Tax Reform, Stock Buy-Backs and Executive Pay
This year’s tax reform has had some negative consequences for executive pay. As a reminder, here’s a link to my January article on 162(m). As it turns out, it has also given many companies additional cash which, of course, is absolutely a positive. Many companies have used some of that cash to execute stock buy-backs. This, in turn, has resulted in some executives making additional compensation. How does all of this work and is there a long-term impact?
Stock buy-backs happen have been around forever. They are seldom a big deal and are usually a way for a company to reward shareholders (share the wealth) without creating an entitlement mindset. (sound familiar?). Using tax reform proceeds to give shareholders a “bonus” is not dissimilar to what many companies did when they gave employees one bonuses of $1,000. The money was unexpected and most likely not in the budget, so sharing it made people happy without hurting the bottom line.
A stock buy-back is the term for a company using its own cash to buy its own stock. The shares purchased by the company are then taken out of circulation. Fewer outstanding shares means higher prices for each share. Shareholder see an increase in value. Even better, that value may result in better tax consequences than the company just giving the shareholders cash (like a dividend.) A rising stock price is a goal of most investors.
At publicly traded companies, executive compensation is essentially synonymous with equity compensation. Pay elements like stock options, RSUs, performance equity are most of executives’ pay. This is by design. Linking executive pay to share value is one way to align executives to investors. The price goes up and shareholders win. Is shareholders win, executives get paid. Simple.
Some recent stock buy-backs may muddy this link. Some executives have cashed out of equity compensation as a result of a stock price inflated by a stock buy-back. There is nothing inherently wrong with taking advantage of equity compensation, but care must be taken to ensure an equitable exchange. If a company allows its executives to cash out too many shares, too quickly, shareholders may end up giving back some of their gains. Granting new executive equity awards to replace those that were cashed out isn’t free. Does your company need a plan for this potential issue?
Many companies already have a preclearance program in place. This ensures that potential executive transactions are reviewed and approved before they are executed. This simple step can be an effective foil to overzealous executive transactions.
Companies can also implement an executive compensation black period for a reasonable length of time after a buy-back. This allows the stock price to “cool off” and stabilize. It also ensures that shareholders get the first pass at taking advantage of the new, higher stock price.
There has recently been a call to review current SEC regulations to determine if the playing field needs to be leveled. I am going to go out on a limb and say that the current buy-back wave will be done before the SEC ever gets to talking about new rules. Much like the bonuses some employee saw earlier this year, the gains from the “Tax Reform Stock Buy-Backs” will be forgotten before the end of the year.