By LARRY SWEDROE
Share repurchases have become increasingly common, not only in the U.S. but around the world. Every year since 1998, approximately ten percent of all U.S.-listed firms announced a buyback program. The surge has been fuelled by changes in regulation that liberalised the ability of companies to engage in buybacks. In addition, for taxable investors buybacks are more tax efficient than dividends. Finally, the shift to more option-based compensation leads to a preference for buybacks over dividends as a means of returning capital to shareholders.
The “buyback wave” has attracted much attention in the financial press and has been criticised by politicians for undermining economic growth, leading firms to skimp on long-term investment to pursue short-term objectives such as earnings per share (EPS). The assumption behind the claims is that companies underinvest, and may use buybacks to prop up their stock price in the short run at the expense of long-term shareholder value. The criticisms have led to proposals from Democrats that would restrict the ability of companies to engage in buybacks.
Alberto Manconi, Urs Peyer and Theo Vermaelen sought to address the claims with their study Are Buybacks Good for Long-Term Shareholder Value? Evidence from Buybacks around the World, which was published in the October 2019 issue of the Journal of Financial and Quantitative Analysis. They examined a sample of 9,034 buyback announcements in 31 non-U.S. markets and 11,096 announcements from U.S. firms over the period 1998 to 2010. They began by reviewing the findings from 41 prior studies on the effects of buybacks and concluded: “On average, buybacks generate positive or at least no negative announcement returns.” Following is a summary of their findings:
- On average, in all major regions (U.S, Asia-Pacific ex-Japan, America ex-U.S., Europe and Japan), buyback announcements made by non-U.S. companies are followed by statistically significant positive short-term and long-term excess returns.
- Outside the U.S., long-term returns following buyback announcements are indistinguishable between firms that become takeover targets and firms that do not. And controlling for takeover risk exposure has no impact on long-term returns. Note that when a company buys back stock because it believes it is undervalued, it is not surprising that its competitors or other bidders have the same opinion and make a takeover bid, correcting the undervaluation.
- The long-term excess returns outside the U.S. have not declined in recent years. Although in the U.S. long-term excess returns have become smaller in recent years (perhaps because the U.S. market has become more efficient), they have not disappeared.
- In countries where stock option compensation is more common, long-term excess returns are smaller—suggesting that some repurchases may be driven by EPS management or the relatively negative tax treatment of dividends (investors prefer buybacks to dividends for tax reasons), and not necessarily in the interest of long-term shareholders. However, there was no evidence buybacks lead to underinvestment.
- Excess returns are larger when the board, and not the shareholders, approves the buyback.
- Outside the U.S., the average completion rate (defined as the percentage of the announced buyback that is actually completed) after one (two) year(s) is 28 percent (40 percent). For U.S. firms, the completion rates are 75 percent and 85 percent, respectively. Buybacks may not be completed if the company perceives the market has become more efficient (undervaluation has been corrected).
- Firms that buy back stock for reasons other than undervaluation (saving personal taxes on dividends, fighting takeover bids, avoiding dilution in EPS from stock options) tend to complete buybacks. When firms initially announce a buyback because they believe the shares are undervalued, they will not complete the buyback if the stock price subsequently becomes efficient.
If markets are efficient (and the lack of evidence on the ability of active managers to persistently exploit any mispricings demonstrates that they are), the results demonstrate that shareholder buybacks do create shareholder value. On the other hand, Manconi, Peyer and Vermaelen note that if the long-term positive excess returns reflect the fact the stock was undervalued at the time of the repurchase announcement, it’s possible that without the buyback the value of the firm would have been even higher. However, in that case the evidence still shows that at least, on average, the extent of undervaluation is larger than any negative real effects from the buyback. In other words, whether you believe markets are efficient or inefficient, there is no evidence that buybacks cause underinvestment, or any other negative effect.
Manconi, Peyer and Vermaelen did find that not all buybacks are created equal. They found that “short- and long-term excess returns are significantly larger for small, beaten-up value firms, i.e., firms with a high U-index, a proxy for the likelihood of undervaluation proposed by Peyer and Vermaelen” in their study The Nature and Persistence of Buyback Anomalies” published in the April 2009 issue of The Review of Financial Studies. They added: “This is in line with survey evidence from the U.S., where 80% of managers report ‘stock price is too low’ as a motivation for announcing a buyback. Our results are consistent with this claim, and support the ‘market timing’ hypothesis that managers are able to time the buyback announcement when their stock is undervalued.”
The authors concluded that their “results fail to support the claim that buybacks are, in general, detrimental to long-term investors. However, not all buybacks are equal. Small, beaten-up, value stocks in countries where markets are likely to be less efficient because of poor liquidity are more likely to be repurchased because of undervaluation. In contrast to results on U.S. markets, there is no evidence that long-term excess returns are mainly driven by takeover bids, or that excess returns have declined in recent years.”
They added: “In sum, we find evidence that undervaluation as well as some country characteristics matter for long-term excess returns. Buybacks tend to be followed by higher long-term returns when the announcing firm has a high U-index and low leverage, in illiquid markets, and to a lesser extent in countries with better corporate governance quality.”