DEFYING CRITICS AND CURBS, BUYBACKS PERSIST: Should Executives Benefit From Them? Buybacks can be a boon for shareholders, but a detriment to employees.

• Author: Lajoux, Alexandra Reed
• Position: BIG IDEAS FOR CORPORATE GOVERNANCE

Despite the new 1% tax on share repurchases under the Inflation Reduction Act of 2022, U.S. public companies today are still using share buybacks to return cash to shareholders--including executives with equity-heavy pay--at unprecedented rates. This year has seen well over half a trillion dollars' worth of stock repurchased by S&P 500 firms in the first eight months of 2022 alone--including a $500 million plan by Kohl's, one of more than two dozen public companies so far to announce buybacks since President Joe Biden signed the new tax into law on August 16,2022. While there are signs of buyback slowdowns ahead, this is the highest reported level since the SEC's 1982 passage of Rule 10b-18 granting a safe harbor for buybacks, enabling them to rival (and in some years surpass) dividends as a way of returning cash to shareholders.

Wall Street loves buybacks, as is demonstrated in the Nasdaq Global Buyback Achievers Index and the Nasdaq US Buyback Achievers Select Index, as well as the S&P 500 Buyback Index. But do shareholders really benefit from them? What about other stakeholders, such as employees and customers? How do buybacks affect the long-term value of companies ? What difference do buybacks really make, and to whom?

Such questions are important for directors to consider, both generally and with respect to their own companies.

WHY BUYBACKS?

Buybacks, whether accomplished through a direct purchase of shares from the open market or (less often) by a premium tender offer, can happen for a variety of reasons. When companies repurchase some of their shares, they take cash out of the company (or, if leveraging, incur debt) and return cash to shareholders who choose to sell--sometimes giving a short-term boost to the stock price for those who do not sell, and often increasing earnings per share (because of the decrease in the ratio's denominator, typically calculated as total shares outstanding).

Through direct market buybacks, a company with undervalued stock can "buy low" in a repurchase in order to later "sell high" in a new stock offering. Another reason for a buyout is to reduce dilution that occurs when companies issue new stock (including new stock that goes to pay their executives): the more stock, or "float," there is out in the marketplace, the less each share is worth, so a buyback reverses that dilutive effect.

Yet another reason companies may buy back their shares is to minimize the risk of a hostile takeover, as companies with high cash balances and lackluster stock price can attract raiders. Finally, a cynical view is that boards approve buybacks in part to increase the value of shares held by executives, who typically are awarded the lion's share of a firm's equity compensation.

LEGAL CONTEXT FOR BUYBACKS

Whatever the reasons for buybacks, one thing is clear: In the United States, it is up to directors to approve them. (In some other countries, shareholder approval is necessary as well.) As stated in the Key Agreed Principles of the National Association of Corporate Directors (NACD), directed toward U.S. public companies, directors must approve all material capital expenditures and transactions "not in the ordinary course of business," which would include share repurchases. The American Bar Association's Model Business Corporation Act (MBCA) defines repurchases as a kind of "distribution' to be approved by directors and establishes liability (under Section 8.32(a) of the MBCA) for directors who approve distributions improperly. It is no wonder that the law firm Skadden Arps has stated, in a client letter on the topic, that "any share repurchase should be authorized and approved by a company's board of directors."

In many cases, this approval process begins at the committee level. All public companies listed on the major stock exchanges are required to have independent audit committees, and the charters of these committees may mention share repurchases as an area of oversight. Examples include Biogen and Citrix Systems. For boards that have finance committees (14%, according to the NACD), this oversight duty often appears in those committee charters, as seen at Philip Morris and Walmart.

Of course, director approval of buybacks does not occur in a vacuum; share buybacks are not the only extraordinary transaction legally requiring board approval. That is, under most state corporation laws and corporation governing documents, directors must also approve dividends, major...