Emerging Issues

Buybacks and the Board: Director Perspectives (Tapestry Networks Report)

Posted by

Stock buybacks continue to be very popular with large American public companies. While many companies believe that stock buybacks are an efficient way to return capital to shareholders in a low-growth and low interest rate environment, critics contend that stock buybacks come at the expense of productive investments and can also unjustly influence senior managers’ pay.

Against this backdrop, Tapestry Networks interviewed 44 directors serving on the boards of 95 publicly traded U.S. companies to obtain additional insight regarding how companies make decisions about share repurchases. These directors’ views on repurchase programs were synthesized in the following report published by Tapestry Networks and the Investor Responsibility Research Center Institute (IRRC Institute).

Highlights of the report include the following:

  1. Boards are central players in capital return decisions.

The interviewed directors noted that the relationship between company strategy, desired capital structure, and health of the balance sheet all demand robust board attention, with directors often having very strong opinions about these matters. Board members actively engage with the different views of senior managers to evaluate whether and how to return capital to shareholders.

Directors noted that the conversation about capital return at most companies happens throughout the year. A general approach typically is agreed upon at the company’s annual board meeting devoted to evaluating strategy. However, directors revisit capital return as they evaluate investment opportunities over the course of the year.

2.  Most directors see a place for both dividends and buybacks, though some directors have a strong preference for dividends.

Most directors favored returning excess cash through a stock buyback because instituting or increasing a dividend creates an ongoing expectation with investors, in those directors’ opinions. The flexibility of buybacks was cited as the advantage to alternative capital return options.

Directors also noted that investor preference was a second advantage of buybacks compared to dividends. One director stated “[A company] polls the top 20-30 shareholders and asks what they prefer. They have typically preferred buybacks.” Directors also observed that activists have pushed for greater capital return, often through buybacks. However, a growing number of major investors, including Fidelity, have suggested shifting the balance further to dividends.

3.  Companies repurchase shares for one or more of the following four reasons:

a.  Buybacks to return capital to shareholders

Directors universally said that excess capital should be returned to shareholders, although they have different opinions on the definition of “excess.” For the vast majority of directors, capital is “excess” only if it remains after all productive investments are made and current dividend expectations are met.

b.  Buybacks to invest in the company’s shares

The majority of directors interviewed believed that a company’s intrinsic business value relative to stock price was an important factor in evaluating whether to repurchase shares. Several directors noted that companies compare the expected return over a given time horizon for a buyback program against the return from alternative investments.

However, a vocal minority of directors interviewed prefer not to link buybacks to a perception that a company’s shares are undervalued. These directors highlighted the following points in support of this position: (1) companies tend to err in identifying when shares are undervalued, (2) company managers and directors may not be savvier than the markets, and (3) companies are not and should not be in the business of picking stocks.

c.  Buybacks to offset dilution

Many interviewed directors noted that offsetting dilution was a justification for part or all of many share buyback plans. However, at least one director expressed concern that a routine dilution offset program might inadvertently cause a company to spend more on compensation than it intends to.

d.  Buybacks to alter a company’s capital structure

The fourth motivation directors mentioned for buyback programs was altering a company’s capital structure, in which a company may take on debt to fund a buyback to achieve a new capital structure target. Directors noted that these types of buybacks were the least common and most highly scrutinized.

4.  Most directors do not agree with popular criticisms of buyback programs.

Some investment professionals and other observers believe that, among other matters, stock buybacks can jeopardize economic growth by limiting value-creating investment, result in underinvestment and wage stagnation, and imperil a company’s growth prospects. The interviewed directors generally did not share this perspective, with many expressing views in agreement with one director who said “I am not aware of any company turning down a good business opportunity to buy back stock.” Many directors said that in a low-growth, low-interest rate environment, it was highly unlikely that companies would be unable to fund any good investment opportunity.

Several directors shared that they were more concerned that companies would squander investment dollars chasing growth. Directors also did not see a direct relationship between buybacks and employee wages.

Some critics also allege that buybacks increase senior executives’ pay by improving a company’s earnings per share. The directors disagreed with these criticisms and noted that compensation targets tied to earnings per share typically factor in projected earnings per share growth due to buybacks, and unbudgeted buyback-related growth can be adjusted out.

To see the full report click here.