The heavy hand of government wants to regulate common stock repurchases. Sen. Elizabeth Warren is calling for an outright ban. Her colleague from New York wants to give the SEC the authority to reject buybacks that hurt workers. An additional ban or burdensome regulation on common stock buybacks is of course misguided. Almost as misguided as the 1993 limit on the deductibility of executive compensation that helped spawn the surge in common stock buybacks in the first place.
The problem with buybacks is not that they deprive companies of capital as some in the political class contend. The problem is that buybacks are abused by management teams to 1.) meet earnings per share-based targets that determine executive bonuses 2.) manipulate quarterly earnings 3.) shift compensation expense off the income statement, and 4.) temporarily boost demand so executives can unload personal holdings.
Rather than banning buybacks altogether, two Harvard professors writing in the Wall Street Journal recommend a simple fix. To wit:
A simple, common-sense regulatory change would curb such abuses. In particular, the SEC should require a firm to disclose each trade in its own shares within two business days, as it does for executives personally trading company stock. This two-day rule would shine a spotlight on repurchases, discouraging executives from using them opportunistically. For example, if such real-time disclosure leads investors to believe that executives are using a buyback to buy underpriced stock, the stock price would start rising, reducing executives’ indirect profits from any subsequent repurchases, and thereby increasing public investors’ returns.
A two-day rule won’t unduly burden firms’ use of repurchases for proper purposes, just as the rule doesn’t unduly burden individual insiders. Indeed, some of the largest stock markets outside the U.S. already require even more timely disclosure by firms trading in their own shares. In the U.K. and Hong Kong, firms must report a repurchase to the stock exchange before trading begins the next day. Japan requires same-day disclosure, and Swiss investors see these trades in real-time.
Even if the two-day disclosure rule doesn’t eliminate completely executives’ abuse of buybacks, it will generate fine-grained data about repurchases that can be used to decide whether more aggressive regulation is desirable.
The regulatory reforms currently under consideration, such as empowering the SEC to block buybacks, might curb these abuses even more. But they also could generate huge economic costs by impairing the circulation of capital in the economy. It would be foolish to go straight to such drastic measures rather than start with a modest regulatory tweak: subjecting firms to the same trade-disclosure requirement as their own executives.
Read more here.
Jeremy Jones, CFA
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