With piles of cash on their balance sheets, it’s no surprise that companies resort to share buybacks as a quick way of returning surplus cash to investors. They are a quick way to boost earnings per share in the short term and that will stand the executive board in good stead when they come to renegotiate their remuneration. I may be being cynical but perhaps that’s why they are so popular. Most investors seem to like them too. But if it all goes wrong and the share price subsequently drops again, those investors that chose not to sell will no doubt be annoyed that the company overpaid for its own stock and damaged the value of their own investment
So if share buybacks sometimes destroy value, do they need to be more tightly regulated? After three years of research, a group of economists at universities in the United Kingdom, Italy, France, and the Czech Republic think so. They are calling for “radical and immediate reform of the financial system”, suggesting that buybacks are “a manipulation of the market, boosting companies’ share prices (and executives’ options and other ‘performance pay’) at the expense of R&D.”
There is an awful lot of buyback activity around at the moment too – Astra Zeneca, UPS, Discovery, IBM to name a few – and given the embarrassment of huge piles of cash on the balance sheet, it seems the right thing to do. But what these economists argue is that it would be better if companies distributed this excess cash as higher dividends which would encourage more stable shareholding rather than which reward predatory investors looking for a fast buck.
The trouble with that is that increasing dividends typically used to signal improving confidence in long-term earnings and in the current economy companies could soon find themselves reducing dividends again. That would surely send their share prices into a dive – and impact executives’ remuneration packages.
So although it’s not clear who are the big winners from share buybacks – the investors or the executives – as long as companies are sitting on very significant cash balances that are generating very low returns, they are not going away.