Government to research use of share buybacks by UK companies

Out-Law News | 01 Feb 2018 | 12:01 pm | 3 min. read

The UK government has commissioned research into the frequency and purposes of corporate share buyback exercises.

The research will be conducted by PwC with support from London Business School academic Professor Alex Edmans, and forms part of the government's wider package of corporate governance reforms. The findings will be published later this year.

The government said that, although there were a number of valid reasons why a company would buy back its shares from the market, it was concerned that some companies could be doing so to artificially inflate executive pay and could result in other investments that might be made by the company being crowded out. A buyback exercise reduces the number of available shares in a company, which in turn can increase the value of the remaining shares.

Business secretary Greg Clark said that the review would "examine how share buyback schemes are used and whether any action is required to prevent them from being abused".

Corporate law expert Jonathan Beastall of Pinsent Masons, the law firm behind, said that the use and effects of public company share buybacks has been the subject of "active debate", both in the UK and in the United States.

"In the US, buybacks are very common and executive reward is frequently linked to share price performance - see, for example, the incentive arrangement recently announced for Elon Musk, chief executive of Tesla," he said. "Linking executive reward to earnings per share alone can provide incentives to increase leverage - and therefore corporate risk - by substituting debt for equity in share buyback transactions so there are arguments for reward to be linked to a number of different metrics to avoid the incentive driving unacceptable corporate behaviour."

"In the UK, investment industry bodies such as the Investment Association (IA) are alive to the benefits and pitfalls of share buyback programmes. Their share capital management guidelines (5-page / 205KB PDF) provide that a company should only exercise a general authority to carry out a share buyback if it is in the best interests of shareholders generally, and normally only if doing so would result in an increase in earnings per share - or, in the case of property companies and investment trusts, if it would result in an increase in asset value per share – for the remaining shareholders. If this increase is not expected, the benefits of exercising the share buyback authority should be explained clearly," he said.

The IA also expects companies to disclose the justification for any share buybacks made in the previous year in their annual reports, including an explanation for why this method of returning capital to shareholders was decided on, Beastall said. The guidelines require the board to discuss the effects that buying back shares have on earnings per share (EPS), total shareholder return (TSR) and net asset value (NAV) per share.

"The IA states that EPS and TSR targets under both short-term and long-term incentive schemes should take account of the effect of share buybacks, market conditions should be carefully considered, and an average price paid for shares bought back should be disclosed," he said.

"It follows that an increasing focus on the duty of directors to promote the success of the company and the publication of substantial votes against shareholder resolutions may also lead to increasing board introspection before proposing a share buyback programme irrespective of the outcome of the proposed research," he said.

Share plans and incentives expert Graeme Standen of Pinsent Masons said that the review tied into increasing political pressure in the UK on the issue of executive pay.

"In the US, there has been concern and debate for some time about the use of buybacks, in particular whether they are used by some boards to inflate executive pay and whether they could be harmful to companies and investors in the longer term," he said. "There are significant differences between the US and UK in the regulation and disclosure of buybacks and in the most widely used executive equity incentive structures, however. That probably means that the precise US concerns will not be as applicable in the UK, although there remains a possibility that the interaction of buybacks and executive performance conditions has not been optimally disclosed and managed by some companies."

"Any disappointing findings by the UK review would probably increase the political pressures for more rigorous executive pay regulation, given that reforms in this area are already underway. Investor and political concerns about executive remuneration are particularly focussed on the quantum and most commonly used structures of performance-related pay, especially long-term incentive plans (LTIPs), and these very often use EPS or TSR performance targets which are popular with many institutional investors, often combined in some way with performance conditions of another type," he said.

"In this context, it will be important for companies not to look at this just as a narrow issue of designing, adjusting and reporting their executive performance conditions. Recently introduced reporting requirements, broader political and investor concerns and the current reform package place executive pay governance in a much broader context. Remuneration committees should think about LTIP design and its interaction with, for example, the anticipated CEO:average worker pay ratio disclosures, their group gender pay gap reporting, the board's engagement with the workforce and other stakeholders, and probably enhanced reporting about their workforce and how they manage that," he said.