Stock buybacks are growing in popularity among UK companies, likely a product of the low interest environment and uncertainty over Brexit. While it is not for the Government to instruct companies on how to spend profits, it is their responsibility to encourage investment in capital and R&D so that firms remain competitive.
Greater sums spent on equity repurchases mean less left over for investment, R&D and wages. Given the dampening effect that Brexit uncertainty has had on investment, the Government should be proactive in urging firms to invest rather than repurchase shares.
Stock buybacks are regarded by many as a smart method to boost the value of undervalued shares as by repurchasing equity, companies reduce the number of outstanding shares and generally push up their price. Earnings-per-share, an important metric in evaluating executive performance, necessarily increases as there are fewer shares. Perhaps of even greater appeal to executives, buybacks are easy, safe and uncontroversial among shareholders. A resultant rise in the share price will satisfy investors, and if executive bonuses are linked to such increases, all the better.
In the UK, buybacks are on the rise. A Government commissioned report shows buybacks increasing from around £13 billion in 2015 to £22 billion in 2017. Business investment since Brexit has flatlined, reflecting the damage caused by political and economic uncertainty. While the report could not definitively determine causation between these statistics, it is likely that some firms are reacting to Brexit uncertainty by injecting extra cash in buybacks rather than risking investment on new factories, better equipment or R&D. However, the premonitions of a post-Brexit recession will become reality if companies continue to forestall their investment decisions. Moreover, the effects of this hesitancy will extend long into the future if firms become less able to compete globally.
Of note in the report is the finding of a correlation between earnings-per-share incentives in executive remuneration packages and lower levels of investment. Firms that used such targets had levels of investment around a fifth lower compared with those that did not, suggesting that executives may react to earnings-per-share incentives by decreasing investment, possibly to repurchase stock instead.
At a time of immense uncertainty in the UK, the Government must make every effort to ensure that businesses continue to invest in profitable opportunities. After Brexit, UK firms may have to pay tariffs on exports and therefore it is vital that they invest in methods to lower costs, or risk losing their competitive edge on global markets. Considering the Government’s plans to strike broad trade deals after leaving the EU, a successful Brexit depends critically on UK companies remaining competitive. Equity repurchases will not accomplish this, reflecting at best a ‘wait and see’ strategy and at worst a total lack of imagination from company executives.
To prevent stock buybacks from crowding out investment, the Government must take action to make spending on capital and R&D a more attractive proposition. From 2019, the Annual Investment Allowance (AIA), which allows firms to claim back corporation tax paid on reinvested profits, was increased to £1 million. This was a positive step, but the AIA is set to revert to £500,000 at the end of 2020. Further increases beyond £1 million must occur to entice behemoths to invest in capital given the major uncertainty in the UK. While indecision is understandable in this context, it leaves Britain ill-prepared for life after Brexit.
To dissuade equity repurchases, the Government must also eliminate the tax arbitrage between the top marginal tax rates charged on dividends (30.6%) and capital gains (28%), which incentivises buybacks. By doing so, buybacks will become, in relative terms, a less efficient form of rewarding shareholders. It should encourage executives to think more deeply on how to utilise surplus cash.
These measures are important parts of the Government’s wider duty to encourage UK businesses to invest in capital and R&D to ensure they remain competitive after Brexit. To make ‘Global Britain’ a reality, it is fundamental that firms can compete in world markets. The more that investment is withheld, the less likely this will be the case.
James Wakefield is undertaking work experience at Bright Blue. Views expressed in this article are those of the author, not necessarily those of Bright Blue.
