Lucy Tobin’s article in the Evening Standard drew my eye. Share buy-backs have always seemed to be controversial amongst commentators in the UK, and this article is yet another to criticise them. Let’s look at the arguments being used and see if they stand up to scrutiny.
Why do buybacks?
The Evening standard claims: ‘Buybacks ostensibly come about because a company believes it is a great investment, its shares are cheap and it’s an excellent time to put its money where its mouth is.’
Now if buybacks were companies betting on their own share prices like this, it would indeed be a misuse of shareholders’ money. Boards should be using their cash either to develop the company or return it to shareholders. If a share price is too low, then it is up to investors to take the opportunity and buy shares.
However, boards are not ostensibly buying their shares because they’re cheap. This is how Tesco and Unilever (both highlighted in the article), explained their buyback programmes:
“For shareholders, our strong performance to date and our confidence in our ability to generate cash in the coming years has enabled us to announce the start of a buyback programme that will balance the maintenance of a strong capital structure with returning surplus cash.” – Tesco, October 2021
“Following another year of strong cash flow delivery, Unilever’s Board has approved a share buyback programme of up to €3 billion.” Unilever, April 2021
In other words, buybacks are about returning surplus cash to shareholders, not second-guessing share prices.
The Evening Standard seems to acknowledge this, quoting a director at AJ Bell (an investment platform): “Most firms, with the occasional welcome exception such as Next, appear to run buyback schemes in an entirely price-insensitive manner, buying stock regardless of price. No investor would do this…”
Do buybacks benefit shareholders?
Buybacks handing back surplus cash to shareholders are little different to dividends. The return is simply in the form of capital gains rather than income. McKinsey studied the impact of buybacks against dividends in the US and found no significant difference in the total return to shareholders whichever was used. This would be what you would expect in theory as well. Shareholders like cash being returned to them and it makes little difference in the end whether this is by buyback or dividends.
But should companies give money back to shareholders?
The Standard goes on: “Critics say these billion-pound giveaways should instead be invested in the business and its staff.”
A company with a lot more cash than it needs has to decide whether to invest it in the business or return it to shareholders. It’s an important board decision. The fact that a company has surplus cash is not a reason to reinvest it. It’s an enabler if that company has projects that would deliver a satisfactory return. If a company doesn’t have suitable uses for that money, it shouldn’t pretend that it does and waste money on marginal projects. It’s too easy for a company to spend money. Keeping a tight discipline and returning any surplus cash to shareholders is an important discipline on management.
The next big controversy?
If shareholders want boards to return less to shareholders and spend more on capital investment or staff wages, they can easily tell boards to do so. There is no sense in arguing that companies generally must do so.
The argument between dividends and buybacks is a technical one. It shouldn’t be a political football. The evidence is that dividends versus share buybacks makes no difference to shareholder return.
Dividends are income and taxed accordingly, whereas buybacks create capital gains, which are generally taxed at a lower rate. Different tax treatments are a matter for the government, and you wouldn’t expect companies to shun buybacks just because they may create a lower tax take for the government.
Are buybacks initiated because they help earnings per share (EPS) and so boost executive pay? Listed company boards, with a majority of non-executive directors, in my experience, are not generally led by a desire to boost executive bonuses, and in any case, a good remuneration committee should adjust bonuses for the net effect of share buybacks on EPS. If shareholders find this is not happening, then they can vote accordingly at the AGM.
There are so many issues on which business should be held to account by the media and politicians, so let’s not waste the next big controversy on misunderstandings about share buybacks.
Shareholder returns and executive remuneration are discussed in more detail in my book: ‘Behind Closed Doors. The Boardroom: How to Get in, Get on and Make a Difference’.