Have corporate bosses run out of more productive things to do with their money? With the world in its third year of solid, if slowing, growth, are buybacks a sad reflection on threadbare late-cycle capitalism? Is there perhaps skulduggery afoot, with bosses trying to jack up earnings per share and share prices so that their own stock-based compensation schemes are worth more? Or do buybacks in fact create more value for shareholders than letting bosses keep the money to squander on misguided acquisitions?
Companies buy back their shares for three main reasons: they think their firm is undervalued and want to tell the market so; they want to have enough shares in hand to satisfy employees exercising their stock options without having to “dilute” current owners or see their balance sheet become too skewed towards equity; or they don’t see any more profitable investment opportunities and want to hand back the unusable cash to shareholders. This last is particularly persuasive when interest rates are low and cash represents a dead weight on the balance sheet.
It also references work by Vermaelen and Peyer (available free from SSRN) that supports the undervaluation/signalling view of repurchases. This paper finds that the market reaction to a repurchase announcement is more positive for low market-to-book firms, particularly when the repurchase is explained by management as being done due to unvervaluation.
Vermaelen and Urs Peyer