Speech
Stock Buybacks and
Corporate Cashouts
Washington D.C.
June 11, 2018
Thank you so much, Neera, for that very kind introduction. I’ve long
admired all that you and everyone here at the Center for American
Progress do to promote a progressive economic agenda. And I share your
commitment to making sure our markets are safe and efficient—and fair
for all Americans. So it’s a real honor to be with you here today.[1]
I also want to thank my friend Andy Green, who in addition to being
Managing Director of Economic Policy here at CAP, has been a critical
source of wisdom for me since my swearing in at the Commission back in
January.
Before I begin, let me start with the standard disclaimer that the
views I’m about to express are my own and do not reflect the views of
the Commission, my fellow Commissioners, or the SEC’s Staff. And let
me add my own standard caveat, which is that I fully expect someday to
convince my colleagues that I am, as usual, completely correct in
everything I say and do.
Today, I’d like to share a few thoughts about corporate stock
buybacks—and some research produced by my staff that raises
significant new questions about this activity. As Neera mentioned, I’m
a recovering researcher. Before I was appointed to the SEC, I was a
law professor who spent most of my time thinking about how to give
corporate managers incentives to create sustainable long-term value.
I’d often ask my students: are we making sure that executive pay gives
managers reason to invest in the long-term development of their
workforce and their communities? Or are we paying executives to pursue
short-term stock-price spikes rather than long-term growth?
Little did I know that, so soon into my tenure, I’d have a sobering
case study to put these questions to the test. That’s because the
Trump tax bill, promising to bring overseas corporate cash home,
became law last December.
Now, we all know what happened the last time a Republican-controlled
government pushed through a corporate tax holiday in 2004. As that
bill’s sponsors hoped, American companies repatriated billions of
dollars of overseas cash.[2]
But corporations didn’t invest most of that money in innovation. They
didn’t invest it in retraining their workforce or raising wages.
Instead, executives largely used the influx of fresh funds for massive
stock buybacks.[3]
So when I first took this job, I worried that 14 years later history
would repeat itself, and the tax bill would cause managers to focus on
financial engineering rather than long-term value creation. Sure
enough, in the first quarter of 2018 alone American corporations
bought back a record $178 billion in stock.[4]
On too many occasions, companies doing buybacks have failed to make
the long-term investments in innovation or their workforce that our
economy so badly needs.[5]
And, because we at the SEC have not reviewed our rules governing stock
buybacks in over a decade, I worry whether these rules can protect
investors, workers, and communities from the torrent of corporate
trading dominating today’s markets.[6]
Even more disturbing, there is clear evidence that a substantial
number of corporate executives today use buybacks as a chance to cash
out the shares of the company they received as executive pay.[7]
We give stock to corporate managers to convince them to create the
kind of long-term value that benefits American companies and the
workers and communities they serve. Instead, what we are seeing is
that executives are using buybacks as a chance to cash out their
compensation at investor expense.
Executives often claim that a buyback is the right long-term strategy
for the company, and they’re not always wrong. But if that’s the case,
they should want to hold the stock over the long run, not cash it out
once a buyback is announced. If corporate managers believe that
buybacks are best for the company, its workers, and its community,
they should put their money where their mouth is. That’s why I’m here
today to call on my colleagues at the Commission to update our rules
to limit executives from using stock buybacks to cash out from
America’s companies.
And I am also calling for an open comment period to reexamine our
rules in this area to make sure they protect employees, investors, and
communities given today’s unprecedented volume of buybacks.
Stock Buybacks and Executive Pay
Basic corporate-finance theory tells us that, when a company announces
a stock buyback, it is announcing to the world that it thinks the
stock is cheap.[8]
That announcement, and the firm’s open-market purchasing activity,
often causes the company’s stock price to jump, so the SEC has adopted
special rules to govern buybacks.
Those rules, first adopted in 1982, provide companies with a safe
harbor[9]
from securities-fraud liability if the pricing and timing of
buyback-related repurchases meet certain conditions.[10]
After experience proved that buybacks could be used to take advantage
of less-informed investors,[11]
the SEC updated its rules in 2003, though researchers noted that
several gaps remained.[12]
In the meantime, the use of stock-based pay at American public
companies has exploded.[13]
Although these pay programs present many challenges, the one that I’ve
spent much of my career thinking about is how to make sure that
corporate management has skin in the game—that is, how to keep top
executives from cashing out stock they receive as compensation.[14]
You see, the theory behind paying executives in stock is to give them
incentives to create long-term, sustainable value.[15]
Because executives who receive shares rather than cash demand higher
levels of pay, the use of stock-based compensation has led to
eye-opening pay packages for top executives. In the trade,
investors—and the economy as a whole—tie executives’ fortunes to the
growth of the company.
But that only works when executives are required to hold the stock
over the long term. Researchers have long worried that executives, who
always prefer cash to stock, will try to sell rather than hold their
shares, eliminating the incentives they were meant to produce.[16]
So it’s no surprise that, in the years leading up to the financial
crisis, top executives at Bear Stearns and Lehman Brothers personally
cashed out $2.4 billion in stock before the firms collapsed.[17]
And it’s no wonder that sophisticated investors have for decades
strictly limited executives’ freedom to cash out their shares.[18]
In the wake of the financial crisis, Congress realized the importance
of keeping executives’ skin in the game, so the Dodd-Frank Act
included several provisions designed to give investors more
information about whether and how managers cash out.[19]
Unfortunately, as you all know too well, those rules have still not
yet been completed, keeping investors in the dark about executives’
incentives.
Nearly eight years since that landmark legislation, it is completely
unacceptable that the SEC has still not promulgated these and other
rules required by law. But it’s not just that the regulations haven’t
been finalized. It’s that the problem itself keeps getting worse. You
see, the Trump tax bill has unleashed an unprecedented wave of
buybacks, and I worry that lax SEC rules and corporate oversight are
giving executives yet another chance to cash out at investor expense.
How Executives Use Buybacks to Cash out
That’s why, when I was sworn in a few weeks after the Trump tax bill
took effect, I asked my staff to take a look at how buybacks affect
how much skin executives keep in the game. I was worried that lax
corporate practices and SEC rules might lead to buybacks that give
executives yet another chance to cash out at investor expense.
So we dove into the data, studying 385 buybacks over the last fifteen
months.[20]
We matched those buybacks by hand to information on executive stock
sales available in SEC filings.[21]
First, we found that a buyback announcement leads to a big jump in
stock price: in the 30 days after the announcements we studied, firms
enjoy abnormal returns of more than 2.5%.[22]
That’s unsurprising: when a public company in the United States
announces that it thinks the stock is cheap, investors bid up its
price.
What did surprise us, however, was how commonplace it is for
executives to use buybacks as a chance to cash out. In half of
the buybacks we studied, at least one executive sold shares in the
month following the buyback announcement. In fact, twice as many
companies have insiders selling in the eight days after a buyback
announcement as sell on an ordinary day.[23]
So right after the company tells the market that the stock is cheap,
executives overwhelmingly decide to sell.[24]
And, in the process, executives take a lot of cash off the table. On
average, in the days before a buyback announcement, executives trade
in relatively small amounts—less than $100,000 worth. But during the
eight days following a buyback announcement, executives on average
sell more than $500,000 worth of stock each day—a fivefold increase.
Thus, executives personally capture the benefit of the short-term
stock-price pop created by the buyback announcement:
Now, let’s be clear: this trading is not necessarily illegal. But it
is troubling, because it is yet another piece of evidence that
executives are spending more time on short-term stock trading than
long-term value creation. It’s one thing for a corporate board and top
executives to decide that a buyback is the right thing to do with the
company’s capital. It’s another for them to use that decision as an
opportunity to pocket some cash at the expense of the shareholders
they have a duty to protect, the workers they employ, or the
communities they serve.
More importantly, policymakers, advocates, investors and corporate
boards have spent decades, and billions of dollars of shareholder
money, trying to tie executive pay to long-term corporate performance.
But the evidence shows that buybacks give executives an opportunity to
take significant cash off the table, breaking the pay-performance
link. SEC rules do nothing to discourage executives from using
buybacks in this way. It’s time for that to change.
The Path Forward
There are two steps we can and should take right away to address the
practice of executives using buybacks as a chance to sell their
shares. First, as I mentioned earlier, the SEC last revised its rules
governing buybacks in 2003. Those rules give companies a so-called
“safe harbor” from liability when pursuing buybacks. But there are no
limits on boards and executives using the buyback—and the safe
harbor—as an opportunity to cash out.
I cannot see why a safe harbor to the securities laws should subsidize
this behavior. Instead, SEC rules should encourage executives to keep
their skin in the game for the long term. That’s why our rules should
be updated, at a minimum, to deny the safe harbor to companies
that choose to allow executives to cash out during a buyback.[25]
And that’s why today I’m also calling for an open comment period to
reexamine our rules in this area to make sure they protect American
companies, employees, and investors given today’s unprecedented volume
of buybacks.[26]
Second, corporate boards and their counsel should pay closer attention
to the implications of a buyback for the link between pay and
performance. In particular, the company’s compensation committee
should be required to carefully review the degree to which the buyback
will be used as a chance for executives to turn long-term performance
incentives into cash. If executives will use the buyback to cash out,
the committee should be required to approve that decision and disclose
to investors the reasons why it is in the company’s long-term
interests. It is hard to see why a company’s buyback announcement
shouldn’t be accompanied by this kind of disclosure.[27]
Executives who can’t sell their holdings in the short term—but instead
have to create real value over time—have far fewer incentives to
manage to quarterly earnings and pursue the kind of short-term
thinking that dominates our economy today. The esteemed experts on our
next panel will, I’m sure, offer broader policy proposals that can
help us address those problems. But at the SEC, it’s time for our
rules to require corporate managers who say they want to manage for
the long term to put their money where their mouth is. At the very
least, our rules should stop giving executives incentives to use
buybacks to cash out.
* * * *
The increasingly rapid cycling of capital at American public companies
has had real costs for American workers and families. We need our
corporations to create the kind of long-term, sustainable value that
leads to the stable jobs American families count on to build their
futures. Corporate boards and executives should be working on those
investments, not cashing in on short-term financial engineering.
Each day when I arrive at work, I’m reminded that the SEC’s mission is
to protect investors, ensure a level playing field in our financial
markets, and encourage capital formation. Updating our rules to
reflect the effects of buybacks on executives’ incentives to create
long-term value would serve all three of those goals.
Investors deserve to know when corporate insiders who are claiming to
be creating value with a buyback are, in fact, cashing in.[28]
A level playing field requires that shareholders selling into a
buyback know what managers are doing with their own money. And
investors who feel assured that buybacks won’t be used as a chance for
insiders to cash in will be more willing to fund the kinds of
long-term investments our economy needs.
All of you here at CAP have provided essential leadership in
developing policies that produce growth for all Americans—and favor
long-term value creation over financial engineering. That’s why I’m so
proud to be here today. I’m very much looking forward to your
questions. And I so look forward to working with you to ensure that
the SEC’s policies create the kinds of markets that American families
need—and deserve.
[1] Commissioner,
United States Securities and Exchange Commission. I am, as always,
grateful to my SEC colleagues Bobby Bishop, Caroline Crenshaw, Marc
Francis, Satyam Khanna, Prashant Yerramalli, and Jon Zytnick for their
invaluable counsel. Professor Jesse Fried of the Harvard Law School
also provided insights that significantly deepened my thinking about
these matters. The views expressed here are solely my own, and do not
necessarily reflect those of the Staff or my colleagues on the
Commission, though I hope someday they will.
[2] See
American Jobs Creation Act, Pub. L. No. 108-357, 118 Stat.
1418-1660 (2004).
[3]
Although the degree to which corporations used the proceeds of
the 2004 holiday for buybacks is debatable, whether they did
so—even though the statute prohibited such uses—is not. Compare
Dhammika Dharmapala, C. Fritz Foley, and Kristin J. Forbes, Watch
What I Do, Not What I Say: The Unintended Consequences of the Homeland
Investment Act, 66 J. Fin. 753 (2011) with Thomas J.
Brennan, Where the Money Really Went: A New Understanding of the
AJCA Tax Holiday (Northwestern Law and Economics Working Paper)
(2014). What’s worse, “the temporary holiday conditioned firms to
anticipate future holidays and to change their behavior by placing
more earnings overseas than ever before.” Thomas J. Brennan, What
Happens After a Holiday? Long-Term Effects of the Repatriation
Provisions of the AJCA, 5 Nw. J. L. & Soc. Pol’y 1 (2010).
[4]
Talib Visram, Tax Cut Fuels Record $200 Billion Stock Buyback
Bonanza, CNN.com (June 5, 2018); see also William Lazonick,
Stock Buybacks: From Retain-and-Reinvest to Downsize-and-Distribute,
Brookings Initiative on 21st Century Capitalism (April 2015), at 2
(“Over the decade 2004-2013, 454 companies in the S&P 500 Index in
March 2014 that were publicly listed over the ten years did $3.4
trillion in stock buybacks, representing 51 percent of net income.”).
[5]
Savvy market observers also worry that the magnitude of this year’s
buyback spree reflects a troubling trend in corporate investment.
See, e.g., Matt Egan, Goldman Sachs Warns Against Falling in
Love with Stock Buybacks, CNNMoney.com (April 26, 2018) (noting a
recent equity research report describing the perhaps-unsurprising
result that, since the 2016 presidential election, “Goldman Sachs’s
collection of stocks that are focused on capital spending and research
and development soared 42% . . . besting the S&P 500’s 24% gain”).
[6]
For an exceptionally clear demonstration as to how buybacks can harm
investors while benefiting insiders, see Jesse M. Fried, Insider
Trading Via the Corporation, 162 U. Pa. L. Rev. 801, 805 (2014)
(referring to stock buybacks as “indirect insider trading” and noting
that such “trading likely imposes considerable costs on public
investors in two ways. First, just like ‘ordinary’ direct insider
trading, indirect insider trading secretly redistributes value from
public investors to insiders. . . . Second, the use of the corporation
as a vehicle for insider trading can lead insiders to waste economic
resources.”).
[7]
In these remarks, I focus on executives’ use of buybacks to cash out
shares granted as part of compensation packages otherwise designed to
link executive pay with long-term performance. There are, of course,
circumstances where managers who founded the firm or are otherwise
large shareholders seek liquidity for those holdings using buybacks.
Those cases, too, should be addressed if the SEC chooses to reevaluate
its rules in this area. But here I focus on cases where executives use
buybacks to cash out shares granted as stock-based pay.
[8]
See, e.g., George Constantinides & Bruce Grundy, Optimal
Investment with Stock Repurchase and Financing as Signals, 2 Rev.
Fin. Stud. 445 (1989) (providing a theoretical model on the role of
repurchases when a firm is undervalued).
[9]
Among other reasons, a safe harbor is necessary because firms often
pursue buybacks under informational circumstances that might lead to
securities-law liability in other contexts. See Fried, supra
note 5, at 813-814 (“The SEC takes the position that Rule 10b-5 .
. . applies to a firm buying its own shares.”).
[10]
Securities and Exchange Commission, Final Rule: Purchases of Certain
Equity Securities by the Issuer and Others, Release Nos. 33-8335,
34-48766, 17 C.F.R. Pt. 228 et seq.
[11]
For example, because these rules permitted firms to announce a
buyback—generating a stock-price spike—and then choose not to buy back
any stock at all without disclosing that fact to investors,
commentators and the SEC worried that managers opportunistically used
buyback announcements to manipulate share prices. See, e.g.,
Jesse Fried, Informed Trading and False Signaling with Open Market
Repurchases, 93 Cal. L. Rev. 1323, 1336-40 (2005); see also
Final Rule, supra note 8 (“Studies have . . . shown that some
issuers publicly announce repurchase programs, but do not purchase any
shares or purchase only a small portion of the publicly disclosed
amount.”).
[12]
See Final Rule, supra note 8. Among other things,
commentators have pointed out that the SEC’s still-lax disclosure
rules regarding buybacks give corporate insiders “a strong incentive
to exploit [those] rules in order to engage in indirect insider
trading: having the firm buy and sell its own shares at favorable
prices to increase the value of the insiders’ equity.” Fried, supra
note 8, at 804. Indeed, there is important evidence that the
limited tightening of disclosure rules in this area have had some
benefits in addressing opportunistic buyback activity. See
Michael Simkovic, The Effect of Mandatory Disclosure on Open-Market
Stock Repurchases, 6 Berkeley Bus. L. J. 98 (2009). That evidence
makes the case for revisiting these rules now all the more compelling.
Indeed, the Commission issued a proposal to update these rules in
2010, see Proposed Rule, Purchases of Certain Equity Securities
by the Issuer and Others, Release No. 34-61414 (2010), but to date has
taken no action on the proposal.
[13]
See, e.g., Kevin J. Murphy, Executive Compensation: Where We
Are and How We Got There, in George Constantinides, Milton
Harris, and Rene Stulz, Eds., Handbook on Economics and Finance 211
(2013).
[14]
See, e.g., Robert J. Jackson, Jr., Stock Unloading and
Banker Incentives, 112 Colum. L. Rev. 951 (2012); Robert J.
Jackson, Jr. & Colleen Honigsberg, The Hidden Nature of Executive
Retirement Pay, 100 Va. L. Rev. 479 (2014); Robert J. Jackson, Jr.
& Jonathon Zytnick, The Effects of a Tax Notch on CEO Golden
Parachute Contracts and Option Exercises (working paper 2018).
[15]
See, e.g., Kevin Murphy, Executive Compensation, in
Orley C. Ashenfelter & David Card, Eds., 3B Handbook of Labor
Economics 2485 (1999).
[16]
See Lucian A. Bebchuk, Jesse Fried, and David Walker,
Managerial Power and Rent Extraction in the Design of Executive
Compensation, 69 U. Chi. L. Rev. 751 (2002); see also
Lucian A. Bebchuk & Jesse Fried, Paying for Long-Term Performance,
158 U. Pa. L. Rev. 1915, 1921 (2010) (describing concerns related to
“ensuring that, whatever equity incentives are used [in executive pay,
executives’] payoffs are primarily based on long-term stock values
rather than on short-term gains that may be reversed.”).
[17]
Lucian A. Bebchuk, Alma Cohen, and Holger Spamann, The Wages of
Failure: Executive Compensation at Bear Stearns and Lehman 2000-2008,
27 Yale. J. Reg. 257 (2012).
[18]
Robert J. Jackson, Jr., Private Equity and Executive Compensation,
60 U.C.L.A. L. Rev. 638, 640 (2013) (“[T]he pay-performance link is
much weaker in public companies than in companies owned by private
equity investors. Borrowing from their private equity counterparts,
public company boards seeking to strengthen the link between pay and
performance should restrict CEOs’ freedom to unload.”).
[19]
See, e.g., Dodd-Frank Wall Street Reform and Consumer
Protection Act §§ 953(a), 954, 955, Pub. L. No. 111-203, 124 Stat.
1376 (2010) (requiring the SEC to adopt rules requiring disclosure of
the pay-performance link, public companies’ policies related to the
clawback of erroneously awarded compensation, and policies related to
insider hedging of public companies’ stocks, none of which has been
finalized).
[20]
We drew information on buybacks from the Securities Data Company (SDC)
database, using transactions identified by SDC as buybacks with
announcements in the year 2017 and the first three months of 2018. For
consistency in treatment across the sample, we identify an initial
sample of 708 repurchases and retain only the first repurchase
announcement by each company—and only those repurchases not followed
by a subsequent repurchase announcement within 60 days. We merged
those data with information from the Center for Research on Securities
Prices (CRSP) database, leaving a sample of 385 public company
buybacks.
[21]
We used data from Form 4 filed pursuant to Section 16. See
Securities and Exchange Commission, Ownership Reports and Trading By
Officers, Directors and Principal Securities Holders, 56 Fed. Reg.
7,242 (Feb. 21, 1991); see also Securities and Exchange
Commission, Mandated Electronic Filing and Web Site Posting for Forms
3, 4 and 5, 68 Fed. Reg. 25,788 (May 13, 2003).
[22]
That finding is consistent with the longstanding finance literature on
the effects of these announcements on stock prices. See, e.g.,
David Ikenberry, Josef Lakonishok, and Theo Vermalen, Market
Underreaction to Open Market Share Repurchases, 39 J. Fin. Econ.
181 (1995); Jesse M. Fried, Insider Signaling and Insider Trading
with Repurchase Tender Offers, 67 U. Chi. L. Rev. 421 (2000).
[23]
On an average day, between 3 and 4 percent of corporate insiders trade
in the company’s stock, but we found that, during the eight days
following a buyback announcement, more than 8 percent do. We direct
the interested reader to the data appendix to this speech, where you
can learn more about our methodology and analysis.
[24]
Investors receive a mixed signal from a buyback announcement that is
accompanied by insider selling. Indeed, as we explain in our data
appendix, we observe statistically significantly lower returns during
the ten- and thirty-day window following buyback announcements with
executive selling than we do in buybacks where executives hold their
shares for the long term.
[25]
The precise way in which the safe-harbor could be restructured to
disfavor the use of buybacks for insider sales is beyond the scope of
my remarks—and, in all events, well within the expertise of our
exceptional Staff. Suffice it to say that, if the Commission were so
inclined, our Staff would have little difficulty making sure that our
rules are not used in a way that encourages corporate executives to
use buybacks to sell their shares.
[26]
We should also use this opportunity to review other problems with Rule
10b-18 and related rules—including the fact that they require only
quarterly disclosure of the amount of shares a company has actually
repurchased, leaving investors largely in the dark about corporate
trading in their own shares. For an exceptionally thoughtful proposal
in this respect, see Fried, supra note 5.
[27]
Except, of course, the fact that our rules let them. See Final
Rule, supra note 8; but see Schnell v. Chris-Craft
Industries, Inc., 285 A.2d 437, 444 & n.15 (Del. 1971) (“Inequitable
action does not become permissible simply because it is legally
possible.”).
[28]
It’s true, of course, that investors eventually receive
disclosure of executives’ selling on Form 4, which is how we were able
to conduct this study. But those disclosures come after the
executive has already sold—too late for shareholders to price the
executive’s decision into their own determination whether to sell
their shares. See Fried, supra note 5. |
