Corporate buybacks are now a daily news item. In 2007 US companies spent an astounding one trillion dollars on stock buybacks that exceeded dividends paid and accounted for two-thirds of net income that year. Since 2000 those same companies distributed three trillion dollars to shareholders through buybacks.
By any measure, these amounts are staggering and evidence a substantial distribution of cash to shareholders, which might otherwise be put to other uses, like investing in new technologies and creating jobs!
exclaimed Paul Griffin, who recently completed research with Professor Ning Zhu focusing on why executives and boards spend these substantial sums. Their work was recently published in the June 2010 issue of Journal of Contemporary Accounting & Economics, titled “Accounting Rules? Stock Buybacks and Stock Options: Additional Evidence.”
When a company engages in stock buybacks (buying its own stock) it removes stock from the market thus increasing earnings per share and, hopefully, stock price. Buybacks are meant to benefit all shareholders, but Griffin and Zhu found that weak governance and unclear accounting allow companies to tilt the playing field in favor of their executives, who receive additional compensation because the buyback makes their stock options more valuable. Previous research did not show a reliable relation between higher CEO stock option compensation and the decision to engage in a buyback. Explained Griffin,
This is how managers can receive additional compensation, and for some, especially in recent years, this aspect of compensation has been sky-rocketing. Few people are aware that these buybacks are being used to enhance CEO compensation, and certainly not the regulators.
The researchers also discovered a positive relation between CEO insider selling following a buyback and the number of shares repurchased, also consistent with governance not protecting outside shareholders.
Professor Paul A. Griffin is an internationally recognized specialist in the areas of accounting, financial valuation and the role of information in security markets. He has published extensively in leading accounting and finance journals, and has written research monographs for the Financial Accounting Standards Board and case books on corporate financial reporting.