Pension Oldie responds to Brookfield/ Just dealI think the private capital versus listed issue equity goes wider than Just insurance. Listed companies are increasingly releasing surplus cash by share buy-backs designed to bolster their share price and thereby reducing funds that would be otherwise invested in future developments in the Company, e.g. R&D, acquisitions etc. but also increasing p/e ratios. This benefits investors selling their shares at the expense of investors operating on a buy and maintain basis. As the London market had traditionally been dominated by investors, such as pension funds, operating on a longer term basis the p/e ratios in London, particularly for technology stocks but perhaps increasingly for financial stocks, have been lower than in the US. This puts them at a disadvantage as a source of capital for those companies wishing to raise capital to fund future developments. Private capital removes the pressure to protect the share price, allowing the owner the freedom to allocate the cash that would otherwise be used for share buy-backs to fund either future developments or a smoothed annual dividend flow. While this is currently particularly affecting the London market, the US market is not immune and is becoming increasingly dominated by stocks with high p/e ratios supported particularly by private investors targeting capital gains in the short term, but also through index tracking funds. Perhaps trustee boards should consider this when deciding how much and how to invest in equities. |
In reply to Pension Oldie, Derek Scott replies
There’s an argument, popular among professors of financial economics, that share repurchases are the same as dividends.
If a company buys back 5% of its shares, the result will be the same as a dividend equal to 5% of the company’s equity market capitalisation.
This myopic principle applies regardless of the relative valuation at which shares are repurchased.
Don’t buy that.
As investors, pension trustees should think about share repurchases the same way they (should) think about share purchases: they’re more attractive, the cheaper the share price, but less and less attractive at higher and higher valuations.
Under IFRS accounting, share repurchases almost invariably boost returns on capital because the amounts spent to buy back shares are deducted from shareholders’ funds.
Share repurchases also boost earnings per share (EPS).
There is a better way, if only accounting standard-setters could get their heads out of their financial economics textbooks.
Companies should be made to carry repurchased shares on their balance sheets as a self-investment, not deducted from shareholders’ equity.
In another departure from current IFRS, companies could use the equity method of accounting to continue to consolidate the proportion of earnings attributable to the shares repurchased.
Dividends, on the other hand, are incompatible with executive share options.
Options give their recipients an interest in increases in the capital value of a company’s shares above the strike prices of the options.
Dividends reduce the capital value of a company’s shares and thus don’t appear to suit the interests of option-holders.
There is a solution to this conflict too.
Reduce the strike price of
executive share options for the value of dividends paid.This would align option-holding executives with long-term shareholders, in deciding the best ways to distribute capital by either share repurchases or dividends or a combination of both.
There remains a problem that paying dividends conflicts with executive remuneration incentives tied to EPS growth.
IFRS accounting flatters the economics of share repurchases, so executives find it in their self-interest to get their company boards to repurchase shares, since this usually improves EPS.
Such a conflict suggests it would be better, not to limit the scope for paying dividends, but to get rid of EPS as an incentive metric.
Remuneration policies and incentive schemes should instead reward a combination of growing operating profits, cash conversion and return on capital.
As for shareholder approval, corporate lawyers should be able to draft rolling AGM resolutions for dividends, as they already do for share repurchases.
While we’re at it, the standard wording of those share purchase resolutions could be beefed up to more than mere reference to the current share price, to add wording about the necessity for repurchases to represent value for long-term shareholders. Accounting for repurchases as an investment, subject to revaluation or impairment, would also bring more boardroom discipline to bear.
Finally, it’s said short-term equity traders welcome share repurchases at any price, for the front-running opportunities they offer.
Long-term shareholders, engaging with executives and non-executives to get across their preferences on dividend and share repurchase policies, need to recognise this competition with other shareholders, of the short-term and/or passive variety.
Further comment
Dividends vs share buybacks – is one better than the other? | HL
