Some items on our site have recently moved. Visit our News Hub for selected articles, special reports, podcasts and other resources.
US companies' share repurchases can pose economic risk if they create too much leverage, BIS study says
16 September 2020 16:54 by Neil Roland
US corporate stock buybacks can pose a risk to financial stability if they result in too much company leverage, a Bank for International Settlements study said.
The study found “clear evidence” that non-financial companies “make extensive use” of share repurchases to meet leverage targets.
Investors and policymakers “should particularly beware of leverage, as it ultimately matters for economic activity and financial stability,” said the study, released this week, part of the quarterly review by the Basel-based group.
At the company level, those with high leverage saw “considerably lower” stock returns than did their competitors during the start of the pandemic in March, the study by senior economist Sirio Aramonte said.
The international group of central banks, including the US Federal Reserve, focused in the study on US non-financial companies.
— Leverage targets —
Stock repurchases have been motivated mostly by companies’ quest for particular levels of leverage, or debt over assets, which can benefit shareholders, the study said.
But these leverage targets can be too high if companies fail to account for “financial distress” costs that are shifted to creditors or taxpayers through bailouts. These costs can include weaker pricing power or higher bankruptcy risk.
Some critics have argued that buybacks are exploited by executives to inflate stock prices and thus boost managers’ performance pay. However, while the study found “some evidence” of this, it also yielded “little indication of detrimental effects on long-term company value.”
The non-financial corporations in the study are distinct from the large banks whose share repurchases have been suspended by the US Federal Reserve through the end of this month in the wake of the downturn.
— Leverage definition —
A company’s leverage is its debt divided by its assets, which are the sum of debt and equity.
In many buybacks, companies issue debt to shareholders to buy the corporation’s equity. The company’s debt increases and its assets decrease, hiking its leverage.
Thus, if a company has $100 in assets, made up of $30 in debt and $70 in equity, its leverage is 0.30. If a $10 buyback is funded with new debt, leverage would increase to 0.40 ($40 debt over $100 assets).
Buybacks in many countries have soared in the last decade.
The US has far more company buybacks — $800 billion last year — than any of the countries with the next largest amounts. Companies in the next largest countries – Japan, the UK, France, Canada and China – had a total of $130 billion combined.
05 September 2022 11:41 by Fiona MaxwellUK financial regulators face an uphill battle to maintain their independence with the announcement of Britain’s new Prime Minister
01 August 2022 13:32 by Fiona MaxwellThe increasingly political debate over insurance capital cuts in the UK post-Brexit is set to become a top-agenda item
12 July 2022 22:12 by Neil Roland18 potentially risky single-stock exchange-traded funds has elicited unusual public criticism by a Democratic US SEC member.