What goes around...
1 Feb 10
Share buybacks are a way for companies to return cash to their investors, but as Alpa Dhanani and Roydon Roberts discovered, some stakeholders question their motives for doing so
by Alpa Dhanani and Roydon Roberts
The early years of this century saw an explosion in the volume of share repurchase activity by UK listed companies. The annual spend on share repurchase activity grew from approximately £10bn in the late 1990s to a record £46bn in 2006, driven both by a significant rise in the percentage of companies engaged in such programmes and an increase in the volume of activity by participating companies.
To better understand repurchase activity in the UK and the motivations underlying such programmes, we undertook research for ICAS commencing in summer 2007 and covering the period 2003 to 2007, before the onset of the financial crisis. Our aim was to help explain the capacity in which share repurchase programmes were used, in an attempt to shed light on the heightened activity.
We also examined the perceived impact on repurchase activity of what are among the most stringent regulatory frameworks in Western economies. While the current financial crisis has led to a significant reduction in share repurchase activity (a fall of some 45 per cent between 2007/8 and 2008/9 in FTSE 100 companies), share repurchases continue to be an important financial management tool for companies and are likely to regain popularity when the markets recover.
Surveying financial managers of companies listed on the London Stock Exchange’s Main and Alternative Investment Markets, we inquired into the perceived relevance of a number of different motivations believed to encourage repurchase activity.
Our questionnaire captured both users of repurchase programmes and non-users, and sought to examine general perceptions of the motives for share repurchases, as well as the specific motivations for particular repurchase programmes. We also surveyed a selection of investment companies (companies whose main activities entail investing in a portfolio of securities), alongside non-investment companies, since their motivations for repurchase programmes may differ. Finally, we investigated the views of investors to assess the extent to which their views and those of corporate managers were congruent. Our results suggest:
• Open market share repurchase programmes dominate repurchase activity in both non-investment and investment companies in the UK.
• Repurchase activity appears to be driven by a multiplicity of motives rather than a single motive. The desire to return excess cash flows to shareholders is the most popular motive for repurchases by non-investment companies, which perhaps explains the fall in activity during the financial crisis. Other motives include the wish to: influence reported earnings per share (EPS) levels; signal undervaluation to capital markets; and optimise gearing ratios. Investment company repurchases appear to be driven mainly by the management of net asset value (NAV) per share and discount to NAV.
• Share repurchases are not perceived as a replacement for regular dividend payments. Moreover, managers did not believe that the reason they are used is because they are fashionable, and only one in four companies used them to influence their share price.
• The views of repurchasing and non-repurchasing companies were very similar, suggesting that differences in repurchase behaviour were not the result of differing perceptions of their uses. Instead, lack of available funds and concern about adverse shareholder responses were cited as reasons for refraining from repurchase activity.
• There were some differences between the views of managers and investors. Managers gave greater weight to the flexibility of share repurchase programmes and their role in influencing corporate gearing levels, and signalling share price undervaluation or expectations of future income. In contrast, investors gave more support to the view that share repurchase programmes may be a trend in the markets, and that they could be more equitably replaced with special dividends. In addition, investors saw repurchases as mitigating principal-agent concerns by returning excess cash flow to investors, although they were also aware that repurchases may exaggerate such concerns by influencing reported EPS, upon which many managerial reward schemes are based.
• Corporate managers and investors alike believe that the level of regulation adds credibility to corporate repurchases. Managers do not perceive regulation relating to reporting requirements and authorisation from shareholders as so onerous as to curb activity, although there are concerns among some managers that the listing requirements surrounding the volume, pricing and/or timing of repurchase programmes restrict their usefulness. A proportion of investors, however, believe that repurchase activity has spiralled out of control and that more regulation is required to protect shareholder wealth, a view not shared by corporate managers.
In response to the views revealed by this survey, companies and investors may wish to give further consideration to the following:
• Using special dividends in place of share repurchase programmes to return excess cash flows to shareholders as a more certain and equitable form of distribution to investors.
• Providing greater justification for the use of share repurchase programmes over alternative distribution methods, and reporting on the extent to which enacted repurchase programmes have met their stated objectives in order to alleviate concerns among the sub-group of investors who favour further regulation.
• Revisiting the reward structures of senior management to ensure that they cannot benefit from simple manipulation of EPS levels through share repurchase programmes.
ALPA DHANANI is a senior lecturer in accounting and finance at Cardiff Business School.
ROYDON ROBERTS is a lecturer in accounting and finance, also at Cardiff Business School.
CORPORATE SHARE REPURCHASES:
The Perceptions and Practices of UK Financial Managers and Corporate Investors is published by ICAS (£15). The full report and executive summary are available to download free from www.icas.org.uk/dhanani This research was funded by the Scottish Accountancy Trust for Education and Research (SATER).