tjh290633 wrote:There has been a useful exchange of views in this topic. Companies always describe share buybacks as returning money or value to the shareholders. ...
Which is what they
are doing. They're not
creating value for shareholders, except in the sense that people generally value wealth they own and fully control somewhat more highly than wealth they own but only control in a limited way. Statements that buybacks "enhance shareholder value" or such like are at best rather misleading, but buybacks do return
already-created value to shareholders.
And
no method of returning value to shareholders creates value for them, including ordinary dividends - they're all methods for transferring already-created value to shareholders, not for creating it in the first place.
tjh290633 wrote:... One desired objective is to enhance the share price. ...
Depends whose "desired objective" you're talking about! Basically, if a company's total fair value is V and it has N shares in issue, then its fair price is P = V/N. If it then buys back M shares at a price of Q, its fair value becomes V-M*Q because of the cash that leaves the company and the fair price of a share becomes R=(V-M*Q)/(N-M). So (N-M)*R = V-M*Q = P*N-M*Q, which rearranges to give P*N = M*Q + (N-M)*R. Dividing through by N gives P = (M/N)*Q + ((N-M)/N)*R), which basically says that the old fair value P is a weighted average of the price Q paid for the buybacks and the new fair price R, with weights M/N and (N-M)/N (which add up to 1, and both lie in the range 0 to 1 for possible values of N and M). A weighted average of two values lies between the two values, and so R will be above P if Q is below it, and
vice versa. I.e. as various people have said in the thread, buybacks below fair value are a good thing for the remaining shareholders, and buybacks above fair value are a bad thing for them. For shareholders who sell into the buyback, it's exactly the opposite way around.
As for all market trading decisions, there is of course the crucial issue of just what the "fair value" of the company is. The directors make the buyback decisions (including the maximum price the company will pay), either themselves or by delegating them to underlings or advisors, and their decisions may be affected in various ways by biases and/or conflicts of interest.
That is IMHO the fundamental issue that lies behind most of the potential (and not infrequently actual) problems with buybacks, such as (not by any means a complete list):
* Bias because it's very hard for directors to take a truly objective view of their company. Basically, a major part of their job is to form plans for the future of the company's business and put them into operation - and they generally have to believe those plans have a good chance of success (there is the alternative that they don't think it's a good chance, but it's the best chance there is - but that means that the company is probably in trouble and ought not to be returning cash until that trouble is resolved!). They ought to (and probably will) also have some contingency plans for them going wrong, but their minds are generally focussed on the main plan's success. And that makes them very naturally disposed to seeing the company's future through rose-tinted glasses - it's possible to tone down the amount of rose-tinting, but it takes effort and willpower, and it's rarely (if ever) completely successful.
* Conflicts of interest between assessing fair value properly and keeping their jobs, caused by major shareholders who want to unload their shares at above fair value, and who can vote the directors out of office if they don't do the buybacks, or to make it considerably more likely to happen by trying to persuade other major shareholders. Note that the threat to actually do so is implicit in that situation and doesn't need to be made explicitly - and generally isn't, at least in public.
* Conflicts of interest between assessing fair value properly and keeping their word (and hence reputation). The clearest examples of that are IMHO when a company announces that it will return a specific large amount of cash (e.g. £2b) to shareholders by buying back shares. That basically says to the market "We'll pay whatever price you demand", and it's hardly surprising that in consequence, shareholders who want to sell but aren't in any particular hurry to do so decide to hold out for prices they believe are clearly above fair value! There probably won't be enough sellers around who want to sell fairly urgently to satisfy the company's demand for buybacks, and so the price settles somewhere above the market's view of fair value. That view of what fair value is may well be wrong, of course, but it can easily be wrong in either direction, and so the company ends up doing the buybacks at above fair value. How far above fair value is basically a matter of the collective greediness of the shareholders who want to sell at above fair value: the price will rise until a sufficient number of them are persuaded to satisfy the company's demand.
* Conflicts of interest between the short-term performance targets and rewards of share incentive schemes and the long-term objectives of the company. The often-used argument that taking shares out of issue with buybacks raises EPS, so that there is clearly such a conflict for share incentive schemes that use EPS as a performance target, is rather incomplete: incentive schemes are
intended to reward directors for benefits to shareholders, so it is hardly a criticism of them that the shareholder benefit of an increase in EPS results in an increase to the incentive! But if the incentive scheme's performance targets and rewards are assessed and rewarded on a short-term basis, that produces a conflict of interest between using cash to drive the share price up short-term and using it to enhance the long-term value of the company. I've never yet seen an incentive scheme that IMHO avoided that conflict (and to put that in context, I regard timescales of anything less than ten years as "short term" for this purpose).
* When the directors delegate the job to underlings or advisors rather than making the decisions themselves, the underlings or advisors are likely to have a conflict of interest between not overpaying for shares and pleasing the directors by getting the buyback completed, which will lead them to push for a maximum price to pay that is above fair value.
* Very obvious conflicts of interest if the directors themselves sell into the buybacks!
tjh290633 wrote:... We have only to look at the example of Lloyds Bank Group to see that this approach has been a failure. If the money had instead been used to enhance the dividend, the share price would have risen to reduce the yield to a sensible level. That would truly be giving more value to the shareholders.
It's only a failure if the objective of the buybacks is to increase the share price - but as I indicate above, I don't think it should be, and if it was, it's hardly surprising that it's failed at that objective. It should primarily be to buy back shares for no more than fair value, with fair value determined in a way that is not affected by the very hard-to-completely-avoid director biases and conflicts of interest. The share price should increase if the shares are bought back for less than fair value, but that should
not be the primary objective, and because the biases and conflicts of interest are so hard to avoid, I'm never surprised when the price ends up falling as the longer-term outcome of buybacks... Though in this case, I suspect that the current strong influence of politics on market sentiment about banks and other financials is probably a much more major factor!
tjh290633 wrote:If the company wishes to reduce the number of its shares, then surely a return of capital to the shareholders, coupled with a share consolidation, is a far more satisfactory and equitable method. If a company wishes to raise more capital, the shareholders have the right to be the first to contribute via a rights issue, unless that right is waived by a resolution passed at the AGM. Surely the converse should be mandatory.
I agree about the inequitability of (most) buybacks - though I would make an exception for buying shares back by a tender offer (a very rarely-used method, regrettably IMHO), since that does give shareholders a fair opportunity to choose whether to take part or not.
But the converse
is mandatory! Companies have to get buybacks approved by shareholder resolution in order to be able to do them legitimately, and just as with rights issues, resolutions to approve them (within limits) are routinely put to AGMs and passed.
Gengulphus