The Dark Side of Share Buybacks
44 Pages Posted: 23 Aug 2017
Date Written: August 19, 2017
Share buybacks reduce taxes, commit managers to pay out free cash-flow, and send positive signals to investors. This paper shows that they also transfer wealth from shareholders to the owners of employee stock options and that this transfer increases the price needed to induce shareholders to sell shares back to the firm. Two costs arise: at firms with poor governance, buybacks occur that harm shareholders; at firms with good governance, some value-enhancing buybacks do not occur. These costs are greatest when the number of outstanding options is large and when the options are out-of-the-money.
Keywords: share repurchases, employee stock options, capital structure, stag-hunt game
JEL Classification: C72, G13, G32, G34, G35
Suggested Citation: Suggested Citation