There is a better way than regulation to fix share buybacks


The SEC recently proposed rules designed to hamper corporate buybacks of their own shares, a practice that drives up stock prices, delivering huge benefits to investors. The proposed rules will require the company to report the share buyback within a day of the transaction, rather than the current practice of a quarter-time delay. In addition, the proposed reports would be more comprehensive.

Part of the motivation for this rule is the concern that share buybacks allow executives to sell the shares they received as incentive compensation at “inflated prices”. To address this issue, we propose a simple and transparent executive compensation plan that would allow companies to address this concern without any additional regulation: incentive compensation for corporate executives should consist primarily of restricted stock (i.e. i.e. restricted stock and restricted stock options). That is, restricted in the sense that the individual cannot sell the shares or exercise the options for six to 12 months after their last day in office.

Under this plan, most incentive compensation would be determined by total shareholder return rather than short-term accounting measures of performance such as return on capital or earnings per share. This view is consistent with the results of a recent study survey of Fortune 500 Directors conducted by Stanford University’s Rock Center for Corporate Governance, where 51% of respondents said they considered total shareholder return to be the best measure of corporate performance relative to accounting-based measures.

The rationale for restricting inventory six to 12 months after an executive leaves is to eliminate perverse incentives to make selfish decisions during the “endgame” immediately before retirement. In particular, the delay would eliminate incentives to engage in stock buybacks only to sell shares acquired at an artificially inflated price immediately after leaving the company.

Of course, the proposal imposes certain costs on the leaders. For starters, if executives were required to hold stocks and restricted options, their savings would most likely be underdiversified, leading to a lower expected risk-adjusted return. Additionally, if executives are required to hold restricted stock and options after retirement, they may worry about a lack of cash.

To address these concerns, we recommend slightly increasing the amounts of equity awards from current levels to bring the expected risk-adjusted return back up. In addition, executives should be permitted to liquidate annually, with board approval, a reasonable percentage of their restricted stock and options.

Arguably, such incentive programs would encourage young executives to leave companies after a period of good stock market performance in order to lock in the gains from their incentive programs. But such a temptation is counterbalanced by the fear that executives who build a reputation for leaving companies early will soon find they have fewer high-quality career opportunities.

The problem of misaligned executive compensation leading to corporate scandals and worse has been widely studied. This research shows that senior executives of companies like Enron, WorldCom, and Qwest made misleading public statements about their respective companies’ earnings and these misleading statements caused the companies’ stock prices to temporarily rise. Some executives liquidated large amounts of their equity positions during the period as their companies’ stock prices temporarily inflated.

Moreover, there is evidence that misaligned incentive compensation played a significant role in the boom in big bank stock prices before the 2008 financial crisis and the subsequent implosion of these big banks in 2008. major banks that received government bailout funds during the 2008 financial crisis sold far more (in absolute and relative terms) of stock before the crisis than the CEOs of banks that did not apply for or receive bailout funds governmental.

In the above cases, if these executives’ incentive compensation had consisted solely of restricted stock that they were unable to liquidate for six to 12 months after their last day in office, they would not have had the incentive financial institution to engage in fraud and stock price manipulation. .

We recognize that one size does not fit all. Boards of directors should use their understanding of the unique circumstances of their companies’ opportunities and challenges to modify their compensation plans to ensure those plans are focused on serving the long-term interests of shareholders. When implementing the proposal, the compensation committees of boards of directors should be the primary decision-makers regarding the mix and quantity of restricted stock and restricted stock options a manager sees himself. to allocate, the maximum percentage of holdings that the manager can liquidate annually and the number of months after retirement/resignation for the shares and options to be acquired. But directors must focus on these issues to avoid costly new regulations that hurt shareholders and weaken capital markets.

Sanjai Bhagat is senior professor of finance at the University of Colorado and author of “Financial Crisis, Corporate Governance, and Bank Capital”, published by Cambridge University Press.

Jonathan R. macey is the Sam Harris Professor of Corporate, Corporate Finance, and Securities Law at Yale University and a professor at the Yale School of Management. macey is the author of several books including “Corporate Governance: Promises Kept, Promises Broken”, published by Princeton University Press.

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