This paper examines the risks and rewards of share buybacks, a popular tool for distributing capital to shareholders. The report argues that careful mitigation measures are necessary to restrict personal gain and stakeholder enrichment, which could lead to poor timing and excessive leverage.

The rise of buybacks

Buybacks are an increasingly popular capital allocation tool that has overtaken dividends as the preferred means of returning capital to shareholders, particularly in the United States. According to the report, companies spent over USD 1.2 trillion globally on buybacks in 2019. However, the use of buybacks in non-US companies is also growing. Buybacks rose from 28% in 2009 to over 46% of aggregate net income in developed markets in 2016.

Advantages

Buybacks can add long-term value when companies adhere to key criteria, such as alignment with the long-term plan and having sufficient liquidity buffers. Buybacks can also boost EPS and share prices, especially if a company’s shares are undervalued.

Pitfalls

The image of share buybacks has been tarnished by controversy. Detractors argue that buybacks lead to excess leverage, which can result in lower levels of resilience. Academics and policy makers have also criticised buybacks for setting the wrong tone for companies and their shareholders. Excessive buyback activity could be a sign of short-term behaviour and a lack of investment options.

Mitigating common pitfalls

Buybacks can further long-term goals if managed correctly. Companies should work to mitigate the downsides by being aligned with the long-term strategy and having enough liquidity buffers. Investors must hold companies accountable for their actions, while policymakers must ensure a level playing field.

Recommendations

The report provides recommendations for companies, investors and policymakers to evaluate buybacks on their long-term merits, including:

Companies

• Ensure that any buyback aligns with their long-term strategy and that they have adequate liquidity buffers and capital for other needs.
• Consider a buyback’s implications for strategy and performance, executive compensation, and investor relations communications in order to evaluate its merits.

Investors

• Encourage the use and disclosure of a roadmap. Hold companies accountable for clearer explanations and disclosures on what buybacks were used for and how they support the long-term strategy of the company.
• Evaluate the potential side effects of buybacks and their implications for incentive compensation.
• Based on available information, investors and shareholders can evaluate whether buybacks are the most efficient use of capital.

Policymakers

• Establish a level playing field and regulations that protect shareholders from abuse and short-term behaviours.
• Evaluate the available evidence and consider whether a policy response is necessary. For instance, this could include a ban or limits on share repurchases.

ESG Considerations

Buybacks and their potential ramifications could align with environmental, social and governance (ESG) considerations. Buybacks are often cited as a short-term mechanism for increasing share prices and EPS, but with reference to long-term company performance, sustainability, and stability, buybacks can be beneficial if they are done correctly. The paper argues that buybacks do not contribute directly to ESG outcomes. Nevertheless, they can be an important part of a company’s capital allocation strategy, which, when done correctly, can help to create a more prosperous and equitable future.