A counter to 1.4 and 2.1 (buybacks can neither add nor destroy value). This ignores taxes. And wouldn’t it favor dividends instead? Give more cash to investors and let them decide how to invest.
I buy in blocks of 100 shares (for optionality) and turned off DRIPs. I choose where to invest the pooled dividends.
Thank you Professor - beautifully clear and logical as usual
Two questions:
1: Is the value of good Governance therefore increasing?
The logic behind this is that your rebut to Myth 1.4 - correctly I think - that investors have a choice to sell if the price is too high- however as passive investors do not opine on price vs value, meaning they rely on Governance process to protect against transferring value to the departing shareholders at their expense.
2: Investor paying tax on dividends is a friction - should we therefore include the frictional costs of executing buybacks?
These transaction costs vary widely by both execution choice and by jurisdiction.. ie execution choice - tender offer vs Accelerated Share Repurchase. Jurisdiction : I estimate that the average transaction cost for companies in the UK and Europe to buyback shares in the open market is 8%, roughly double the cost than an equivalent firm in the US. This difference is largely due to more punitive UK & EU disclosure rules pre and during execution.
You frame dividends and share repurchases as two 'equivalent' mechanisms for returning capital to shareholders. I would like to challenge that supposition.
When a company raises capital, it has two broad options: debt or equity. Debt creates a fixed-term contractual claim. Equity creates a beneficial ownership claim that can exist indefinitely. Because equity is perpetual and subordinate, it is structurally more expensive.
In the early stages of a company’s life, issuing equity is often necessary. Cash flows are uncertain. Financial flexibility matters more than cost. But once the business matures and can fund itself internally, the logic changes. Surplus capital should be used to retire the capital that financed the business in its early phases of life.
With debt, this principle is widely accepted and legally obligatory (although debt may be rolled so let's set aside contractual obligations). If a company no longer needs to borrow as much, it reduces its leverage and financial risk declines. Sensible capital allocation.
Why should equity be treated differently?
A share repurchase is economically the retirement of equity capital. It reduces the ownership claims outstanding and increases the proportional interest of remaining shareholders. In that sense, it is the equity equivalent of paying down debt. The purpose is balance sheet optimization and capital structure discipline.
If shares are repurchased below intrinsic value, the transaction is accretive. But the benefit to the shareholder is not the primary objective. The core rationale is the retirement of surplus equity once it is no longer required to fund the business.
A dividend, by contrast, is a partial liquidation of the balance sheet without altering the capital base. For that reason, dividends should follow the exhaustion of superior capital allocation opportunities, including reinvestment and the retirement of undervalued equity.
Dividends and buybacks are therefore not interchangeable tools. One adjusts the capital structure by reducing outstanding ownership claims, while the other distributes surplus cash when the company has no other use for it. They serve different economic purposes and should be deployed under entirely different conditions.
It looks to me like, for companies I own, they are buying back shares to reduce the dilution effect of paying executives with stock or options. I don't know if this is true in general.
Several years ago, Yardeni did an analysis and concluded that most buybacks were to reduce the dilution effect of companies paying employees using stock shares and options.
Dividends and buybacks are capital allocation choices—not the source of value themselves. Buybacks should be always a choice if the company shares are undervalued…
A counter to 1.4 and 2.1 (buybacks can neither add nor destroy value). This ignores taxes. And wouldn’t it favor dividends instead? Give more cash to investors and let them decide how to invest.
I buy in blocks of 100 shares (for optionality) and turned off DRIPs. I choose where to invest the pooled dividends.
Thank you Professor - beautifully clear and logical as usual
Two questions:
1: Is the value of good Governance therefore increasing?
The logic behind this is that your rebut to Myth 1.4 - correctly I think - that investors have a choice to sell if the price is too high- however as passive investors do not opine on price vs value, meaning they rely on Governance process to protect against transferring value to the departing shareholders at their expense.
2: Investor paying tax on dividends is a friction - should we therefore include the frictional costs of executing buybacks?
These transaction costs vary widely by both execution choice and by jurisdiction.. ie execution choice - tender offer vs Accelerated Share Repurchase. Jurisdiction : I estimate that the average transaction cost for companies in the UK and Europe to buyback shares in the open market is 8%, roughly double the cost than an equivalent firm in the US. This difference is largely due to more punitive UK & EU disclosure rules pre and during execution.
Professor Damodaran,
You frame dividends and share repurchases as two 'equivalent' mechanisms for returning capital to shareholders. I would like to challenge that supposition.
When a company raises capital, it has two broad options: debt or equity. Debt creates a fixed-term contractual claim. Equity creates a beneficial ownership claim that can exist indefinitely. Because equity is perpetual and subordinate, it is structurally more expensive.
In the early stages of a company’s life, issuing equity is often necessary. Cash flows are uncertain. Financial flexibility matters more than cost. But once the business matures and can fund itself internally, the logic changes. Surplus capital should be used to retire the capital that financed the business in its early phases of life.
With debt, this principle is widely accepted and legally obligatory (although debt may be rolled so let's set aside contractual obligations). If a company no longer needs to borrow as much, it reduces its leverage and financial risk declines. Sensible capital allocation.
Why should equity be treated differently?
A share repurchase is economically the retirement of equity capital. It reduces the ownership claims outstanding and increases the proportional interest of remaining shareholders. In that sense, it is the equity equivalent of paying down debt. The purpose is balance sheet optimization and capital structure discipline.
If shares are repurchased below intrinsic value, the transaction is accretive. But the benefit to the shareholder is not the primary objective. The core rationale is the retirement of surplus equity once it is no longer required to fund the business.
A dividend, by contrast, is a partial liquidation of the balance sheet without altering the capital base. For that reason, dividends should follow the exhaustion of superior capital allocation opportunities, including reinvestment and the retirement of undervalued equity.
Dividends and buybacks are therefore not interchangeable tools. One adjusts the capital structure by reducing outstanding ownership claims, while the other distributes surplus cash when the company has no other use for it. They serve different economic purposes and should be deployed under entirely different conditions.
I welcome your comments.
It looks to me like, for companies I own, they are buying back shares to reduce the dilution effect of paying executives with stock or options. I don't know if this is true in general.
Several years ago, Yardeni did an analysis and concluded that most buybacks were to reduce the dilution effect of companies paying employees using stock shares and options.
Thanks for sharing !
Dividends and buybacks are capital allocation choices—not the source of value themselves. Buybacks should be always a choice if the company shares are undervalued…