Buybacks enrich the bosses even when business sags: special report
NEW YORK: When health insurer Humana Inc reported worse than expected quarterly earnings in late 2014 including a 21 percent drop in net income it softened the blow by immediately telling investors it would make a $500 million share repurchase.
In addition to soothing shareholders, the surprise buyback benefited the company’s senior executives. It added around two cents to the company’s annual earnings per share, allowing Humana to surpass its $7.50 EPS target by a single cent and unlocking higher pay for top managers under terms of the company’s compensation agreement.
Thanks to Humana hitting that target, Chief Executive Officer Bruce Broussard earned a $1.68 million bonus for 2014.
Most publicly traded US companies reward top managers for hitting performance targets, meant to tie the interests of managers and shareholders together. At many big companies, those interests are deemed to be best aligned by linking executive performance to earnings per share, along with measures derived from the company’s stock price.
But these metrics may not be solely a reflection of a company’s operating performance. They can be, and often are, influenced through stock repurchases. In addition to cutting the number of a company’s shares outstanding, and thus lifting EPS, buybacks also increase demand for the shares, usually providing a lift to the share price, which affects other performance markers.
As corporate America engages in an unprecedented buyback binge, soaring CEO pay tied to short-term performance measures like EPS is prompting criticism that executives are using stock repurchases to enrich themselves at the expense of long-term corporate health, capital investment and employment.
“We’ve accepted a definition of performance that is narrow and quite possibly inappropriate,” said Rosanna Landis Weaver, program manager of the executive compensation initiative at As You Sow, a Washington, D.C., nonprofit that promotes corporate responsibility. Pay for performance as it is often structured creates “very troublesome, problematic incentives that can potentially drive very short-term thinking.”
A Reuters analysis of the companies in the Standard & Poor’s 500 Index found that 255 of those companies reward executives in part by using EPS, while another 28 use other per-share metrics that can be influenced by share buybacks.
In addition, 303 also use total shareholder return, essentially a company’s share price appreciation plus dividends, and 169 companies use both EPS and total shareholder return to help determine pay.
Standard Practice: EPS and share-price metrics underpin much of the compensation of some of the highest-paid CEOs, including those at Walt Disney Co, Viacom Inc, 21st Century Fox Inc, Target Corp and Cisco Systems Inc.
Fewer than 20 of the S&P 500 companies disclose in their proxies whether they exclude the impact of buybacks on per-share metrics that determine executive pay.
Humana would not say whether it adjusted targets to account for its buyback last year. In a statement to Reuters, the company said it sets annual per-share targets for executives that take into account the company’s “capital allocation strategy,” which includes buybacks, dividends, acquisitions and investments.
Experts said Humana would not have reached the target without the $500 million buyback. The company told analysts at the time of the repurchase announcement in November 2014 that it expected to report annual earnings per share of between $7.40 and $7.60 for the full year.
“Given the magnitude of the repurchase, the EPS would have been below $7.50 had it not been for the repurchase,” said Heitor Almeida, a professor of finance with the College of Business at the University of Illinois in Champaign.
As reported in the first article in this series, share buybacks by US non-financial companies reached a record $520 billion in the most recent reporting year. A Reuters analysis of 3,300 non-financial companies found that together, buybacks and dividends have surpassed total capital expenditures and are more than double research and development spending.
Companies buy back their shares for various reasons. They do it when they believe their shares are undervalued, or to make use of cash or cheap debt financing when business conditions don’t justify capital or R&D spending. They also do it to meet the expectations of increasingly demanding investors.
Lately, the sheer volume of buybacks has prompted complaints among academics, politicians and investors that massive stock repurchases are stifling innovation and hurting US competitiveness and contributing to widening income inequality by rewarding executives with ever higher pay, often divorced from a company’s underlying performance.
“There’s been an over-focus on buybacks and raising EPS to hit share option targets, and we know that those are concentrated in the hands of the few, and that the few is in the top 1 percent,” said James Montier, a member of the asset allocation team at global investment firm GMO in London, which manages more than $100 billion in assets.
The introduction of performance targets has been a driver of surging executive pay, helping to widen the gap between the richest in America and the rest of the country. Median CEO pay among companies in the S&P 500 increased to a record $10.3 million last year, up from $8.6 million in 2010, according to data firm Equilar.
At those levels, CEOs last year were paid 303 times what workers in their industries earned, compared with a ratio of 59 times in 1989, according to the Economic Policy Institute, a Washington-based nonprofit.
Salary And A Lot More: Today, the bulk of CEO compensation comes from cash and stock awards, much of it tied to performance metrics. Last year, base salary accounted for just 8 percent of CEO pay for S&P 500 companies, while cash and stock incentives made up more than 45 percent, according to proxy advisory firm Institutional Shareholder Services.
Thomson Reuters Corp, owner of Reuters News, used EPS to determine half of the performance awards in the three-year pay cycle ended in 2014 for CEO Jim Smith and other executives. Smith last year took home $6.6 million in compensation. The company’s three-year performance awards going forward are based on both EPS and free cash flow per share. A company spokesman said Thomson Reuters does not adjust for the impact of stock buybacks on those metrics.
Share repurchases can make the difference in meeting preset targets, according to a Reuters review of corporate proxies.
At Xerox Corp, revenue, net income and spending on research and development all declined last year. But the printer and copier maker’s EPS target of $1.12 was unchanged from the prior year, and managers hit it exactly after $1.1 billion in share repurchases.
Half of CEO Ursula Burns’s annual bonus target was predicated on hitting that EPS level; ultimately, she received a bonus of $1.98 million out of a possible $2.2 million. EPS is also a major determinant of even bigger bonuses for a three-year performance cycle ending this year.
Xerox repurchased $1.35 billion of its shares in the first three quarters of this year. The company declined to comment. Its proxy statement does not indicate whether it adjusts targets to account for buybacks.
Managers at information technology company EMC Corp hit their EPS target for 2014 of $1.90 with the help of $3.7 billion in share repurchases. Based on the share count before the buybacks, EPS last year would have been only $1.81, little changed from $1.80 a year earlier, according to a Reuters calculation.