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Yamil Berard
Yamil Berard
Articles (192) 

How Buybacks Can Erode Long-Term Growth

SEC commissioner wants new rules to incentivize executives to hold shares long-term. A selling spree often occurs eight days after buyback announcement

July 06, 2018 | About:

As share buybacks by U.S. corporations continue at a breakneck pace, one single factor could bring the practice among corporate managers to a screeching halt.

SEC Commissioner Robert J. Jackson Jr. wants to launch a wholesale review of the rules that govern buybacks. In a speech a few weeks ago, Jackson said corporate managers use buybacks as a chance to cash out the shares of the company they received as executive pay. In such cases, the executives capture the short-term pop of the stock within the week or so after the buyback is announced. As a result, investors are hurt and companies cannot expand their growth opportunities.

In a study of buybacks over the last 15 months, the Securities and Exchange Commission learned that a number of executives had strategically pocketed returns of more than 2.5% after selling shares within 30 days of a buyback announcement.

“We give stock to corporate managers to convince them to create the kind of long-term value that benefits American companies and the workers and communities they serve,’’ he said. “Instead, what we are seeing is that executives are using buybacks as a chance to cash out their compensation at investor expense.”

Executives often claim that a buyback is the right long-term strategy for the company, and they’re not always wrong, Jackson said. “But if that’s the case, they should want to hold the stock over the long run, not cash it out once a buyback is announced.

“If corporate managers believe that buybacks are best for the company, its workers and its community, they should put their money where their mouth is.”

Surge in bank stocks

It’s no coincidence that stocks of the nation’s global banks are looking brighter these days.

In early afternoon trading on Friday, stocks of the nation’s top global banks were all in the green. Leading the way was Wells Fargo (NYSE:WFC), which reported an increase of 1.37%. Morgan Stanley (NYSE:MS) was up 1.22% while shares of Citigroup (NYSE:C) surged 0.81%. JPMorgan Chase (NYSE:JPM) climbed 0.58%. Bank of America (NYSE:BAC) rose 0.66%. Goldman Sachs was up 0.85%.

Just several days ago, several of the banks declared major buybacks and quarterly dividend increases, triggering a pop in bank shares by as much as 4%. Prior to the buyback announcement, bank stocks had been in negative territory for most of June.

Corporate executives are required to disclose trades of company stock by the SEC, but there is a lag time between when the reports are filed and when the public gets to learn the details of the trading activity.

The most recent trade data by the major banks on GuruFocus insider trades' pages shows an assortment of buys and sells no later than May. In recent months, directors at JPMorgan Chase bought shares, while several executives at Goldman Sachs, Morgan Stanley, including CEO James P. Gorman, sold shares, GuruFocus showed.

The SEC reported in the first quarter of 2018 alone, American corporations bought back a record $178 billion in stock. For the year as a whole, estimates by JPMorgan Chase & Co. strategists led by Dubravko Lakos-Bujas show a total of gross share repurchases of $800 billion this year, compared to $530 billion last year.

No confusion here

Jackson, a former law professor, said he has spent a great deal of time thinking about how to give corporate managers incentives to create sustainable long-term value.

Back when he was in academia, “I’d often ask my students: are we making sure that executive pay gives managers reason to invest in the long-term development of their workforce and their communities? Or are we paying executives to pursue short-term stock-price spikes rather than long-term growth?” he said.

It is apparent that Jackson is now getting ready to put his questions to the test, in light of so many buybacks.

As an SEC commissioner, he doesn’t have to go very far to hunt for evidence. The information for his case study is now literally at his fingertips. All he has to do is ask his staff to crunch it and they will serve it up.

Jackson’s research team at the SEC studied 385 buybacks over the last 15 months. The team matched the buybacks by hand to information on executive stock sales, which were available in SEC filings, he said.

First, the team found that a buyback announcement leads to a big jump in stock price. In the 30 days after the announcements, companies enjoy abnormal returns of more than 2.5%.

“That’s unsurprising: when a public company in the United States announces that it thinks the stock is cheap, investors bid up its price,’’ he said.

The bigger surprise, however, was that it was common for executive to use buybacks as a chance to cash out. In half of the buybacks, at least one executive sold shares in the month following the buyback announcement. In fact, twice as many companies have insiders selling in the eight days after a buyback announcement as insiders who sell on an ordinary day.

“So right after the company tells the market that the stock is cheap, executives overwhelmingly decide to sell,” Jackson said.

On average, in the days before a buyback announcement, executives trade in relatively small amounts, such as less than $100,000 worth.

However, during the eight-day period following a buyback announcement, executives on average sell more than $500,000 worth of stock each day, the SEC reported. That’s a five-fold increase.

“Thus,’’ Jackson said. “executives personally capture the benefit of the short-term stock-price pop created by the buyback announcement.”

Rule update

The SEC first adopted stock buyback rules in 1982. Those rules give companies a safe harbor in cases of securities-fraud liability if the pricing and timing of the buyback-related purchases meet certain criteria.

The rules were updated in 2003 after the SEC learned that buybacks could be used to give an edge to more savvy investors. Jackson said new gaps have come up in the rules since American public companies have increased stock-based pay.


Rating: 5.0/5 (5 votes)

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Comments

Alberto Abaterusso
Alberto Abaterusso - 4 months ago    Report SPAM

Great article. I have enjoyed a lot reading it.

I like to keep trace of those companies that grant its executives with shares they can sell after lock-up periods that can last up to 365 days. The waiting period should offer some kind of wealth protection to investors.

rossgivens
Rossgivens premium member - 4 months ago

Excellent article; perspective.

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