Can You Have Your Stock and Sell It, Too?

Critics contend that something is amiss when companies buy back stock at the same time executives are selling.

Some may regard that as a cynical
view, but if so the cynics appear to be on
the ascendancy. Companies may have to
look at this issue within the boardroom,
lest they find themselves looking at it in
the courtroom.

Randy Myers is a contributing editor of CFO.

More Knocks Against Buybacks

Researchers have found virtually no link between buybacks and share-price increases.

While it is commonly thought that buyback programs foreshadow higher stock prices,
substantial research suggests otherwise. Critics also say that firms run the risk of bungling
the timing of buybacks, the net effect being a substantial waste of corporate cash.

In a 2003 study entitled “Changing Motives for Share Repurchases,” J.F. Weston
and Juan Siu, of the Anderson Graduate School of Management at UCLA, surveyed
the academic literature from the prior two decades and found that, while buybacks
in the 1960s and 1970s tended to precede substantial stock-price gains, that phenomenon
has largely disappeared. Part of the reason may be that during that time,
most buybacks were accomplished through fixed-price tender offers in which management
made it clear what it thought the firm’s stock was worth. Since the 1990s,
most buybacks have taken the form of open-market transactions, which are less
transparent.

A 1981 study by Larry Dann in the Journal of Financial Economics looked at 143
fixed-price tender offers between 1962 and 1976. Dann found that in the three days
following the announcement, share prices enjoyed a “cumulative abnormal return”
of 23 percent on average. By the expiration of the tender offer, share prices on average
were 13 percent above their preannouncement levels.

But the good ol’ days appear to be over. A 1995 study by David Ikenberry, Josef
Lakonishok, and Theo Vermaelen in the same publication looked at 1,239 open-market
share repurchases from 1980 to 1990 and found that announcement of those
buybacks sparked a five-day price jump, on average, of just 3.5 percent. Other research
conducted between 2000 and 2002 says the gains are less than half that percentage.

Meanwhile, critics are sounding off on companies’ tendencies to buy high and
then see the price track lower. Sometimes much lower. Dell spent more than $7 billion
on its stock in 2005, buying shares priced in the mid 30s; as of September the company
was trading in the low 20s. “A buyback is bad when shares are overpriced,” says Michael
Gumport, a certified financial analyst and founder of consultancy MG Holdings in Summit,
New Jersey. “If you don’t know the value of your stock, it’s really simple; you just
pay a dividend. I know plenty of companies that bought back shares and found out a
year or two later that they would have saved a lot of money by waiting.” — R.M.

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