As we previously discussed, the use of share buybacks has accelerated in recent years, both in Canada and the United States. This has sparked anxious debate over the extent to which buybacks can form part of an effective long-term growth strategy. Particularly in the United States—where buybacks hit a record of more than $1 trillion USD in 2018 following tax reforms—commentators have blamed buybacks for various ills, including wage stagnation, income inequality, and underinvestment in R&D. In response, some U.S. legislators have sought to curb their use, such as by tying buybacks to conditions including paying employees a certain hourly wage, and providing a minimum number of paid sick days.
What motivates buybacks in the first place? Simply put, share buybacks are used to return cash to shareholders, and are therefore an alternative to paying a dividend. Typically, buybacks are used during periods in which other investment opportunities (such as acquisitions) are unappealing. Buybacks are also often used by a company’s management to signal that they believe their shares are undervalued.
The debate concerning share buybacks is complex and politically charged. There is, however, one issue on which many commentators have found common ground: the need to align executive compensation with the use of share buybacks. Executive compensation packages are almost always tied to long-term company performance by paying out at least a portion of compensation in shares or share options. Yet recent studies have shown that in the days following a share buyback, executives are significantly more likely to cash out the shares they received as part of their compensation packages. Specifically, in a speech by SEC Commissioner Robert Jackson, he revealed that in half of the 385 buybacks studied, at least one executive sold his or her shares in the following month. Further, twice as many company insiders sold shares in the eight days following a buyback announcement than on an ordinary day.
This means that some executives are able to capture the short-term increase in share price which tends to follow a buyback announcement, which calls into question their motivations for doing so. As Commissioner Jackson put it, if executives believe that a buyback is the right long-term strategy for their company, “they should want to hold the stock over the long run, not cash it out once a buyback is announced. If corporate managers believe that buybacks are best for the company, its workers, and its community, they should put their money where their mouth is.”
To be sure, buybacks may often form part of an effective long-term strategy, and it is not clear to what extent this study might be replicated in the Canadian context. Nonetheless, shareholders, boards, and compensation committees would be well-advised to closely review their executive compensation packages to safeguard against the mere appearance of the opportunistic use of buybacks. Specifically, stakeholders can take two steps to ensure that the incentives set through executive pay are properly aligned. First, performance metrics in compensation packages should be structured to negate temporary effects of share buybacks. Second, a 2017 study revealed that few companies disclose the details concerning their share buyback decision-making. Companies should be urged to provide detailed disclosure of the decision-making driving a buyback. In addition, compensation committees should be required to approve an executive’s decision to sell his or her equity stake in the period following a buyback, and should justify why this is in the best interests of the company. Together, these reforms would ensure that buybacks are only used when truly in the best long-term interest of the company.
The authors would like to thank Felix Moser-Boehm, articling student, for his assistance in preparing this legal update.