Since management both holds lots of options and makes the decision to do buybacks it is unlikely that they are completely unrelated. Empirically it has been know since at least 1998 that management with lots of stock options are more likely to buyback shares[1].
yep, sounds like a nice reason for otherwise completely stupid action - willfully spending best asset, cash, [thus in particular worsening the company's asset structure] to buy the worst asset - the company's own stock - as the stock once bought back loses all the value to the company.
1st read the 2013 IBM annual report's financial section as it relates to this subject. A cursory read will tell you that the following quote is completely false:
"There are two ways of looking at this. The first is that IBM spent $13.859 billion buying back those 73 million shares — an average of $190 per share. But in fact the share count only fell by 50 million shares, which means that IBM actually paid $277 per share by which the share count was reduced. That’s a crazy sum of money, far greater than IBM’s all-time-high share price. (The current price, by the way, is $162.)
The other way of looking at this is that the $13.859 billion didn’t really go entirely to shareholders, as Sorkin implies. Rather, some 50/73 of it went to shareholders — that’s about $9.5 billion — while the rest of it, about $4.4 billion, went, in one way or another, to employees. And especially to senior employees."
Without boring everyone to tears the author makes the completely false assumption that new shares issued are issued at $0 (however employees exercised 5.6m shares at $90 a share, or say the 1.5m shares employees purchased at a 5% discount to market price, there are a whole host of other programs)
Those two things are not connected in any way. Say you do a share buyback of 100 shares and give out 50 shares in compensation to employees. What you've done is given 100Xshare_price to your shareholders (you've gone out on the market and bought those shares from them) and 50Xshare_price to your employees (by issuing the new shares and thus diluting your shareholders). That second decision is independent from the first.
Say you take control of a company with a nice cash pile from past successes, but that isn't doing too great. You manage to get a great deal of options on the expectation you'll invest that cash pile to grow the business.
Now you can work your ass off to grow the company, or if manage to convince the right people so you can get those buybacks through, you could go for burning through that cash pile on buybacks, and profit nicely from the resulting rise in share price.
And if you're really good at sweet-talking the board, you could manage to sneak in additional options too. After all the share price is rising.
It's mostly a "buyer beware" type thing: It's not good or bad per se. Often the employee stock compensation may be necessary, e.g. to lure fresh blood in. And sometimes buybacks is the best response to a stagnating business: There may not be a short term prospect to be able to invest that cash pile in new product lines, for example.
But it's bad for you if you invest without understanding what is going on. Then again, that's always the case.
That won't work actually. In an efficient market the share price is unchanged by a share buyback. What will change is earnings per share, as you have the same earnings divided by less shares.
> But it's bad for you if you invest without understanding what is going on. Then again, that's always the case.
If you can get a deal where raising EPS gets you a nice bonus, then sure you can game the system. Those shareholders don't know what they're doing. The shareholders are still the ones that are getting the money from the share buybacks they're just also deciding to give a bonus to management based on flawed metrics.
Dividends theoretically should cause a fall in share prices the day after. Most aren't nearly large enough to be noticeable but for example in 2004 Microsoft issued a $3 dollar dividend and the share price fell by roughly that amount.
Conversely, stock repurchases you have money out but you also have a concentration of the stock.
In both cases money goes out of the company reducing its NPV but with stock repurchases the concentration and corresponding increase in EPS should offset the loss of money assuming the stock is priced correctly.
So there is an incentive for anyone with options to not pay dividends and save that money for stock repurchases. As well although theoretically buybacks shouldn't increase prices they do tend to as its seen as sign that management thinks the price is undervalued.
Both cases have the same exact outcome. If the company is worth Y and you decide to give out X, at the end of the transaction (dividend or repurchase) the shareholders as a whole will have a company worth Y-X on their hands plus X in cash for the same total of Y.
> As well although theoretically buybacks shouldn't increase prices they do tend to as its seen as sign that management thinks the price is undervalued.
That is indeed an extra benefit of repurchases, that they potentially signal that management believes the share is undervalued.
Think of it this way. Consider a company has NPV of 10 dollars with 10 outstanding shares priced at $1 and 5 dollars in the bank. If it pays out 5 dollars in dividends the NPV is now $5 and there are still 10 outstanding shares worth 50 cents each.
If the same company buys stock back with that 5 dollars the NPV also falls to $5. However there are only 5 outstanding shares now so each share is still worth 1 dollar.
Now if management doesn't have options, story over no one is any better or worse off assuming market efficiency.
However if management has options to buy 5 shares at say, 25 cents, they gain significantly more because the total number of shares has been diluted but the NPV is still the same.
In the first scenario total shares increase to 15 and their value decreases to ~33 cents. Transferring 1.6 dollars to management.
In the second scenario total shares increases to 10 and their value decreases to 50 cents. Transferring 2.5 dollars to management.
Yeah, that has been discussed in a few other comments. There's nothing stopping you from doing the same deal with dividends by giving out the dividend as well as adjusting the outstanding options, or adding clauses to the options to fix this case by changing the strike price or number of options in case of share buybacks.
The article doesn't argue that though, it's saying that since not all shares are retired and some are used as compensation that the value of the buyback isn't all given to shareholders. In reality those two transactions (buyback and issuing shares as compensation) are completely separate transactions that don't depend on each other.
Also I think I am wrong. Stock options are public information so it should be incorporated into the price of the stock any ways. Theoretically at least.
A long time ago a company (I think it was GM, but I'm not sure) got clever. Instead of declaring a dividend, they did something like an 11 for 10 stock split, then did a buyback of 1/11th of the outstanding shares.
The net result is that each shareholder ends up with same number of shares that they had before, and the same fraction of ownership of the company they had before, and they received money from the company in proportion to their share of ownership. It's just like a dividend--except it could be reported as a stock buyback and get treated as capital gains instead of ordinary income.
Because of this, what was once was a short paragraph in the Tax Code is now a couple pages or so, in order to close that loophole without taking capital gains treatment away from legitimate buybacks.
When you gaze at the ~3000 pages of the Tax Code (the widely reported 70k pages is a gross exaggeration) and wonder how it got so big, a good part if of it is because of things like that split/buyback trick. People will put a lot of effort into finding ways to minimize their taxes (rightly so), and so a lot of things have to be specified in great, nit-picky detail, such as how to decide if a buyback is really a buyback or is some kind of disguised dividend or other payment.
Sure, if you believe your stock is overvalued raise cash and retire debt, and if you believe it's undervalued take on debt and buy back shares. That's orthogonal to the issue of "if I want to give back 100$ to my shareholders what's the best way to go about it?".
Why tax them differently? In Canada, share buybacks create "deemed dividends" to ensure equal treatment.