Buy-backs are a poor strategy for real growth

Time of article published Jun 20, 2012

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R530 billion is a lot of money. You could do loads of things with R530bn – build factories, improve existing ones, build infrastructure, improve existing infrastructure, invest in research and development, put it in the bank, or, if you’re a listed company, you could use it to buy back lots of shares.

Sadly it looks as though many companies have decided on the bank and buy-back strategies. In the short term, these are presumably perceived as the safest options. It is a sort of “external locus of control” approach to business, which sees companies waiting until someone else sorts out the operating environment so that they can invest with almost no risk.

While they wait for the government to present them with joined-up and supportive policies, while they wait for labour to become skilled and hugely productive, and while they wait for the trade unions to support their cost-cutting and job destroying initiatives, the companies can sit back and watch the cash pile up.

For listed companies, buying back shares is becoming an increasingly attractive way of using this cash. In a corporate world that has become fixated on generating returns to shareholders, rather than actually generating economic growth, the buy-back strategy is a wonderful way of making management look as though it is engaged without putting it under any performance pressure. In addition, from a management perspective this use of the company’s funds has the enormous benefit that it helps to support the share price, which is very useful if you happen to be an executive sitting on a load of share options that were received as part of a remuneration package.

It is amazing that buy-backs have been received with such uncritical support from the investment community given that they represent a partial liquidation of the company. This is all the more bizarre when you consider that management often explains that it is buying back the shares because the market does not fully appreciate the “true” and implicitly greater value of the company and its shares.

One of the most insightful books written on corporate governance, Contests for Corporate Control by Mary O’Sullivan, deals at length with the implications of share buy-backs. Writing 10 years ago O’Sullivan discusses the fact that through dividend payments and share buy-backs, listed companies – in the US and Europe – are likely to be distributing more money back to investors than they are receiving from them.

This raises obvious questions about why a company would bother with a listing if not to access funds from investors. There are other reasons for having a listing, not least of which is to provide executives with share options of potentially enormous value, but the spectre of companies pumping money out to investors should heighten concerns about stock exchanges being little more than casinos.

In South Africa, the increasing use of buy-backs has invariably been accompanied by retrenchments and/or a growing reliance on labour brokers. This is a trend that O’Sullivan identified much earlier in the US. She noted that throughout the 1980s and 1990s there had been a noticeable shift in US corporate behaviour “away from a strategy of retaining both people and money”.

In explaining this strategy O’Sullivan wrote that US executives noted that their prime responsibility was to “create value for shareholders”. For their success in maximising shareholder wealth, these executives were generously rewarded.

Given what has happened in the US in the intervening years, perhaps it would be wise to spend some of the R530bn on devising a more effective growth model.

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