Share buybacks can boost share price and performance
05 December 2016
- Research finds share buybacks can boost short-term share price
- WBS also finds they can boost long-term performance
- Firms with low debt can use buybacks to optimise their capital structure
- But for firms with too much debt share buybacks have a negative impact
Controversial share buybacks funded by debt not only boost share price in the short term but boost performance in the long term, research has found.
Share buybacks have become a popular option for companies with excess cash over the last decade, but more and more firms are now borrowing money to repurchase shares.
Those that see their share price low and looking to increase debt on their balance sheet to lower their tax bill are taking advantage of low interest rates to conduct leveraged buybacks.
It has led to concern about the rising level of corporate debt in share buybacks, but a study of all the leveraged buybacks issued in the US by Chendi Zhang, of Warwick Business School, and Zicheng Lei, of Surrey Business School, found that when companies had low debt levels it boosted performance in the long term.
Dr Zhang, Associate Professor of Finance, said: “It had been thought that using debt in share repurchases is bad for economic growth in the long run as it harms future investment.
“But we provide evidence that it is not true. We found that, on average, leveraged buybacks benefit shareholders - they create value.
“In the short run we found an increase in share price as leveraged buybacks are seen as a signal of a firm being confident about its future performance,
“And also in the long term, the next one to three years, we found stock performance improves. This is consistent with the leveraged optimisation hypothesis.
“Indeed, we found that when firms’ debt level is too low then they benefit the most from leveraged buybacks, and firms can use this to optimise their capital structure.”
The study, Leveraged Buybacks, published in Journal of Corporate Finance, which analysed the performance of up to 300 US companies that had repurchased shares through debt, did find that for companies with too much debt, leveraged buybacks harmed the firm’s capabilities.
Dr Zhang added: “In more extreme cases, 20 per cent of the firms we looked at, who already have too much debt, the long-run performance is much worse.
“But on average we found it benefited company shareholders. The main advantage of debt in the current environment is that it is tax deductible, so you can reduce your tax bill.
“Other benefits that have been found are ‘agency costs’, where leveraging up acts as a motivation for executives as they work harder to pay off the debt, plus it is another signal that you are confident about the future by taking on more debt.”
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