The Department for Business, Energy and Industrial Strategy (BEIS) recently announced plans to launch a review into how companies use share buybacks. Driving the review is a concern that share buybacks are being used by companies to artificially increase ‘earnings per share’ which can be used to measure performance.
The review forms part of a series of corporate governance reforms which have featured heavily on Talking Business recently. Excessive levels of executive pay is one growing trend the Government is keen to stamp out.
What is a share buyback?
A company completes a share buyback when it purchases its own shares from shareholders. A company cannot hold shares in itself and so the purchased shares are usually cancelled (although they can be held in treasury in certain circumstances). The cancellation results in the remaining shares increasing in value as the number of shares in issue has reduced whilst the company’s underlying value has stayed the same.
Share buybacks are commonly used by SMEs as an exit strategy for shareholders but they also allow a company to recover shares when an employee holding those shares ceases to be employed by the company.
How does this benefit a company’s executives?
Earnings per share can be used as an indicator of a company’s performance and so it will often be used to determine how well the company’s executives have performed in driving the company forward. This means that earnings per share is often linked to an executive’s remuneration package and associated bonuses.
BEIS is concerned that share buybacks are being misused to increase earnings per share and, as a consequence, reward executives when the performance of the company does not justify it. Rewards will often reach levels well beyond what would be considered reasonable by other stakeholders.
It is the age old issue of ‘fat cats’ being rewarded for non-performance (or even failure!).
Buybacks can be helpful though, right?
The simple answer is yes and, more confusingly, completing a share buyback to increase earnings per share is a legitimate strategy which is employed by many listed companies, albeit for more genuine purposes.
