Stock repurchases, or buybacks, have become the preferred way for large firms to shuttle cash to shareholders. From the end of the Great Recession through 2016, S&P 500 companies spent $3.3 trillion repurchasing shares–– compared with paying just $2.3 trillion in dividends. Finance theory offers two reasons shareholders love repurchases. First, buybacks are “tax efficient”–– meaning the typical investor pays less tax on cash received from a repurchase than a dividend. Second, for firms with few attractive investments, buybacks reduce management’s temptation to waste available cash. Two other motives for repurchasing stock are potentially less kind to shareholders––earnings management and market timing. Other things equal, repurchases reduce the number of outstanding shares, thereby increasing earnings per share (EPS). This gambit is attractive because the market often wallops firms that miss their earnings targets. Dangling from this stick, there is a carrot––CEO compensation is often tied to EPS. But repurchasing stock just to magnify earnings could harm shareholders. A recent study looked at firms that would have just missed their EPS forecast but for a stock repurchase; these firms reduced capital expenditures and R&D in subsequent quarters. In other words, management repurchased stock to get EPS over the hump, rather than use the cash to invest in the company’s future. Another justification often given for buybacks is market timing. Suppose management’s assessment of company prospects suggests the stock price should be higher. If there is no credible way to correct the market’s misperception, a stock buyback may offer the best alternative for enhancing shareholder value. Repurchasing undervalued shares means remaining stockholders will profit when the market comes to its senses. The only problem is management’s view may be wishful thinking. Indeed, The Economist recently observed, “managers in aggregate are about as good at predicting share prices as dart-throwing simians.” But managers who repurchase “undervalued” stock may not just be monkeying around with shareholder value. Recent research found more than half of repurchasing firms were able to buy stock back at small discounts relative to the average market price during the repurchase month—the median discount was 0.88%. Furthermore, firms that repurchased infrequently got even better deals. The median discount for firms buying just once a year was 5.9%, compared with 1.5% for monthly buybacks–– presumably because less frequent repurchasers have more flexibility to “time the market” to take advantage of undervaluation. Recent data point to a slowdown in the repurchase boom. Through March 2017, buyback volume of S&P 500 companies was off 1.6% from the prior quarter and 17.5% from first quarter 2016. Even with the decline, the $133.1 billion in stock repurchased from January through March exceeded buybacks in 24 of the last 31 quarters. Going forward, it appears firms sitting on mountains of cash are unlikely to quit buying back shares.

Given the market generally punishes firms that miss their EPS forecast, do you believe it is ethical to use stock repurchases just to hit the target?