Audit Committee Leadership Network, October 2016
Many leading public companies devote a substantial and growing portion of their income to repurchase shares of their own stock. Because of pressure from shareholders, particularly activist investors, to return capital, companies must carefully evaluate their capital allocation and return strategies. Reasons to consider a share buyback include the amount of cash a company has on hand, the low cost of capital, the perception that share prices are undervalued, and dilution caused by equity compensation plans.
On September 26–27, 2016, members of the Audit Committee Leadership Network (ACLN) met in New York to discuss these trends and how their boards consider capital allocation decisions. This ViewPoints includes background information and synthesizes the perspectives that members shared before and during the meeting on the following topics:
The rise of share repurchase programs
A substantial group of large public companies are allocating a growing share of their income and cash flow to buying their own stock on the open market. Companies consider the perspectives of their investors when deciding whether a buyback is an appropriate use of capital – though investors disagree with each other about capital return issues. While critics have identified some potential flaws in buyback programs, audit chairs discounted many of the criticisms and said that these programs remain an effective use of capital for a company that is performing well and generating excess cash, especially given sustained low interest rates.
Corporate capital allocation decision
Companies deploy a range of options for allocating their capital to grow their business, from expanding into new geographies, to investing in research and development, to acquiring other companies. ACLN members said that in nearly every case, their companies try to exhaust their options for growth before returning capital to shareholders. When they do conclude that there is enough remaining capital to distribute to their shareholders, companies must choose between share buybacks and dividends. These decisions have practical implications, such as the tax consequences for investors, but the signals that these decisions transmit about the company and the future are often more important considerations.
Board oversight of capital allocation
Capital allocation is an area in which directors, particularly those with financial expertise, play an important role in a company’s decisions. To effectively participate, board members work closely with their finance organizations to understand plans and proposals, and to challenge management’s assumptions about their alternatives.