Announcing layoffs along with a stock buyback – let’s think about what that means. AstraZeneca did that just the other day, and they’re far from the only ones in this industry (or others) spending billions to buy back their own shares while they’re cutting costs elsewhere.
We already know what the companies have to say about what it means. All you have to do is say “shareholder value” and you’re most of the way there. Mix in “continued commitment” and “cost containment”, fit ’em all together with a verb or two, and you’ve got yourself an instant press release. And we also know what the investment community thinks: they like it. Go back over the news stories that have come out when a buyback is announced, and all the quotes will be about how large the amount is, whether it’s in line with what people were expecting, or if it’s one of those good moments when the company is spending even more to buy back its shares. No one would be so foolish as to announce a truly inadequate-looking stock repurchase.
That’s a key point. As far as I can tell, share buybacks have two purposes. There’s the obvioius one of trying to provide some steady buying activity in the stock and (in theory) a floor for its price, while retiring shares to decrease the float (and increase earnings-per-share). But the other reason is signaling. “We think our stock’s worth buying at this price”, the company is saying, “and so should you. We care enough about our existing shareholders to spend money tending the share price for them. Please don’t sell us, or downgrade us. We’ll buy back even more – promise!”
Signaling is, I think, the greater of those two. There’s a lot of room to question the actual financial effectiveness of stock buybacks. As one person in that link notes, if you want to reward current shareholders with cash, you should pay them a dividend. Trying to keep your stock price up (even if the plan were to work) only really rewards the people who sell your stock and realize the gains. (See below for who some of those people are, though).
That signaling had better be worth something. It goes without saying, or should, that the money being used to buy back shares could also be put back into a company’s actual business. That’s another signal, one that makes me grit my teeth. To me, a stock buyback has always said “We’re willing to tell the world that we think that buying our own shares will provide a better return than investing in what we’re supposed to be doing for a living.” And why would you tell the world something like that? Isn’t that also saying “We can’t think of much else to do with this cash, what with our business in the shape it’s in, and parking it in an investment fund would be sort of embarrassing, So we might as well use it to bribe the Street. God knows it’s the only language they understand.”
There are other people willing to put it in just those terms. That “Marketplace” link above features a quote from William Lazonick of UMass-Lowell (note: affiliation fixed after original post), who’s not keeping his views bottled up:
“Here we have all these companies obsessed, basically with keeping their stock prices up, and saying the best thing that they can do with their money is spend billions of dollars on stock. And my view of that is, any company that says that they have nothing to better do with their money, the CEO should be fired.”
A CEO’s reply to that might well be that this attitude is why Lazonick’s a professor rather than a CEO himself. But is he wrong? Here’s a recent paper of his, which contends that the problem is that share buybacks are all too effective (update – that link appears to be broken, so here’s Lazonick at the Harvard Business Review on the subject). Lazonick says that the problem is tied to the increasing compensation of top executives in shares and options, and that using company money to prop up the stock price is, basically, market manipulation to reward the executives.
He has some figures from our own industry: From 1997 to 2009 “Amgen did
repurchases equal to 99 percent of R&D expenditures, Pfizer 67 percent, Merck 62
percent, and Johnson & Johnson 57 percent.” It could be worse – companies in the IT sector have often managed to spend even more than their R&D budgets on repurchases, partly because they increased the number of shares outstanding so hugely during the dot-com boom years.
One complication with the market-manipulation view is that stock buybacks don’t correlate very well with total stock returns. If anything, the correlation is negative: companies (and sectors) that spend the most on repurchases have lower returns. Of course, there’s a correlation/causation problem here – perhaps those returns would have been even lower without the buybacks. But there’s clearly no slam-dunk financial case to be made for repurchases.
Except one: that they’re often the easiest and least controversial use of the money. Companies get criticized if they sit on cash reserves, and they get criticized for missing earnings-per-share numbers. Why not try to address both at the same time? And without having to actually think very hard about what to invest in? I think that Pfizer’s Ian Read is being truthful when he says things like this:
Pfizer declined to make an executive available to discuss its policy. But in a statement, the company said it “remains committed to returning capital to shareholders through share buybacks and dividend payments.”
As for the cut in research spending in February, Pfizer said it has “accelerated our research strategy and made important changes to concentrate our efforts to deliver the greatest medical and commercial impact.”
In a conference call with analysts this month, Pfizer’s chief executive, Ian C. Read, said his company would “continually look” for acquisitions that would increase revenue growth. But in deciding how to use the proceeds from recent asset sales, he said “the case to beat is share repurchase.”
And that, truly, is a shame.