23 November 2015
There are a number of very good reasons why a company may undertake a share buyback.
ICSA’s Policy & Research Director, Peter Swabey, offers a counter argument to John Stittle’s article on share buyback, ‘The cost of buying back’, from the November’s issue of Governance and Compliance.
There are a number of very good reasons why a company may undertake a share buyback. This explains why, when resolutions to give authority for share buybacks are put to investors, they are usually approved by a significant margin. For example, the company might have a model for capital allocation agreed with shareholders. This might be:
Alternatively the company might be seeking to maintain issued share capital at a constant level by repurchasing to offset shares issued under share plans and thereby avoid investor dilution. Investors may not see this as a bad thing at all.
Share buybacks might be seen as a negative signal about the businesses’ prospects but it is more likely that they will be 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 commented: ‘Finally, someone is listening to shareholders.’
Shareholders might prefer to have cash returned to them, that they can then reinvest in other businesses, which can in turn use the cash to spend on R&D and infrastructure. Greater regulation of returns to shareholders would not, in a well-run company, change the investment decisions already made by management and the board.
It might possibly be the case that the absence of identified opportunities for future investment represents, as John Stittle argues, ‘a lack of effort’ on the part of the company, but there is no logical link between investment in acquisition or R&D and infrastructure and whether or not a company operates a buyback. Investment in the business clearly restricts the amount of capital potentially available for a buyback but reducing the amount of cash expended in this way does not automatically mean that more money will be spent on R&D or infrastructure. It could be that there are simply no appropriate projects on which to spend cash at the time and if so it would not make sense to invest in R&D or make an acquisition for the sake of it. Expenditure on projects is not always a better use of cash than returning capital to shareholders.
Some companies may, ‘construct other reasons for share buybacks to cover their lack of effort in identifying opportunities for future investment’ but the explanation given by Glencore in 2014 ‘prudent capital allocation and balance sheet policies ... following the Xstrata acquisition’ and ‘maintaining balance sheet efficiency and a strong investment grade rating’ is a perfectly rational justification for a share buyback if approved by investors. Which it was – at the 2015 AGM by a rate of 99.92%. Investor sentiment at the time was almost all positive, with analysts at JP Morgan saying: ‘We view it as a powerful signal of intent from management, with Glencore the first of its peers to return excess capital to shareholders.’
The share price also rose on the announcement. It is true that the price has subsequently fallen significantly and it is probably also true that the directors are regretting the share buyback, but investor reaction at the time clearly suggests that they were not alone in their view that it was the right thing to do.
Share buybacks can have an impact on EPS (earnings per share), return on assets and other financial indicators, but this is not an inevitable reflection, as the original article suggested, of senior managers acting in self-interest. EPS and TSR (total share return) are, or at least should be, positively affected by a share buyback. A buyback will also, as in the case of Glencore, usually have a positive impact on the share price. EPS and TSR are certainly common metrics for executive remuneration schemes. However, the reason why these metrics are so often mandated by investors for such schemes is that they are widely seen as directly linking executive remuneration to shareholder interests. Put simply, increases in EPS and TSR are good things for investors. Any well-run company will naturally have sufficient discretion built into its remuneration policy – for which, of course, investors vote – in order to allow the remuneration committee to flex payouts to take account of the impact of share buybacks on performance metrics. This may be done, for example, by adjusting EPS to counteract any upside arising from the buyback. Given that the majority of investors so often vote in favour of share buybacks, it seems unlikely that the only motivation for them is self-interest by company executives and directors and rather that they are widely perceived as being in the interests of shareholders.
Peter Swabey is ICSA’s Policy & Research Director
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