Shareholders should question the logic behind a buy-back scheme

Share repurchase programmes are in vogue for public companies large and small, but the jury remains out on whether they are always a good long-term strategy

Barely a day passes during the current annual results season without a major listed company announcing a new share repurchase programme, or the extension of an existing one. Over the past two years, companies in the Standard & Poor's 500 index have spent about $1.1trn on share buy-backs, according to figures published by the Financial Times.

And in recent weeks, a flurry of shipping companies on both sides of the Atlantic have added their names to the list of those promising to pass cash back to shareholders in a similar fashion.

In New York, George Economou’s DryShips intends to repurchase $50m of its own shares over the next year, financed with cash.

While in Scandinavia, Stolt-Nielsen plans to continue a $30m buy-back programme, having spent only $1.7m since it was started in March 2016. And ferry group DFDS has said it would spend DKK 400m ($67m) on a repurchase programme to be completed at the latest by mid-August.

While the sums involved for each shipping company are relatively small, the scale of the share buy-back market overall is colossal.

And with recent changes to the US tax regime expected to generate a flood of overseas earnings being repatriated onshore, repurchases are only likely to increase.

But the scale of the spending continues to raise questions from some about the effectiveness of their use, and the prospect of heightened risk.

In theory, share buy-backs offer a simple and effective way of returning a company’s surplus cash to shareholders. And yet, as with so many elements of modern markets, there is also the risk of manipulation.

Greatest suspicion usually falls on management, who often stand to benefit if they are compensated in stock or by lifting earnings per share. Apple has spent more than $150bn in the past decade buying its own shares, and staff with stock options have benefited greatly from that.

d1bbfec22e55f755f9a2df5c126ff80d George Economou's DryShips has announced a plan to buy up to $50m of its own shares Photo: TradeWinds Events

Another accusation is that although management often have discretion about when to make repurchases, they can be bad judges of the value of their own stock. After all, when a company has more cash than its management know what to do with, its share price is likely to be high and, hence, not the best investment.

Warren Buffett’s conservative Berkshire Hathaway conglomerate rarely repurchases its own shares, and will only do so when their value is low, which it defines as less than 1.2x book value.

Of course, on a similar metric, with nearly every shipping share trading below net asset value, shipping buy-backs would be good value.

"With nearly every shipping share trading below net asset value, shipping buy-backs would be good value"

More fundamental criticism is that buy-backs reduce companies’ appetite for — and ability to execute — real investment in the business. Buy-backs may also increase leverage and risk, neither of which are constructive outcomes.

If a company has generated such cash that management does not know how to spend it effectively to expand the business, perhaps the question should not be whether to repurchase shares but whether to find a new management team that does have a bigger vision?

Nevertheless, it should be acknowledged, share repurchase programmes can be an entirely credible tool for management to shape the capital structure of their companies. But without doubt they carry risks both for shareholders and creditors.

Shareholders should demand that management fully explains the logic behind buy-back programmes, and be prepared to reject them if they find them unpalatable.

Company management teams should be held to account over their responsibility to work in the interests of the owners of their company, not their own.