Key Takeaways
– Most S&P 500 companies conducting buybacks from 2018-2021 did not adjust performance goals or incentive awards to account for the lower share count post buyback.
– However, companies conducting the largest buybacks tend to adjust goals or incentive awards to offset the impact.
– The use of per share metrics is common in incentive plans, but most companies balance these metrics with other performance categories, reducing the impact of buybacks on incentive payouts.
– Shareholder returns for companies conducting buybacks are similar to returns for non-buyback companies, dispelling the notion that buybacks are used to inflate stock prices for the benefit of management.
– The majority of activist share repurchase demands are successful.
Introduction
The concept of stock repurchases, or buybacks, has attracted significant attention and debate in recent years. The Securities and Exchange Commission (SEC) reported that buybacks amounted to nearly $950 billion in 2021 and over $1.25 trillion in 2022. In response to the growing interest in buybacks, the SEC revised rules in 2023 to increase transparency and reporting requirements. This Viewpoint summarizes research on buybacks within the S&P 500, their impact on incentive compensation, and recent regulations governing buybacks.
Background on Buybacks
Prior to the rules issued in 1982 that allowed for buybacks, companies relied on dividends to allocate excess cash. However, granting special dividends was less tax-efficient, as they were subject to ordinary income tax. Buybacks provided a more tax-effective method, allowing shareholders the option to participate in a plan to repurchase shares.
Recent regulations, including the Inflation Reduction Act of 2023, introduced an excise tax on corporate share buybacks and proposed limitations on executives selling shares within three years of a buyback program.
Pros and Cons of Buybacks
Proponents of buybacks argue that they efficiently reallocate excess cash, signal positive underlying fundamentals, reduce stock volatility, provide optionality to shareholders, and complete the capital cycle. Detractors claim that buybacks promote short-term thinking, artificially drive stock prices higher, transfer wealth rather than create it, and divert cashflow from other investments.
Impact on Incentive Compensation
Pay Governance conducted a review of publicly available incentive plan disclosures of S&P 500 companies conducting buybacks from 2018 to 2021. The study found that 46% of these companies used per share metrics, such as earnings per share (EPS) or cash flow per share, in their incentive plans. However, 76% of these companies did not adjust for buybacks when determining incentive payouts or did not disclose the use of adjustments.
Further analysis revealed that 15% of companies factored in the impact of share repurchases on shares outstanding when setting goals, while 11% adjusted for the impact when determining incentive awards. The companies conducting the largest buybacks were more likely to factor in buybacks during the goal-setting process or adjust incentive payouts accordingly.
The study also showed that the prevalence and weighting of per share metrics in incentive plans were not significantly different for companies conducting buybacks compared to the total S&P 500. This suggests that buybacks do not have an outsized influence on incentive outcomes.
Conclusion
The research on buybacks within the S&P 500 highlights that while companies conducting buybacks may not adjust performance goals or incentive awards to account for the lower share count, those conducting the largest buybacks tend to offset the impact. The use of per share metrics in incentive plans is common, but companies balance these metrics with other performance categories to reduce the impact of buybacks on incentive payouts.
Furthermore, the study found that shareholder returns for companies conducting buybacks are similar to returns for non-buyback companies, dispelling the notion that buybacks are used to inflate stock prices for the benefit of management. The majority of activist share repurchase demands are also successful, indicating the support for buybacks among shareholders.
Overall, the research suggests that buybacks are a commonly used strategy that is not overwhelmingly driving executive incentive payouts or distorting performance metrics. The recent regulatory changes aim to increase transparency and reporting requirements, providing shareholders and regulators with greater visibility into buyback processes and executive stock transactions.
Original Story at corpgov.law.harvard.edu – 2023-07-16 13:34:43
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