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CORPORATE STOCK BUYBACK: PRO ET CONTRA
A.S. Akhmetov, student Supervisor: E.IBych, senior lecturer
Financial university under the Government of the Russian Federation (Russia, Moscow)
DOI: 10.24411/2411-0450-2019-10468
Abstract. This article describes a stock repurchase process by public companies, reviews buyback, its reasons and purposes, advantages and disadvantages. The author considers the buyback process and analyzes its effect on company's performance, employees, shareholders and investors. Moreover, current stock buyback situation on the U.S. and Russian financial markets is analyzed as well.
Keywords: stock market, stock buyback, capital gains, investment, option programs, profitability.
Many large US public companies have significantly increased the amount of share repurchases in recent years. Analysis of this situation is very important for many market participants, company's staff and authorities.
To begin with, buyback is an action when a company buys its own shares from existing stockholders or directly from open financial market. However, you should not confuse buyback with buyout. The latter means a repurchase control interest of a company when its executives decided to delist from stock exchange or reorganize a company.
Buybacks seem attractive for corporations for some reasons. Firstly, when management considers the stock market to unfairly undervalue company's stock and they wish to maintain a share price at competitive level [1]. The stock price rises as demand increases. Secondly, corporations use buyback to increase shareholder's wealth [2]. So, companies repurchase stocks and then liquidates shares. Therefore, the equity capital reduces, as number of shares decreases, and share of stockholders grows respectively. It means when a company allocates profits through dividends, the earnings will be divided for a smaller number of shares and stockholders' profits significantly increase. Thirdly, many companies successfully apply own shares as a part of senior management reward and motivation programs [2]. Senior staff have call options on their company's shares, so if corporation enhances productivity and it causes stock price growth, top managers will exer-
cise those options and can earn a lot more through selling shares. Fourthly, there are various income taxation systems in different jurisdictions [3]. Some government bodies establish different tax rates on dividends and capital gains from shares. Therefore, companies choose such types of investment returns to shareholders according to which their profits are maximized.
Nevertheless, buybacks tendency should sufficiently alert the shareholders and potential investors. When a corporation spends cash on a repurchase own shares, it implicitly indicates that there are no appropriate projects in which a company could invest available cash and generate further cash flow for owners and investors. Thus, companies return money to shareholders using buyback operations on financial market. Thereby, companies themselves become the driver of growth in stock prices and the market as a whole. As financial market indexes are considered as leading economic indicators, then unreliable information about situation in the economy may be provided and this can cause incorrect actions of regulators (i.e. central banks, Ministry of finance, etc.).
As mentioned above, buybacks give a message that there is no good opportunity for companies to invest money in production assets. Moreover, companies could create new jobs or increase employee's wages, but they prefer repurchase shares [4]. It is noticed that volume of buybacks increases before economic crisis. Now current situation on the
U.S. market is considered. There was a boom of corporate buyback in 2018. American companies, especially finance, IT and utilities sectors, spent more than 1 trillion USD on buybacks. This is a record level since 2009 [4]. For example, companies from S&P 500
have rapidly increased a volume of buybacks in recent years (see fig. S&P 500 companies uses of cash 2000-2018). Since 2004 there has been a tendency to exceed stocks buy-backs over dividend payments by the largest U.S. companies.
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Fig. S&P 500 companies uses of cash 2000-2018 Source: compiled by the author based on FactSet, Haver Analytics and Citi Research Equity Strategy
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However, many experts, politicians and economists are worried about this tendency. They believe that authorities should prevent or limit corporate stock buybacks, because it makes richer and richer billionaire owners, but not workers. Moreover, buyback creates value of company out of nothing and allows corporations to hike such important indicator for investors as earnings per share (EPS) [5]. Thus, when a company repurchases its shares, it maintains an artificial demand for these stocks. As a result of these actions, market capitalization of a company grows. However, a company did nothing significant: it did not improve production efficiency, did not make an advantageous bargain, etc. Such buybacks from companies can delude investors.
But supporters of the stock buybacks claim that it is the best use of money right now [4]. According to the figure above, volume of buyback greatly increased right before the world economic crisis 2008. Thus, the current economic situation in the world is also unstable and many economists predict the new economic crisis soon. Therefore, numerous
companies do not intend to invest money in some new projects and want to protect it by conducting operations like stock buybacks.
As for Russian public companies, PJSC "Lukoil" and PJSC "Magnit" also buyback own shares from market to motivate top managers. In addition, repurchases allow them to maintain stock price, especially during rapid falling on the market.
To sum up, a corporate stock buyback is a mixed blessing. It is useful, when company encourages top management using option programs. Buybacks positively affect company's shareholders as their return increases even if profit of company is at the same level. However, corporations should not abuse buy-back as it leads to overestimated value of company and can mislead potential investors, other market participants and authorities. Moreover, such actions indicate inefficient and unethical use of money as it primarily allows the owners to get rich, whereas company can spend funds on the improvement of employee conditions.
References
1. Andreou P.C., Cooper I., Lopez I.G.O., Louca C. Managerial overconfidence and the buy-back anomaly// Journal of Empirical Finance. Volume 49. December 2018. Pp. 142-156. URL: https://www.sciencedirect.com/science/article/abs/pii/S0927539818300720 (accessed 25.03.2019).
2. Evgeniou T., de Fortuny E.J., Nassuphis N., Vermaelen T. Volatility and the buyback anomaly// Journal of Corporate Finance. Volume 49. April 2018. Pp 32-53.URL: https://www.sciencedirect.com/science/article/pii/S0929119917307022 (accessed 25.03.2019).
3. Rosenthal S. Tackling Stock Buybacks: Too Little, Too Late from Foreign Investors // Forbes. 22.02.19. URL: https://www.forbes.com/sites/stevenrosenthal/2019/02/22/tackling-stock-buybacks-too-little-too-late-from-foreign-investors/#7d6cee7e7a29 (accessed 27.03.2019).
4. La Roche J. Corporate stock buybacks are booming // Yahoo! Finance. 20.02.19. URL: https://finance.yahoo.com/news/corporate-stock-buybacks-rise-schumer-sanders-172223775.html (accessed 23.03.2019).
5. Pisani B. Stock buybacks hit a record $1.1 trillion, and the year's not over // CNBC. 18.12.18. URL: https://www.cnbc.com/2018/12/18/stock-buybacks-hit-a-record-1point1-trillion-and-the-years-not-over.html (accessed 23.03.2019).
ОБРАТНЫЙ ВЫКУП АКЦИЙ КОРПОРАЦИЯМИ: «ЗА» И «ПРОТИВ» А.С. Ахметов, студент
Научный руководитель: Е.И. Быч, старший преподаватель Финансовый университет при Правительстве Российской Федерации (Россия, г. Москва)
Аннотация. В данной статье рассматривается процесс обратного выкупа акций публичными компаниями, показываются его причины и цели, преимущества и недостатки. Автор статьи проводит анализ влияния выкупа на результаты деятельности компании, её сотрудников, акционеров и инвесторов. Кроме того, анализируется текущая ситуация с обратным выкупом акций на финансовых рынках США и России.
Ключевые слова: фондовый рынок, обратный выкуп акций, прирост капитала, инвестиции, опционные программы, прибыльность.
