April 24, 2020
The COVID-19 crisis has decimated company revenues, profits and share prices. And governments worldwide have already committed trillions of dollars in financial support, far exceeding the stimulus packages of the Financial Crisis.
The amount of public spending is – and will be – a subject of much debate. But perhaps we shouldn’t be focusing on the size of that package, but rather how that money gets spent.
As companies look to government support to revive sagging balance sheets, it’s important to ask where that money will be allocated.
Let’s start with the airline industry. Research from ISS shows that over the past decade U.S. airlines have spent one third more on share buybacks than the amount they are currently seeking in U.S. government as a result of the pandemic. In a share buyback, the company buys shares in itself from the marketplace, on the belief that they are undervalued. Since 2010, U.S. airlines have directed US$79 billion to buybacks. Today U.S. airlines are seeking US$54 billion in support from the US Federal government although it appears they will only receive half that amount.
The airlines are not alone in asking for bailout cash or employing share buybacks when their stocks are devalued. Buybacks have increased significantly across all industries over the past 10 years, and while this is a time-honoured practice for companies, we get concerned when investments in other business areas may be sacrificed as a result of corporate cash being committed to buybacks. More concerning for us is the close link between buybacks and executive compensation. By removing shares from the market, buybacks can boost the Earnings Per Share (EPS) of a company’s stock, a common metric for determining executive compensation.
Lawmakers in the U.S. seem to be aware of the potential misallocation of bailout money. The U.S. Coronavirus Aid, Relief, and Economic Security Act (‘CARES Act’), for example, attaches specific conditions around capital distribution and executive compensation to those companies borrowing under its provisions. These include a moratorium on share buybacks until a year after any bailout loans are no longer outstanding, as well as freezing dividend payments and limiting executive compensation over the same period.
These are especially important considerations in light of COVID-19. Beyond the provisions set out in the CARES Act, however, we would encourage all companies (regardless of whether they are recipients of government bailout support) to ask themselves:
- Is it in the interests of all stakeholders to allocate capital to share buybacks, or increase dividends, as opposed to funding sick leave or guaranteeing employee income?
- Is executive compensation tied to metrics like EPS the most appropriate reward structure? What role do company ESG measures play? Any?
- Is the COVID-19 crisis, and any attendant public funding, an opportunity to revisit not only historic capital allocation practices, but perhaps also the broader purpose of your company?
Crises are often catalysts for change. And while we acknowledge that companies are dealing with pressing challenges as a result of the pandemic, we also recognize that the current circumstances are fertile land to consider foundational reforms.
Short-term measures like share buybacks and maintaining dividends do not help make companies more resilient – either in this crisis or to the impact of future shocks. That’s why, in our governance-focused conversations, we’ll be asking companies to consider their long-term resilience in light of the many risks that accompany a return to business as usual – including business as usual in the way they allocate their capital.