Out-Law News | 25 Jul 2019 | 11:31 am | 2 min. read
Researchers were asked to examine whether companies were using share buybacks in order to meet the 'earnings per share' (EPS) targets in senior executive remuneration packages or to inflate the value of share awards, rather than reinvesting the money in the business. The research (152-page / 1.5 MB PDF) was commissioned as part of the government's 2017 package of corporate governance reforms.
Corporate governance expert Martin Webster of Pinsent Masons, the law firm behind Out-Law, said: "The research is a pretty comprehensive rebuttal of the suggestion that share repurchases were being used to flatter EPS performance so executives could benefit under LTIPs [long-term incentive plans]. It also rejects the idea that money was being used on share buybacks rather than for long term investment in the business."
The research is a pretty comprehensive rebuttal of the suggestion that share repurchases were being used to flatter EPS performance so executives could benefit under LTIPs.
A buyback exercise reduces the number of available shares in a company, which in turn can increase the value of the remaining shares. EPS is frequently used as a performance metric in executive pay packages involving the use of LTIPs, although its use is declining, according to the report.
FTSE 350 listed UK companies carried out between £15 billion and £20 billion worth of share buybacks each year between 2007 and 2017, according to the report. While the number of companies carrying out a repurchase exercise in any given year was "relatively small", all except 35 FTSE 350 listed companies undertook some share repurchase activity during the period under review, indicating that "most companies that undertake share repurchases do so periodically, rather than every year".
The report found no significant relationship between share repurchases and either the existence of an EPS condition, or the proportion of an incentive award linked to that condition, over the 10-year period of the study. Further analysis showed that no companies managed to successfully use a share repurchase to beat its EPS target over that period, although one company, which carried out the largest share repurchase exercise, came very close.
The researchers found some "weaker" evidence that companies on course to miss their EPS target carried out more repurchases in any given year than those on course to hit it. However, as no company actually succeeded in hitting a target that would otherwise have been missed by virtue of undertaking a share buyback, they said that it was "difficult to conclude that the EPS target was the motivation for the buyback".
LTIP targets were one of the least important considerations when conducting share buybacks reported by senior executives who were surveyed as part of the research. The most important reported factors were share price and the availability of good investment opportunities.
The report found no relationship between share purchases and investment opportunities over the 10-year period; a finding which it said was consistent with both its survey findings and with the existing academic evidence. Repurchases tended to be driven by factors which had nothing to do with investment opportunities, such as excess cash and undervalued equity.
The findings of the report are unlikely to reduce shareholder and media opprobrium over executive equity incentives.
The researchers found some correlation between the use of EPS targets and lower investment, unrelated to the use of share buybacks. However, there was insufficient evidence to establish whether the EPS targets were themselves causing the reduced investment. The researchers suggested that further work take place in this area, "to shed light on the behavioural impacts of different types of incentive measures".
"If the use of EPS targets is found to contribute to underinvestment, or other forms of short termism, then it would strengthen the case for exploring alternatives to EPS as a performance measure," the report said. "It would also strengthen the case for replacing LTIPs with deferred share awards as a simpler way of aligning executives with long-term shareholder interests."
Share incentives expert Lynette Jacobs of Pinsent Masons said that the report was triggered by continuing and growing concerns about executive remuneration, which had given rise to the suggestion that companies were instigating share buybacks to increase the value of directors’ LTIP awards.
"The findings of the report are unlikely to reduce shareholder and media opprobrium over executive equity incentives," she said.
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