Corporate America has increasingly relied on share repurchases to fuel earnings per share (EPS) growth in recent years. A study by Reuters found that nearly 60% of nonfinancial, publicly traded companies have bought back shares in the last five years, and share repurchases and dividends exceeded capital spending in 2014.
Critics suggest that the boom in repurchases has been driven by executives seeking to "game" incentives--inflating short-term results to line their pockets. With this in mind, directors need to ask: how should buybacks influence incentives and compensation decision making? We offer four principles to help directors answer this question.
Meaningful sustained stock ownership is the best tool to encourage thoughtful capital deployment decisions that drive long-term value creation. Significant ownership mitigates the temptation for executives to use share repurchases to manipulate incentive payouts. A market-competitive equity program with both (i) long-tailed vesting periods and holding requirements and (ii) a culture and ethic of stock ownership will help to align management with shareholders and promote judicious long-term capital deployment.
Annual incentive plans work best for measuring operating results. The impact of share repurchases should generally be excluded from calculations of goal setting and incentive payouts in annual plans. Since share repurchases are often opportunistic and not confined to fiscal years, executives have the greatest line-of-sight to performance if buybacks don't figure into incentive calculations. Alternatively, annual incentive plans can exclude EPS as a metric altogether.
Long-term incentive plans work best when measuring the company's ability to deliver results for shareholders (particularly in budget-based plans). The impact of share repurchases on longer performance periods requires careful consideration. Many companies include the impact in incentive calculations for multi-year periods to encourage management to execute share repurchase strategies that create long-term value for shareholders.
Compensation decision making should fall under a robust board process to evaluate all capital deployment strategies, including share repurchases. This process should relate any findings to the compensation committee to ensure a holistic view of the company's performance and inform program design, pay actions, and the exercise of discretion.
Each company's circumstances vary and these "best...