Buybacks: Short-term Boost vs. Long-Term Shareholder Value
When a company has too much cash its executives and directors puzzle the question: What should we do with the money? Should we update our facilities? Should we invest in new research? Should we build a new plant? Should we increase benefits or wages?
This year we are seeing in real time what happens when companies have massive amounts of cash. The combination of corporate tax cuts and repatriation of money from fattened corporate bank accounts abroad to record-breaking balances. For the most part, the companies are not doing any of the things listed above that feed long-term success. Instead, they are repurchasing their shares. In the first quarter of 2018, companies conducted $178 billion in buybacks.
Buybacks, which were illegal and viewed as a form of market manipulation a few decades ago, have become increasingly common, and increasingly questioned. Recently The Atlantic asked, “Are stock buybacks starving the economy?”—based on an important new study by the Roosevelt Institute. Politico drew attention to this issue, too.
Companies spent nearly $7 trillion in buybacks from 2004 to 2014. Buybacks at the bottom of the market make sense. If a board thinks that the price of its stock is a bargain there are cases where they make sense—an announcement typically increases a stock’s value and the value of shares is diluted less. The recent buybacks are harder to explain, however, unless one considers that the executives are paid in stock and benefit personally from the buybacks.
In June, SEC Commissioner Robert Jackson and his staff came out with a study on buybacks and executive compensation that found many executives sold equity they would have received as compensation after the announcement. “Twice as many companies have insiders selling in the eight days after a buyback announcement as sell on an ordinary day,” according to the study.
If executives really believed that buybacks were the best use of capital for long-term good of the company—in other words that the stock was undervalued—they would be holding on to their shares. Instead they “cash[ed] out their compensation at investor expense.”
AbbVie, the maker of Humira and other expensive drugs, announced a $10 billion buyback in February. In the following weeks, according to Politico, eight executives sold a total of $26.8 million of stock, personally benefiting from a higher stock price.
The opportunity cost at a pharmaceutical company—the things the money could have been spent on instead—seems particularly striking. There is always more research that can be done. Human knowledge is not a finite resource.
Other financial choices are represented by other buybacks. This year, As You Sow filed a shareholder resolution at Monster Beverage asking the company to address the lack of transparency regarding slavery and human trafficking in its supply chain. Monster earned a 0 (zero)—dead last among all companies—in the October 2016 KnowTheChain benchmark report scoring supply chain accountability on slavery and human trafficking. In discussions with the company, the cost of issuing a slavery risk-assessment report came up repeatedly. And yet, time and time again, the company has allocated millions to spend on buybacks.
This is why, I’m passionate about CEO pay. The cycling of capital (buybacks) makes the rich richer and does nothing for long-term shareholders. The lack of investment in research undermines the vision for the sustainable world we want to live in. The structure of most plans for CEO pay increases short-term focus, invites manipulation, and disincentivizes the long-term focus we need.