London Business School, is welcome and PwC will no doubt conduct a well-executed piece of research.
If they find the case proven, the government will need to take action; if they do not – and it is fair to say that some commentators regard the research in the same light as sending an expedition to the moon to prove that it is not made of green cheese – the fact that PwC are also one of the leading remuneration consultants will, unfortunately, leave scope for the conspiracy theorists to denounce the research as conflicted if its results fail to match their prejudices.
Either way, I doubt that it will be the last word on this issue.
Peter Swabey FCIS is policy and research director at ICSA: The Governance Institute