Stock repurchases are popular. Between January 2009 and 2018, S&P 500 firms spent $4.3 trillion to buy back their shares, which is significantly more than these firms spent on dividend payments to their shareholders (Lazonick, Sakinç, and Hopkins, 2020). Stock repurchases are also controversial. Skeptics argue that, contrary to what managers claim, repurchasing isn’t done to buy undervalued stocks but to benefit the managers themselves. Shilon (2020) cites examples of how managers repurchase stocks to meet earnings-per-share (EPS) targets set in their compensation contracts and thus increase their personal compensation. Nguyen, Vu, and Yin (2020) reveal a negative association between firms’ stock repurchases and innovation. Bendig, Willmann, Strese, and Brettel (2018) show that stock repurchases are associated with cuts in marketing costs and more product recalls.
However, not everyone agrees with this sinister view of stock repurchases. As firms repurchase (and eventually retire) some of their shares, the number outstanding drops, thus reducing claims on future profits, and so the price of each remaining share rises. In a seminal paper on this topic, Ikenberry et al. (1995) indicate that stock repurchasing is associated with positive long-term value, finding that, after the initial announcement of repurchases, the average abnormal four-year buy-and-hold return was approximately 12.1 percent. Manconi et al. (2019) confirm this finding using more recent international data.
In a new study, we weigh in by examining the association between corporate social responsibility (CSR) and stock repurchases. McWilliams and Siegel (2001) define CSR as “actions that appear to further some social good, beyond the interests of the firm and that which is required by law” (p. 117). We, like many who recently studied finance and accounting, consider a firm’s CSR ratings as a sign of commitment to ethical behavior. This makes sense because managers of firms with a positive image have created a high expectation that they will behave appropriately or face severe reputational damage if they don’t (Klein and Leffler, 1981). Several studies affirm that socially responsible firms behave more ethically. Gao et al. (2014) show that managers of these firms are more likely to refrain from insider trading. Hoi et al. (2013) reveal that they are less likely to avoid paying taxes. And Hong and Andersen (2011)document that theyare less likely to manage accruals, the type of earnings management that managers deem unethical (Graham, Harvey, and Rajgopal, 2005). A common theme in these studies is that high-CSR firms have ethical corporate norms and act in a way to preserve their higher reputation.
Our research questions are motivated by these studies. We know from previous research that free cash flow is positively associated with stock repurchases, which supports the notion that one motive for repurchasing stock is to return excess cash to shareholders (e.g., Nohel and Tarhan, 1998). Of course, this logic assumes that keeping the excess cash in the firm is not putting it to its best use.. If this is true, and a high degree of CSR is a sign of an ethical corporate culture, we expect the positive association between free cash flow and stock repurchases to be amplified for high-CSR firms – in line with the argument that ethical managers will drain out the excess cash flow by returning it to shareholders rather than hoard it for their own benefit (Jensen, 1986).
We also know from previous research that the proportion of stock options awarded to top executives is associated with more repurchasing, and this association is consistent with the notion that managers take their compensation largely in the form of stock options and then repurchase shares to artificially boost the stock price and enrich themselves (e.g., Kahle, 2002) at the expense of other stakeholders. Since the managers of high-CSR firms care more about their market reputation and have more to lose by engaging in self-serving behavior, we expect this positive association between stock options and repurchasing to be lower for high-CSR firms.
Indeed, we find that a strong commitment to CSR increases the positive association between free cash flow and stock repurchases and decreases the positive association between the amount of stock option grants to executives and stock repurchases. These results indicate that ethical culture might play a role in the repurchasing decisions: Ethical culture may encourage repurchases aligned with shareholders’ interests and discourage those primarily in managers’ interest. Furthermore, we also find that high-CSR firms are associated with a greater completion rate of announced repurchase programs and receive more favorable stock market reaction around repurchase announcements. Overall, our findings suggest that ethical aspects also affect a firm’s payout policy decisions.
REFERENCES
Bendig, D., Willmann, D., Strese, S., and Brettel, M. (2018). Share repurchases and myopia: Implications on the stock and consumer markets. Journal of Marketing, 82(2), 19-41.
Gao, F., Lisic, L. L., and Zhang, I. X. (2014). Commitment to social good and insider trading. Journal of Accounting and Economics, 57(2-3), 149-175.
Graham, J. R., Harvey, C. R., and Rajgopal, S. (2005). The economic implications of corporate financial reporting. Journal of Accounting and Economics, 40(1-3), 3-73.
Hoi, C. K., Wu, Q., and Zhang, H. (2013). Is corporate social responsibility (CSR) associated with tax avoidance? Evidence from irresponsible CSR activities. Accounting Review, 88(6), 2025-2059.
Holme, R., and Watts, P. (2000). Corporate social responsibility: making good business sense. World Business Council for Sustainable Development: Switzerland.
Hong, Y., and Andersen, M. L. (2011). The relationship between corporate social responsibility and earnings management: An exploratory study. Journal of Business Ethics, 104(4), 461-471.
Ikenberry, D., Lakonishok, J., and Vermaelen, T. (1995). Market underreaction to open market share repurchases. Journal of Financial Economics, 39(2-3), 181-208.
Jensen, M. C. (1986). Agency costs of free cash flow, corporate finance, and takeovers. American Economic Review, 76(2), 323-329.
Kahle, K. M. (2002). When a buyback isn’ta buyback: Open market repurchases and employee options. Journal of Financial Economics, 63(2), 235-261.
Klein, B., and Leffler, K. B. (1981). The role of market forces in assuring contractual performance. Journal of Political Economy, 89(4), 615-641.
Lazonick, W., Sakinç, M., and Hopkins, M. (2020). Why Stock Buybacks are Dangerous for the Economy. Harvard Business Review.
Manconi, A., Peyer, U., and Vermaelen, T. (2019). Are buybacks good for long-term shareholder value? Evidence from buybacks around the world. Journal of Financial and Quantitative Analysis, 54(5), 1899-1935.
Nguyen, L., Vu, L., and Yin, X. (2020). Share repurchases and firm innovation. Accounting & Finance.
Nohel, T., and Tarhan, V. (1998). Share repurchases and firm performance:: new evidence on the agency costs of free cash flow. Journal of Financial Economics, 49(2), 187-222.
Shilon, N. (2020). Pay for Destruction: The Stock Buybacks That Make CEOs Rich But Impoverish Their Firms. Available at SSRN 3678734.
This post comes to us from Anand Jha, Manoj Kulchania, and Min-Jeong Kwon at Wayne State University. It is based on their recent paper, “Stock Repurchasing and Corporate Social Responsibility,” available here.