Over the last 20 years, U.S. companies have increasingly stepped up their use of stock repurchase programs, and according to a recent Goldman Sachs report, 85% of companies in the S&P 500 Index now routinely buy back their own stock. Figure 1
Over the last 20 years, U.S. companies have increasingly stepped up their use of stock repurchase programs, and according to a recent Goldman Sachs report, 85% of companies in the S&P 500 Index now routinely buy back their own stock.
Common wisdom is that these stock buyback programs are a good thing for investors. Even the renowned Warren Buffett – one of the most skillful investors of modern times – has talked publicly about how happy he is that one of the company in which he is invested – IBM – is undertaking a massive buyback program.
But from my perspective, owners should not regard stock buyback programs as an unqualified positive. In contrast, I believe these programs can in fact work to the detriment of investors.
The Evolution of the Stock Buyback Program
The move toward corporate stock buyback programs started when academics decided that if a company issued shares of stock to one of its managers – the CEO for instance – the fact that the CEO held shares in the company and that individual investors held shares in the company somehow “aligned” the interests of the CEOs with the investors. To some extent, this must be true, but certainly, one major difference is that the individual investor holding the company’s shares has had to use their savings to build their ownership stake, whereas CEOs get these shares simply for showing up and fulfilling their duties as company managers.
Not only does this method of compensation lead to all sorts of unseemly excesses, it also causes logistical problems for the very CEOs that are benefiting from the practice. Namely, issuing a lot of stock makes CEO performance look worse than it may be.
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Article originally posted in Forbes website.