Do Executives Really Benefit From Stock Repurchases?

Stock Buyback Image

A Wall Street Journal article earlier this month reported that stock buybacks in 2022 are proceeding at a record clip. Citing data from Goldman Sachs Group Inc., the article stated that – in the first two months of the year alone – firms in the S&P 500 have announced buyback plans valued at $238 billion., PepsiCo, Union Pacific, Best Buy, and Colgate-Palmolive are among the firms accounted for in this “surge of activity,” with Goldman analysts projecting $1 trillion in total 2022 buybacks, a 12% increase over last year.

In addition to paying dividends, stock buybacks are a common tool that companies use to return cash to shareholders. A stock buyback occurs when a public company uses cash to purchase shares of its own stock.

However, there are skeptics who call into question the motivations behind corporate buybacks. Some investors would rather see companies investing their cash for long-term value through capital purchases and R&D, rather than for the short-term increase in share price.

Another common refrain, according to Assistant Professor of Finance Michael Farrell, is that share repurchases are a symbol of corporate greed. Critics, he says, allege that self-interested managers repurchase shares to increase the price of insider sales, defend the stock price against selling pressure, and manipulate earnings per share by reducing the numbers of shares outstanding – and are lining their own pockets in the process.

But is that truly the case?

Farrell and his research collaborator Leonce Bargeron of the University of Kentucky, probed this issue through a novel identification strategy. They looked at dual-(share) class firms with active trading in both share classes, seeking to isolate the magnitude and duration of the demand-drive price effect of stock repurchases.

“Comparing the prices of distinct securities with identical cash flow rights and risks isolates the demand-driven price effect of repurchases,” he says. “The non-repurchased share class serves as a near perfect counterfactual to the repurchased share class.”

Their findings were recently published in the journal Management Science.

Their study sample, which covered the period 2004 through 2019, was composed of 19 dual-class firms with active trading in both share classes, and included 2,766 monthly share class observations, of which 401 had repurchases.

What they found was that repurchases create small price effects that dissipate quickly.

Specifically, a repurchase of 0.30% of shares outstanding — the average monthly repurchase in their sample across months with a repurchase — increases the stock price by approximately 40-70 basis points. And that price effect typically reverses out in the following month.

This small, short-lived increase in the stock price, Farrell says, leaves little scope for CEOs to benefit from repurchases motivated by self-interest.

“A back-of-the-envelope calculation suggests that the average CEO could create an additional $12,500 a year in direct benefits from repurchases, a trivial fraction of a CEO’s $5.6 million average annual compensation,” Farrell states.

In addition, he says, if shareholder value takes a hit from myopic repurchases, this will result in decreased value of the CEO’s firm-specific portfolio, not to mention the potential damage to the CEO’s reputation and job security.

The full study, “The Price Effect of Stock Repurchases: Evidence from Dual Class Firms,” Leonce Bargeron and Michael Farrell, was published in Management Science, Vol. 67, No. 10, October 2021, pp. 6568-6580.

Research@ LubarFaculty scholarship in the Lubar School of Business spans the business fields and beyond through both theoretical and applied research that is published in leading journals.  Here are some of our faculty’s most recent publications:
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