Why Buybacks Aren’t
Always Good News
force behind the stock market’s recent strength has been the flood of
money that corporate America has poured into share buyback programs.
According to Standard & Poor’s, the companies in its flagship
500-stock index are on track to repurchase more than $435 billion
worth of their shares this year. That’s significantly more than the
$349 billion repurchased in 2005 and more than triple the $131 billion
in shares that were bought in 2003.
applaud the buyback binge, considering these programs entirely beneficial. After
all, buybacks support a company’s stock price and buoy per-share earnings by
reducing the amount of stock outstanding.
But less obvious
to investors are the downsides associated with buybacks. By artificially
inflating a company’s earnings per share, repurchases can mask business
slowdowns, for example. Companies can hurt their financial positions by putting
scarce cash into repurchases. And when buybacks are used to offset multitudinous
stock option grants to corporate executives, an even more pernicious outcome can
occur: the purchases may actually destroy shareholder value by forcing companies
to essentially buy stock in the open market at high prices to cover shares sold
at lower prices to executives.
may not surprise you to learn, buybacks can wind up bolstering top executives’
compensation. A new study by Jill Lehman, a managing director at the Center for
Financial Research Analysis, and Paul Hodgson, a senior research associate at
the Corporate Library, makes these and other risks clear.
“If a company is
generating negative cash flows prior to the buybacks it seems that they
shouldn’t also be using cash to buy back those shares,” said Marc A. Siegel,
director of research at the C.F.R.A. “With all the buybacks going on, we thought
it would be interesting to marry up which companies might be executing fiscally
unwarranted repurchases with companies where executives are being compensated on
metrics that are benefited by buybacks.”
study found only three companies that had negative cash flows over the past
three years before accounting for the costs of their share reductions. They were
Dominion Resources, Ryder System, and the Southern Company.
But the story
definitely becomes more interesting as one looks at compensation practices among
S.& P. companies making repurchases and generating negative cash flows as a
result for the last two years. A total of 78 companies meeting those
requirements popped up.
companies, the study found, 33 used an earnings-per-share measure to analyze
performance when determining executive pay — that’s about 42 percent. Among the
S.& P. 500 as a whole, only 28 percent of the companies used that measure.
Per-share measures, of course, are hardly exact barometers of financial
performance because they can be greatly influenced by the reduction in shares
outstanding associated with buyback programs.
makes one wonder whether some repurchase programs have been instituted to
generate higher levels of earnings per share, thereby ensuring the payout of
short- and long-term incentives.
The study found
that chief executives at 89 percent of these 78 share-repurchasing companies
received an annual bonus in 2005, compared with 78 percent of chief executives
for all companies in the S.& P. 500.
companies in the group that use per-share performance measures were more likely
to have paid a bonus to their chief executives last year. At the 33 companies
using such measures, only 3 percent did not pay out an annual bonus in 2005; by
comparison, 13 percent of the companies in the sample that did not use per-share
measures failed to pay a bonus.
The median bonus
among negative-cash-flow companies that have bought back shares was also a bit
higher than it was in the S.& P. as a whole: $1,565,050 versus $1,487,800.
per share is a commonly accepted measure of short-term corporate performance,
the study’s authors questioned its effectiveness in assessing long-term value
growth. Nevertheless, some of the buyback companies use earnings per share to
assess performance for both the short term and the long term, “a very poor
governance practice resulting in the same set of performance achievements being
rewarded twice,” the study said.
did this: Eli Lilly, Hershey, Huntington Bancshares,
Masco, Pitney Bowes, Procter & Gamble, Pulte Homes and
Robert Half International.
The study said
that none of the companies that engaged in share repurchases and used an
earnings-per-share measure discussed in their proxies the impact of buyback
programs on their pay calculations. Home Depot, a company that has been
criticized for its pay practices, did the right thing starting in 2004 by
excluding the effects of share repurchases during the performance period when
measuring earnings per share for compensation purposes. But this year, the
company said its long-term incentive plan would no longer be adjusted for the
impact of share repurchases.
executive’s incentive plan at Countrywide Financial, a mortgage lender
that has engaged in buybacks, seems designed to get a big boost from
earnings-per-share growth, the study said. While other executives at the company
receive pay based on growth in its return on equity, Angelo R. Mozilo’s bonus is
based solely on earnings per share. Mr. Mozilo has received bonuses worth $56.7
million in the past three years. Countrywide did not return a phone call seeking
As buybacks have
ballooned, the study said, some companies conducting the programs have changed
their pay-for-performance targets to include earnings per share. In 2004, for
example, Eli Lilly moved from a bonus plan that assessed changes in economic
value at the company to one that measured moves in earnings per share.
Philip Belt, a
Lilly spokesman, said his company’s buybacks were so small relative to its
market value that linking the program to executive pay was ludicrous. “In the
last two years, our total buybacks have been approximately half a billion
dollars, a very small amount,” he said.
Masco and Hershey said that their compensation committees consider the impact of
share buybacks when they set executive pay. And a Ryder spokesman said that the
company’s negative cash flow position was a temporary imbalance because recent
capital expenditures will generate revenues from contracts over time. He said
the buyback program offsets stock grants and employee share purchase plans at
Clearly, not all
buybacks are created equal — at least for investors. And as the numbers of
buybacks grow, the manner in which they may mask a company’s true performance
becomes more problematic.
“We have a
concern here that investors may not appreciate the full impact that the buyback
has on the earnings per share,” said Howard Silverblatt, senior index analyst at
S.& P. “When the buybacks stop, where is the growth going to come from?”
Adding to the
anxiety about repurchases, Mr. Silverblatt said, is the fact that the shares
have not been completely retired. The company can bring them back onto the
market at any point; this would dilute existing shareholders’ stakes.
“What is the
company going to be doing with these shares?” he asked. “It is an enormous
amount of assets under control of management that has not been retired and could
be put back into the market.” Using cash to pay dividends would be far
preferable, of course, especially given the lower tax rates that apply to such
payments. But managements are wary of dividends because, once they grant them,
shareholders come to expect them.
look great from a distance. Up close, however, the picture blurs. More
significantly, they may be a way for some corporate managers to think, once
again, of themselves first and their owners second.
version of this article appears in print on , on Page BU1 of the New York
edition with the headline: Why Buybacks Aren’t Always Good News.
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New York Times Company