Stock Buybacks and Company Executives’ Profits
April 16, 2020
Stock Buybacks and Company Executives’ Profits
A stock buyback occurs when a publicly traded firm
voluntary quarterly distributions to shareholders known as
repurchases some of its shares from investors with excess
dividend payments. A firm may also use its net income to
cash or borrowed funds. In recent years, the annual
buy back or repurchase its shares on the open market (the
aggregate value of such repurchases has risen to historical
secondary stock market where shares are traded). Stock
highs, reaching nearly $1 trillion as firms, such as Apple,
reacquired via a buyback is called treasury stock, which is
Exxon Mobil, Microsoft, IBM, Visa, Citigroup, Cisco,
either permanently removed from stock-market circulation
Pfizer, Oracle, and Bank of America, have conducted
or retained by a company to be resold in the future.
billion-dollar-plus stock repurchases. As aggregate buyback
levels have soared, general scrutiny of them has intensified.
Some publicly traded firms may choose not to pay
dividends or conduct buybacks; some may conduct a
The scrutiny also appears to have heightened after the 2017
buyback and pay dividends during the same period; and
tax revision (P.L. 115-97) was enacted. This tax legislation
others may do one but not the other. A buyback and a
resulted in overall corporate tax cuts that increased surplus
dividend are similar in the sense that they both involve
corporate cash, which in turn led to significant increases in
redistributing cash to shareholders. Dividends, however,
buybacks at various firms.
have a much longer history and tend to represent an
ongoing commitment to shareholders that firms may be
Legislation related to buybacks has been introduced in the
reluctant to overlook for fear of sending a negative signal to
116th Congress. S. 915 and H.R. 3355 would prohibit a firm
securities markets. Firms are not generally expected to
from conducting a buyback. S. 2391 would ban buybacks
continue buybacks year after year.
unless they were accompanied by new buyback disclosure
reforms. S. 2514 and H.R. 4419 would levy a tax on
Aggregate dividend payments previously generally
companies that did not distribute a worker “dividend” from
surpassed buybacks in size. By the late 1990s, the aggregate
their profits. The dividend’s size could be based on the size
annual size of stock buybacks generally exceeded that for
of the company’s recent stock buyback. As part of broad
dividend payments. As indicated earlier, buyback scrutiny
private equity fund reform, S. 2155 and H.R. 3848 would
appeared to have heightened after the 2017 tax revision.
prohibit firm buybacks in which a private equity fund has
After the reforms went into effect, historically robust
acquired a controlling interest.
dividend payments ensued, but the significant increases in
stock buybacks received more media attention.
The Coronavirus Aid, Relief, and Economic Security
(CARES) Act (P.L. 116-136) bars certain eligible firms that
Regulation 10b-18
receive Department of the Treasury loans from conducting
In 1982, the Securities and Exchange Commission (SEC),
buybacks for the loan’s duration plus a year afterward.
which regulates equity market trading, adopted Rule 10b-18
that provides companies with a legal safe harbor during a
Some observers have central concerns that buybacks (1)
stock buyback program. Rule 10b-18 ensures firms that
represent a problematic short-term oriented use of firm
repurchase stock generally would not be subject to legal
assets at the expense of longer-term investments; (2) can be
liability for manipulation under the Securities and
exploited by senior executives for personal financial gain;
Exchange Act of 1934 (P.L. 73-291) if the volume of daily
and (3) are often debt-financed, which can boost a firm’s
stock buybacks does not exceed 25% of the previous four
vulnerability.
weeks’ average daily trading volume in company stock. By
various accounts, in the years soon after Rule 10b-18 went
Others, however, emphasize that buybacks (1) can help
into effect, there was significant growth in buybacks, which
signal that a company’s stock is undervalued; (2) are often
are annually dominated by a few large well-capitalized
used to offset share dilution after new stock is issued to
firms. According to Reuters, between 2010 and 2014, 60%
facilitate stock- and stock option-based employee
of the approximately 4,000 publicly traded nonfinancial
compensation programs; (3) represent the most financially
U.S. companies conducted buybacks.
prudent use of a company’s excess cash to finance itself; (4)
represent shareholders reinvesting cash proceeds to boost
Earnings Per Share and Buybacks
capital formation; and (5) have arguably buoyed the past
Several decades ago, many publicly traded firms’ top
decade’s bull stock market.
executives began receiving a significant amount of their
compensation in the form of long-term-incentive (LTI) pay,
Background
which is long-term compensation designed to incentivize
A firm’s net income (also called net profit) is the remaining
executives to perform in ways to help achieve a firm’s
cash after operating expenses, interest, and taxes are
strategic objectives, purportedly better aligning their
deducted from its revenue. It is also the funding source for
interests with those of shareholders. LTI pay tends to be
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Stock Buybacks and Company Executives’ Profits
dominated by company stock-based compensation,
repurchase stocks solely to boost EPS to meet their
including stock options (securities that allow the option
compensation targets.
holder the right to buy or sell shares of a certain stock at a
specified price for a specified period of time); stock grants
Former SEC Commissioner Robert
(stock that cannot be sold by their recipients until a certain
Jackson’s Research
amount of time has transpired, the vesting period); and
In 2018, former SEC Commissioner Robert J. Jackson’s
restricted stock (stock awards that are subject to certain
staff conducted an extensive study of how executives
conditions, including employment for a defined period of
appeared to have exploited their firm’s buyback
time, and the firm’s fulfillment of certain financial
announcements in 2017 and part of 2018. The
performance goals). By various accounts, mainstreaming
commissioner noted that an announced buyback tends to
the LTI component of executive pay has led to an
convey management’s view that firm shares were
unprecedented growth in the size of senior executive pay
undervalued and generally resulted in a temporary uptick in
packages at publicly traded firms.
share price of about 2.5% in the ensuing days. His staff
found that after companies announce buybacks, an
Executive pay packages, which are formulated by corporate
unusually large number of senior executives sold their
boards, often make the receipt of such LTIs dependent on a
corporate shares during subsequent days. Specifically, the
company’s success at satisfying certain annual financial
staff found that during the eight days after an announced
metrics, a major one being earnings per share (EPS). An
buyback, individual executives on average sold more than
indicator of profitability, EPS is the part of a company’s
$500,000 worth of stock per day; however, they sold an
profit allocated to the outstanding number of shares of
average of less than $100,000 daily of company stock
common stock.
during the days before such announcements. (Some firms
prohibit such stock sales.)
In general, when an executed stock buyback removes
outstanding company shares, the EPS’s denominator falls;
On the implications of the findings, the commissioner
earnings are then divided by a smaller amount and the EPS
observed,
increases. Thus, buybacks can boost a company’s EPS,
which is frequently employed as an executive compensation
It’s one thing for a corporate board and top
metric. The stock market’s reaction to the reduced supply,
executives to decide that a buyback is the right thing
however, may be somewhat offset by its reaction to the
to do with the company’s capital. It’s another for
forgone interest on the cash that was used in the buyback to
them to use that decision as an opportunity to pocket
repurchase stock.
some cash at the expense of the shareholders they
have a duty to protect, the workers they employ, or
Stock buyback plans, which generally extend several years,
the communities they serve. [T]he evidence [also]
and sometimes are not implemented, are promulgated by
shows that buybacks give executives an opportunity
senior executives, including the CEO, and then authorized
to take significant cash off the table, breaking the
by a company’s board. When announcing whether
pay-performance link [compensation agreements
implementing a buyback is intended, firm managers—
that tie executive pay to measures of corporate
poised to sell corporate shares—may be trying to replicate
performance.]
the aforementioned stock market price impact of an actual
buyback, according to Harvard Law School Professor Jesse
One observer, Fortune magazine’s Shawn Tulley, did not
Fried. The mere announcement of a stock buyback may
question the integrity of Commissioner Jackson’s research
result in a transient rise in share price.
or findings. He did, however, raise some questions about
the relative significance of the findings. He noted that
Some observers, such as Harvard Business School’s
public company CEOs and other senior managers tend to
William Lazonick, have raised concerns that senior
receive the vast majority of their compensation through
executives are self-interestedly motivated to conduct
restricted shares and stock options, observing that those
buybacks to help inflate the EPS. Others, however, argue
financial instruments generally take four years or more
that the alleged connections between buybacks, EPS, and
before they are tradeable. As a consequence, Tulley argued
executive pay are tenuous.
that the staff’s research lacked a meaningful comparison
between the size of the buyback-based executive stock
For example, David Kostin, chief of research at Goldman
selloffs and the size of what he called the “trove” of
Sachs, found that in 2018, S&P 500 index firms’ senior
executive stock options and restricted stock grants that
executives whose pay was tied to EPS devoted a lower
executives typically have at any point in time and cannot
proportion of their total cash spending to buybacks than did
trade.
firms in the index whose senior executive pay was not
linked to EPS (28% to 32%, respectively). The findings,
Gary Shorter, Specialist in Financial Economics
Kostin argued, help to dispel the notion that executives
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Stock Buybacks and Company Executives’ Profits
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