Nonfinancial companies in the United States paid their shareholders $ 456 billion in share buybacks in fiscal year 2017, according to Calcbench. That’s more than the $ 300 billion from five years ago.
To increase their buybacks, American companies have increasingly turned to investment banks. Many companies now buy back their shares of Bank of America, Goldman Sachs, JPMorgan and other banks, which deliver shares borrowed from institutional investors, rather than gradually buying back shares through brokers on the open market.
This relatively new form of investment bank-facilitated buyback, called accelerated share buyback (ASR), has become quite popular since the mid-2000s. Last year, for example, nonfinancial companies spent more than $ 48 billion in ASR, or about 10.5% of the total dollar amount of the buybacks.
ASRs are fast. When a deal is struck between a company and its investment bank, the company’s share count drops overnight. And not for a trivial amount. On a recent study to be published in the Accounting and finance reviewI find that ASR firms buy back on average about 5% of their outstanding shares.
The immediate reduction of outstanding shares often increases reported earnings per share (EPS). And while an ASR’s impact on EPS doesn’t typically exceed a few cents, it’s often more than enough to help companies meet or exceed analyst forecasts.
The study of 293 ASRs traded between 2004 and 2011 shows that 29% of ASR companies would have overlooked the consensus EPS forecast without an ASR. That compares with just 14% of companies that bought back their shares on the open market. This suggests that ASRs are more likely to be used opportunistically to stimulate EPS than traditional buybacks.
The use of ASR as an EPS management device depends on two factors: whether the CEO’s bonus is dependent on the company’s EPS performance, and whether the company has a reputation for consistently exceeding analysts’ EPS targets. When either condition is met, the probability of an ASR nearly doubles.
While the results show that managing EPS through ASR does not generate a more favorable investor reaction to earnings announcements, it can help managers improve their compensation and reputation. An examination of the representational statements of the sample companies shows that in only three cases did compensation committees mention taking into account the EPS impact of an ASR when deciding on the CEO’s bonus pay.
Despite concerns about their accounting implications, ASRs have become an important part of corporate buyback programs. And indeed, the evidence suggests that many ASR firms report better operating performance during the post-buyback period.
As more ASR transactions take place and more data is analyzed, there will be fewer questions about what motivates managers to implement them.
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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of the CFA Institute or the author’s employer.
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