Share buybacks are not being used make targets easier, says Government-sponsored research

Two years after the publication of the Green Paper on corporate governance and the reiteration of the Government's manifesto commitment to look at whether share buy backs have been used to “inflate pay”, the Department for Business, Energy and Industrial Strategy (BEIS) has just published a 151-page report on the subject. (Share repurchases, executive pay and investment BEIS Research Paper Number 2019/011)

The Government’s concern, at the outset, was “to ensure that they (share repurchases) cannot be used artificially to hit performance targets and inflate executive pay.”  It also wanted to look more generally at whether share buy backs are an unproductive use of capital. The report cites US research which has argued this. The case has been made in the UK, for example by Andrew Smithers, who argued that executive incentives have increased volatility in corporate performance as well as creating a disincentive for capital investment. The Kay review in 2012 also highlighted the problem of “short-termism” in the UK equity markets.

The short conclusion to a long and carefully-worded academic report is that no significant relationship was found – over the period from 2007 to 2017 – between share buy backs and either the existence of EPS performance measures or the amount of a long-term share-based plan linked to EPS. The research also indicated that no company had successfully used share buy backs to beat EPS targets.

There is, however, some evidence, though not causal, to link EPS measures in pay incentives and lower investment.  The report argues that this strengthens the case for replacing long-term incentive plans with deferred share awards – or what we at FIT tend to call time-vested restricted shares. 
 

FIT comment

The report says that, while the analysis shows that systematic use of share buybacks to manipulate EPS is unlikely, this is not the same thing as saying that it does not happen at all.

This leads to one of the most important points for Remuneration Committees of companies which use EPS as a performance measure for pay.    As a matter of due diligence, the impact of share buybacks on EPS should be quantified and understood. 

The report says that 30% of 73 companies surveyed for the research said they adjusted their EPS targets. This may seem low but the most common reason given for not adjusting was immateriality.   Even so we think that Committees should satisfy themselves that this is the case just as they consider the risks of unintended consequences and the behavioural impact of any performance measure linked to pay. 
The evidence of a direct relationship between executive incentives and cuts in capital investment may be an even more significant finding for Remuneration Committees and further encourage the debate on pay for relatively short-term performance versus pay for more long-term stewardship.

Where Remuneration Committees prefer to link variable pay to performance here are 4 questions to ask:

1.    What is the benefit of share buybacks for this company now?
2.    What impact, if any, are they having on performance measures?
3.    How do we ensure that we measure performance consistently?
4.    Are we satisfied that we are rewarding shareholders and executives fairly?
 

If you wish to discuss anything arising from this briefing, please ask your usual contact at FIT or call us on 020 7034 1111 or email us at Info@fit-rem.com.

This paper is intended to be a summary of key issues but is not comprehensive and does not constitute advice. No legal responsibility is accepted as a result of reliance on the contents of this paper.

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