Minow: “Can’t Boards Find A Better Use For Capital Than Buybacks?”
So much gets written about share repurchases, and not enough gets even a part of it right.
Once in a while that writing reminds us on how most writers get it wrong. We saw one such entry last week, from Nell Minow. The corp gov luminary typically gets it right, although we disagree with the subjects she chooses to get right.
In this instance, she misses the basic corporate finance thinking behind share repurchases. Instead, she falls into the trap of evidence-free conjecture that various critics employ to support whatever bias they bring to the debate.
Some minor misses
She begins right away, in the third sentence, asserting “a public company[‘s] ... primary obligation by law and presumably by market forces is to find the best use for that money to create long-term value for shareholders.” Nowhere does any law obligate a public company to “create long-term value”. Market forces don’t “presumably” obligate companies to do that, but in fact do so.
She also has a limited view of how corporations invest. Company leaders “decide whether [investor funds] will be spent more effectively on research and development of new products or on marketing the old ones.” Investment goes way beyond R&D or marketing, and can include human capital (surprised she missed it), production capacity, and many other uses. Better to direct corporations to either invest capital or return surplus funds to shareholders, and then classify the myriad ways to invest.
She derives her main thoughts from a new report from the Investor Responsibility Research Center Institute, latest in a long line of analyses of this subject. The title, “Buybacks and the board”, accurately describes its principal contents: analysis of 44 interviews with corporate directors about share repurchase practices. It provides interesting anecdotes, but hardly a rigorous study of the subject.
A bigger miss
Minow has three concerns with share repurchases. None make much sense.
First, she wants better disclosure. She admits that buybacks mean:
executives do not have any better...ideas for creating...growth. [Then, w]e’d rather have them return capital to investors than to overspend on acquisitions...[I]f they cannot find a use for the capital, they owe us an explanation...beyond financial engineering tied to quarterly numbers.
She borrows this point directly from the IRRC Institute report, which claims “[t]here is room to improve corporate disclosures about share repurchase programs”. The report, though, does not analyze available disclosures about share repurchase programs in any way, say in correlating better disclosure to higher returns.
For our part, while an explanation is nice, PMs neither expect one, nor believe it when we receive it. We just want the cash.
Second, buybacks “suggest that boards of directors have approved incentive compensation plans that promote buybacks even when they are not in the interest of shareholders.” (Our emphasis). We cannot think of a buyback that was not in the interest of shareholders, and defy anyone to provide concrete examples. And, while buybacks can “suggest” anything, we have yet to see any solid evidence that shows buybacks boost exec comp to the detriment of investors.
To deal with this elusive correlation, “[b]oards should make it clear that they reward only higher earnings” and not EPS. Actually, boards should avoid most conventional earnings measures, so here she doesn’t go nearly far enough.
Finally, she criticizes borrowing cash to fund share repurchases: “it is harder to understand a decision to take on debt to purchase the company’s own shares, a maneuver with short-term gains but significant long-term risks.” As evidence, she quotes a bond market analyst, who naturally worries about companies increasing debt and decreasing equity. She also fails to explain how increasing debt leads to short-term gains and long-term risks, or even defines those terms with any rigor. More generally, we find no analysis of the relationship among leverage, repurchases, investment, profits, and share prices, either provided or cited.
Balance sheet structure can become very complicated. Some companies have “too much” equity and “not enough” debt, whatever these concepts mean, if they’re even relevant. Finance professionals have debated this subject for decades. In short, she glosses over a significant debate as a means of further criticizing share buybacks.
Overall, she quotes the IRRC Institute approvingly: “...some view buybacks as financial engineering to juice short-term corporate performance at the expense of investments that would better grow companies and the economy over the long-term.” We’d like to know who views buybacks this way, and based on what evidence? Others “view” buybacks as a proper use of corporate profits that executives would otherwise spend on wasteful investments that fail to grow companies and the economy over the long-term. Who is right?
PMs don’t care what “some” writers (or executives) think. Instead, everyone could benefit from solid evidence, about this controversial point, and about the subject overall. In the mean time, we’ll happily accept the share buybacks.