By Allen He
Buybacks are a recurrent topic of controversy, especially as guidelines seem to shift year to year and differ from country to country. In the US, the Biden administration put forth a new proposal, upping the ante after last year’s proposed 1% tax on buybacks (intended to raise billions in tax revenue). The White House’s most recent proposal would prevent executives from selling their shares for three years after repurchasing stock, in the hopes that this will quash the incentive to repurchase shares in the first place. If companies can’t benefit from the immediate heightened trading activity that typically follows a buyback, the option might lose its shine for those stirring up quick grabs for the wrong reasons.
To this end, the SEC’s latest proposal calls for rapid disclosure – one business day to be exact – after executing a buyback. The cost of compliance alone may be enough to dissuade companies from buying back stock. This builds on Chairman Gary Gensler’s agenda to champion corporate transparency, the idea being accountability begets resiliency. And he’s not wrong. In The Dangers of Buybacks: Mitigating Common Pitfalls, our research shows that chronic overdistribution of capital leaves firms vulnerable in the face of unforeseen risks – the COVID-19 crisis for example – not to mention lower returns on invested capital.
The SEC is certainly moving things in the right direction. Their priorities happen to align with our playbook for policymakers and regulators, which outlined key recommendations for avoiding damaging drawbacks:
So why all the pushback? Those against the new proposals see more frequent disclosures as a burden to issuers and investors. But beyond the extra paperwork, many believe the more readily available information could be gamed by opportunistic investors and used maliciously, undermining the long-term efforts of companies and their stakeholders. Besides, other nations have already been living with the next-day disclosure rule and their buyback activity hasn’t exactly faltered. Buybacks in the UK and Japan have more than doubled in the last decade, from $11 billion and $10 billion respectively in 2009 to $40 billion and $78 billion in 2019.
Figure 1: 2009 – 2019 Buybacks by companies in the UK and Japan ($USD billion)
Even so, our research suggests the proposed changes to buybacks in the US are still better than the wild-west free-for-all we’ve gotten used to. Forgive the cliché, but we can’t let perfect be the enemy of good. Buybacks are not inherently bad, they’re merely a tool. Proposals like these only aim to encourage companies to use this tool responsibly. When the short-term snares are avoided, buybacks can be an appropriate instrument in long-term value creation, without being a detriment to investing in other priorities, such as R&D, talent, and innovation. Adopting these rules would maintain a viable place for buybacks in the capital markets as a means of returning capital to shareholders on a more level playing field.
Research has shown that companies tend not to do a very good job timing the market. To improve the potential for greater ROI on share repurchases, companies can take a price-average approach over a longer time horizon – spending equal amounts on buybacks quarterly, rather than trying to get the timing exactly right. However, the current downturn presents a timely opportunity to take advantage of lower buyback costs. So for those trying to time the market, assuming all other needs are already being met, this might be the moment.
Strategy, Investor-Corporate Engagement | Report
6 October 2020 - Returning capital to shareholders is an important and legitimate goal of many corporations. Buybacks are often an effective way to distribute capital, but care must be taken to mitigate downfalls related to personal gain and enrichment, poor timing, and excess leverage.Learn More