Faulting Companies for Legally Repurchasing Shares is Disingenuous

Financial columnist Andrew Sorkin, writing in the New York Times on Aug. 11, 2015, cited political scrutiny of stock buybacks noting “…a backlash from some investors and government officials, who have questioned whether such use of profits is a productive way to deploy capital rather than reinvesting in businesses and jobs.”

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In a buyback, a company uses company resources to repurchase its shares in the open market. More recently journalist Gretchen Morgenson (March 25, 2016 NYT) pointed to stock buybacks as “one of the great conundrums of our time” wondering why so many companies use them and why many shareholders seem to consider them to be good news. She uses recent decisions by Yahoo to illustrate her concerns.

Corporate leaders are paid, and paid well, to decide how their company’s resources are best used. When they decide to distribute resources to shareholders, it suggests they have already made the other investments that they deem prudent. And they should buy other companies, build additional plants, and hire more employees whenever these investments have positive net present values.

When they choose to instead distribute resources to shareholders, they have two options: pay dividends, which go equally to every shareholder; or repurchase shares and thereby distribute resources to investors who have chosen to exit the stock at current prices.

A key feature of dividend payments is that they tend to create an expectation that dividends will be repeated in the quarters and years to come. Academic arguments can be made for either dividends or repurchases, depending on the circumstances the company faces. Buybacks and dividends have different tax consequences that vary across recipients so there is not always one best choice for the company. Nothing is simple. But we expect investors and their advisors to understand these choices and to make investment decisions in companies whose business opportunities and strategies about dividends, buybacks and internal investments suit their needs and preferences.

The notion that redistributing profits is somehow wrong is an ill-informed indictment of the capitalist system. Giving the money back to shareholders, who will then decide how to redeploy the funds, is actually quite efficient and consistent with the basic capitalistic model.

Are there other concerns about repurchases? Sorkin cites concerns about transparency and full information for investors. Morgenson echoes those concerns. She fears that investors do not understand buybacks. They typically increase the earnings-per-share of the company because the number of shares outstanding decreases, but these increases do not reflect greater profitability and overall earnings. One of the core tenants of investing in public equity markets is that investors should know enough to make informed decisions or should not invest. John Bogle, the founder and retired CEO of The Vanguard Group, and others have emphasized that most investors should buy diversified portfolios of stocks, such as index funds that have low management fees, and should not try to pick individual stocks. Bogle’s strategy is independent of issues such as dividends or buybacks.

Moreover, the U.S. requires companies to announce planned stock buybacks when the plan is created and the results of the repurchase plan must thereafter be reported quarterly. (SEC rule 10b-18 issued in 1982). If the SEC wants to modify the rule, it should. But the rhetoric that suggests companies are behaving badly when they follow mandated rules is disingenuous. Informed investors know what is going on and uninformed investors should not be buying individual stocks.

Another concern is that companies may have an informational advantage. They may only repurchase their securities when prices are below “true” value. The requirements for public companies to disclose material information in their quarterly 10Q filings, their annual 10K filings and their 8K filings for material events all moderate the risk of unequal information. And companies must announce repurchase programs. Investors and their advisors have access to the information they need to assess these issues.

Morgenson seems more concerned that people are being hoodwinked. She points out, correctly, that when companies buy back stock, it suggests that they have no further profitable investments available within the company that represent a better use of the funds. She is right, and as long as investors spend the time to understand this reality, they will correctly assess the future growth opportunities available to the company, and will choose to allocate their capital accordingly. If I view share buybacks as bad news about the future of the company, I can be one of the shareholders who chooses to sell my stock.

As journalists, Sorkin and Morgenson deliver valuable insights and information to the public. The reader bears a responsibility to both read and assess their articles and to make informed decisions. As you can see, part of my response is that informed investors and advisors should already know these issues. Buybacks are not a hidden practice. But Sorkin and Morgenson provide current examples and context to revisit and re-evaluate the issue, and that is very welcome.

 

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John A. Elliott
Dean, UConn School of Business
John A. Elliott is dean of the UConn School of Business, as well as the Auran J. Fox Chair in Business. John is a certified public accountant with professional experience as an auditor and consultant. His research is concentrated on the role of accounting information in financial analysis and contracts. When not attending his son’s athletic events or visiting his daughter and her family, John and his wife, Laura enjoy travel. John is also an avid fan of the UConn men’s and women’s basketball teams. View Posts