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Companies turning again to stock buybacks to reward shareholders

  • By Jia Lynn Yang,
  • The Washington Post
  • – 12/15/2013
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Battered by months of dis­appointing sales, networking giant Cisco (CSCO) needed a way to give its shareholders a pick-me-up. So the San Jose-based firm did what has become routine for many big U.S. companies in a slow-growing economy: It announced last month that it was buying back shares of its stock.

The amount authorized to be spent was $15 billion, surpassing the $10 billion in net income the company earned last year. It's also 21/2 times what Cisco spent on research and development, and it comes as the company lays off 5 percent of its workforce, or 4,000 employees.

This is what U.S. multinationals do now with their cash. Rather than tout big new investments, raise worker wages or hire more employees, companies are more likely to set aside funds to reward shareholders — a trend that took a dip during the recession but has roared back during the recovery.

The 30 companies listed on the Dow Jones industrial average (.DJI) have authorized $211 billion in buybacks in 2013, according to data from ­Birinyi Associates, helping to lift the benchmark stock index to heights not seen since the tech boom of the late 1990s. By comparison, the amount is nearly three times what the group spent on research and development last year, according to data from S&P Capital IQ.

Why spend so much on stock repurchasing? When the number of shares outstanding falls, the value of each one goes up, instantly rewarding shareholders.

The repurchase also lifts earnings per share, an important number closely watched by investors — and by corporate boards in determining executive pay. Of the 30 companies making up the Dow index, all but four list earnings per share in their public documents as a metric used to determine executive pay.

Ultimately, analysts say, when companies spend money on buybacks rather than investment, they're signaling low hopes for economic growth.

"Corporate profits are very high, but corporations are not expecting a huge burst of growth," said Ben Inker, co-head of asset allocation at GMO, an investment-management firm. "Given that they're not expecting a lot of growth, there isn't a lot of reason to invest. So they're finding ways of getting money back to shareholders."

The types of companies that authorize buybacks transcend industry. Among the Dow 30, more than half have approved stock buybacks this year, essentially earmarking money for repurchases that can take place over years. Home Depot (HD) authorized $17 billion in February; Goldman Sachs (GS) signed off on $10.8 billion in April; Pfizer (PFE) greenlighted $10 billion in June; and Wal-Mart (WMT) authorized $15 billion in June.

The announcements often come on top of ongoing share repurchases that outpace spending on research and development. AT&T (T), for instance, has spent $11.1 billion this year buying back shares, compared with the $1.3 billion it spent last year on research and development. Pfizer has used $11.5 billion to repurchase shares; the pharmaceutical company logged $7.9 billion in research last year.

Cisco spokeswoman Kristin Carvell said the company has not announced a time frame for completing the $15 billion buyback, so evaluating the size of the authorization next to annual net income is "not necessarily a direct comparison."

She rejected the idea that the company is authorizing buybacks because it doesn't see investment opportunities. Carvell said Cisco is able to do both — return cash to shareholders and make investments. Carvell also said that the recent layoffs were done not to cut operational costs but rather to allow the company to invest in "key growth areas."

Cisco announced its buyback authorization the same day it released disappointing quarterly earnings. The bad news outweighed the repurchase declaration and sent the stock down 11 percent.

In the past three decades, the stock buyback has become a standard move in the playbook of corporate America, echoing a growing fixation on maximizing shareholder value.

The rise of share buybacks reflects a belief that a company's primary purpose is to return value to shareholders, even though that principle is not codified by U.S. statute.

Helping to fuel the stock market's meteoric rise is the Federal Reserve's stimulus program designed to lower borrowing costs. Companies are taking advantage, often by borrowing money at low rates to repurchase shares, although it's unclear how much of the debt is being used to pay for buybacks.

"It somehow feels scarier if they borrowed the money to buy back stock than if they had some investment opportunities," Inker said. "That somehow seems more sustainable than just levering up to reduce the share count."

Some analysts say companies are better off repurchasing shares than pouring money into investments promising dubious payoffs, especially in a slow-growing economy. But others argue that the rise of the share buyback is encouraging executives to make decisions that aren't always good for their firms or for the economy, rewarding companies for finding quick ways to please shareholders rather than innovating and planning for long-term growth.

"It's not just the money," William Lazonick, a professor of economics and director of the Center for Industrial Competitiveness at the University of Massachusetts at Lowell, said of buybacks. "It changes the strategy of the company. It undermines innovation."

Share buybacks weren't always a fixture in corporate America. In 1985, only 52 stock repurchases were authorized, according to Birinyi Associates. This year there have been 885.

Buybacks at all companies this year are on track to reach $754 billion, shy of the $863 billion record set in 2007 but far above the 2009 low during the recession.

Lazonick traces the rise of buybacks to a rule passed by the Securities and Exchange Commission in 1982 that gave "safe harbor" to corporations repurchasing large parcels of stock — a way to protect them from charges of price ma­nipu­la­tion.

"It's systemic," Lazonick said. "One company does it, everybody feels compelled to do it. Otherwise their stock price will lag behind."

Another factor, experts say, is that executive pay is increasingly tied to movements in the stock market as corporate boards try to tie pay to performance. And often, the compensation itself comes in the form of stock.

The use of restricted stock grants to pay executives hit an all-time high in 2012, according to research firm Equilar, with 93 percent of Standard & Poor's Composite 1500 companies granting restricted stock to employees, compared with 80 percent in 2007.

But some corporate governance experts question why pay is so closely tied to share prices and metrics such as earnings per share, which executives can so easily alter in the short term.

Roger Martin, former dean of the Rotman School of Management at the University of Toronto, likened stock-based pay to professional football players being allowed to bet on the games they play in: They have too much control over the outcome.

"In football, they have this absolute rule, which is if you're ever caught betting on football if you're a player or manager, you get punted out for life," Martin said. "In the world of business, it's a different rule."

As the stock market has surged back to pre-recession levels, executive pay has shot back up as well. Equilar found that chief executives' compensation is "growing at levels last seen prior to the recession," according to its 2013 report on CEO pay strategies. Meanwhile, average worker pay has remained stagnant since before the crisis.

And pressure is growing, often from activist investors, for firms to return even more value to shareholders. Carl Icahn, for instance, has been loudly pressing Apple (AAPL) to do a buyback of as much as $150 billion, although he recently scaled back his request.

Companies can take years to complete the process. This year, the companies in the Dow 30 have executed $132 billion worth of buybacks. Lazonick has calculated that over the past decade, companies in the S&P 500-stock index (.SPX) have spent just over half of their net income executing buybacks.

Still, lawmakers have rarely taken notice. In the summer of 2008, when gasoline prices spiked, a handful of Democrats on Capitol Hill, including Sen. Charles E. Schumer (D-N.Y.) and Sen. Robert Menendez (D-N.J.), blasted oil companies for announcing buybacks while customers paid more at the pump.

"What's shocking is that Big Oil is plowing these profits into stock buybacks instead of increasing production or investing in alternative energy," Schumer said in a statement at the time.

No substantive policy action on buybacks followed. Yet the way firms deploy their capital — along with what executives are paid — has broad ramifications for the economy.

"Executives get paid for what other companies are doing or what the sentiments of investors are, something that has nothing to do with their business plans," said Keith Johnson, former legal counsel to Wisconsin's public pension fund. "It's just a really bad way to run an economy. It perverts the allocation of capital."

For firms, repurchasing shares has become something to boast about to shareholders — proof that executives are looking out for them.

"We have a financial priority to return value to our shareholders through dividends and share repurchases," Jeff Davis, treasurer and executive vice president of Wal-Mart, said on an earnings call with analysts last month. Davis reported that the company spent $1.7 billion on repurchasing shares in the most recent quarter. Of the $15 billion approved by the firm to be spent this way, Davis added, there was still room for billions more.

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