Accelerated Share Repurchases (ASRs): Managing EPS?
Non-financial firms in the United States paid their shareholders $456 billion in share buybacks in fiscal 2017, according to Calcbench. That’s up from $300 billion five years ago.
In ramping up their repurchases, US firms have increasingly turned to investment banks. Many companies now buy back their stock from Bank of America, Goldman Sachs, JPMorgan, and other banks, which deliver shares borrowed from institutional investors, rather than gradually repurchasing stock through brokers on the open market.
This relatively new form of investment bank-facilitated buyback, called an accelerated share repurchase (ASR), has grown quite popular since the mid 2000s. Last year, for instance, non-financial firms spent over $48 billion on ASRs, or about 10.5% of the total dollar amount of repurchases.
ASRs are quick. When a deal is struck between a company and its investment bank, the firm’s share count is reduced overnight. And not by a trivial amount. In a recent study forthcoming in the Review of Accounting and Finance, I find that ASR firms on average buy back about 5% of their outstanding shares.
The immediate reduction in shares outstanding often boosts reported earnings per share (EPS). And while an ASR’s impact on EPS does not typically exceed a few cents, it is often more than enough to help companies meet or beat analysts’ forecasts.
The study of 293 ASRs transacted between 2004 and 2011 shows that 29% of ASR firms would have actually missed the consensus EPS forecast without an ASR. That compares to only 14% of those firms that repurchased their shares on the open market. This suggests that ASRs are more likely to be employed opportunistically to stimulate EPS than traditional repurchases.
The use of ASRs as an EPS management device depends on two factors: whether the CEO’s bonus is contingent on the company’s EPS performance, and whether the company has a reputation for consistently beating analysts’ EPS targets. When either condition is met, the likelihood of an ASR almost doubles.
While the results show that managing EPS through ASRs does not generate a more favorable investor reaction at earnings announcements, it may help managers improve their compensation and reputation. An examination of the sample firms’ proxy statements shows that in only three cases did compensation committees mention taking an ASR’s EPS impact into account when deciding on the CEO’s bonus payment.
Despite concerns about their accounting implications, ASRs have become an important part of firms’ repurchase programs. And, in fact, evidence suggests many ASR firms report improved operating performance during the post-repurchase period.
As more ASR transactions are conducted and more data analyzed, there will be fewer questions about what motivates managers to implement them.
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Quite informative. Any idea about why many ASR firms report improved operating performance post repurchase period
Unlike EPS-suspect ASR firms, firms that are not suspected of using ASRs to meet/beat analysts’ forecasts report better operating performance during the post-ASR period. The evidence suggests that these non-EPS-suspect firms undertake ASRs in the first place to signal their favorable prospects to investors.
This is a great article about a practice that most investors (and many analysts) do not yet understand. As described, the repurchasing company’s counter-party delivers “borrowed shares” to the company, which may recognize an immediate reduction in share count for the calculation of earnings per share.
But there has been no reduction in shares outstanding at the time the deal is struck because the economic ownership of the lending institution has NOT changed. From an economic and transactional perspective, the company is buying shares from a dealer who sells those shares “short.” The short interest of the company is increased by this transaction and the actual number of outstanding shares is not reduced.
Why would a dealer risk capital by shorting millions of shares of stock to a repurchasing company without seeking a hedge in the marketplace? In fact, these deals are usually struck between the company and the counterparty without venturing into the open marketplace. If they went to the open market to hedge their short, they would effectively transfer the company’s buying pressure into the market.
In fact, the company and the counterparty dealer often strike a deal where the company provides a hedge to the dealer in the form of OTC (over-the-counter) options, so the dealer’s loss if the stock trades higher is capped, and also the dealer’s gain if the stock trades lower is likewise capped. Then, the company and dealer work together to “unwind” the short position in the open market, and simultaneously unwind the hedge.
Should companies employing this strategy be able to recognize a reduction in shares upon striking a deal with a counterparty who sells short to the company? Economically, the share count has not been reduced until the counterparty covers its short in the open market.
Also, would be interested to hear if Nidhi has any evidence to share …
Actually the company and bank ALWAYS trade an OTC derivative. An example of standard terms is at https://investor.tiffany.com/node/20951/html. The OTC derivative specifies that a substantial number of shares (typically 80%) needs to be delivered by the bank to the company upfront. The other 20% of the shares are delivered by the bank at expiry of the OTC derivative. The nature of the risk underlying the OTC derivative is such that the bank is immune from small changes in stock price (delta neutral) at inception of the trade.
Existence of a short position in the market between two dealers should not necessarily inhibit the company from retiring shares. Even if the company used an open market repurchase instead of an ASR in order to buy back its shares, they would never know whether the stocks they repurchase resulted from a long sell or short sell by the counterparty due to anonymity on the stock exchange.