Psychological Assessment of Share buyback programs

Updated Jan , 2024

Introduction

In the fast-paced world of finance, the intricate web of decisions, strategies, and transactions often involves a significant level of ambiguity. Share buybacks, one of the common practices in the corporate world, have recently fallen under scrutiny as they traverse the grey zone of financial ethics. This article delves into the fascinating realm of psychological assessment, examining how it can provide valuable insights into the minds behind share buyback decisions.

Understanding the Grey Zone in Share Buybacks

Share buybacks, also known as stock repurchases, occur when a company purchases its own shares from the open market or from its existing shareholders. This strategic maneuver can be a powerful tool for a company, but it often draws the attention of investors, regulators, and the public due to its potential to influence stock prices and the distribution of wealth. The question that arises is, “Are these buybacks a reflection of responsible corporate decision-making, or do they sometimes fall into the grey zone of unethical practices?”

The Controversy Surrounding Share Buybacks

Share buybacks, in essence, are neither good nor bad; they are a financial tool. Companies utilize them to return value to their shareholders, boost stock prices, and manage their capital structure. However, when share buybacks become excessive or are employed for ulterior motives, they can be perceived as a dubious financial maneuver.

The controversy arises when companies prioritize buybacks over investing in research and development, employee compensation, or other long-term value-generating activities. Such actions can be detrimental to the overall economy and are often seen as a red flag for investors and regulators. This is where the psychological assessment comes into play, helping us understand the motivations and decision-making processes behind these actions.

The Power of Psychological Assessment

Psychological assessment is a comprehensive evaluation of an individual’s psychological and emotional characteristics, providing valuable insights into their behavior, motivations, and decision-making processes. It encompasses various techniques and tools to gain a deeper understanding of a person’s personality, cognitive abilities, and emotional states. In the context of corporate decision-making, psychological assessment can shed light on why certain companies fall into the grey zone with share buybacks.

Assessing Decision-Makers

In the corporate world, decisions about share buybacks are typically made by top executives and the board of directors. Understanding their psychological profiles can provide clues about their motivations and potential biases. For instance, some decision-makers may be strongly incentivized by short-term financial gains, while others may have a more long-term, sustainable approach in mind.

A psychological assessment can identify traits such as risk tolerance, impulsivity, and preference for immediate rewards over delayed gratification. These traits can significantly influence decisions related to share buybacks. Decision-makers with a high tolerance for risk might be more inclined to engage in buybacks as a strategy to boost stock prices in the short term, even if it means sacrificing long-term investments.

Uncovering Organizational Culture

The culture of an organization plays a vital role in shaping its decisions and actions. A psychological assessment can extend beyond individual assessments to evaluate the collective psychology of an organization. It can help uncover whether the company’s culture encourages responsible financial practices or if it fosters a short-term, profit-centric mentality.

For example, an organization with a culture that values innovation, employee development, and ethical decision-making is less likely to fall into the grey zone with excessive share buybacks. Conversely, a culture that prioritizes immediate financial gains without considering the long-term consequences may be more inclined to engage in such practices.

Share Buybacks and Cognitive Biases

Cognitive biases are systematic patterns of deviation from norm or rationality in judgment, often influencing decision-making processes. In the context of share buybacks, several cognitive biases can lead decision-makers into the grey zone. Psychological assessment can help identify and mitigate these biases.

Confirmation Bias

Confirmation bias is the tendency to search for, interpret, and remember information that confirms one’s preconceptions. In the context of share buybacks, decision-makers may seek out data and analysis that support their decision to repurchase shares, while disregarding information that suggests otherwise.

Psychological assessment can help detect confirmation bias by examining how decision-makers process information and whether they actively seek out diverse perspectives and data. Mitigating this bias can lead to more informed and responsible decision-making.

Overconfidence Bias

Overconfidence bias is the tendency to overestimate one’s own abilities and the accuracy of one’s beliefs and predictions. Decision-makers who are overconfident may believe that their share buyback strategy is foolproof and fail to consider potential risks and downsides.

Psychological assessment can reveal the level of overconfidence in decision-makers and offer strategies to balance their self-assessments with a more realistic view of the situation. This can lead to more cautious and prudent decisions regarding share buybacks.

The Role of Emotions in Share Buybacks

Emotions play a significant role in decision-making, and share buybacks are no exception. The emotions of key decision-makers can greatly impact the choice to engage in buybacks and whether they fall into the grey zone.

Fear and Greed

Two potent emotions that often come into play in the world of finance are fear and greed. Fear can drive decision-makers to repurchase shares as a defensive maneuver to protect the stock price, especially during economic downturns. On the other hand, greed can lead to share buybacks as a way to maximize short-term profits.

Psychological assessment can gauge the emotional responses of decision-makers in different financial scenarios. It can identify their emotional triggers and help them manage fear and greed, allowing for more balanced and responsible decisions.

Loss Aversion

Loss aversion is the psychological phenomenon where people tend to prefer avoiding losses rather than acquiring equivalent gains. In the context of share buybacks, decision-makers may be more averse to the idea of seeing the company’s stock price decline than they are motivated by the prospect of stock price appreciation.

Psychological assessment can uncover the degree of loss aversion in decision-makers and provide strategies to mitigate its influence. This can lead to more rational and objective decision-making regarding share buybacks.

Ethics and Responsibility in Share Buybacks

The ethical dimension of share buybacks is a critical aspect of the grey zone. Decision-makers must balance their financial goals with corporate responsibility, and psychological assessment can help align their values with their actions.

Value Alignment

Psychological assessment can determine the values and ethical principles held by decision-makers. When these values align with responsible corporate behavior, the likelihood of falling into the grey zone with share buybacks decreases.

For instance, if a company’s executives prioritize long-term sustainability, social responsibility, and fairness, they are less likely to engage in excessive buybacks at the expense of other important corporate investments.

Accountability

Accountability is a crucial component of responsible decision-making. Decision-makers who undergo psychological assessment are more likely to be aware of the consequences of their actions, both financially and ethically. This awareness can drive them to make more responsible choices regarding share buybacks.

Psychological Assessment in Practice

Psychological assessment is a multi-faceted process that involves a combination of interviews, questionnaires, and standardized tests. It aims to create a holistic profile of an individual’s psychological traits and tendencies. When applied to the context of share buybacks, the assessment should be conducted on key decision-makers within a company.

Interview-Based Assessment

One common method of psychological assessment is the interview. Decision-makers can be interviewed by trained psychologists who ask a series of questions aimed at understanding their personality, motivations

Share buybacks fall in the Grey Zone

A growing number of individuals are voicing concern over the widespread use of this fraudulent method of increasing EPS

Senators Elizabeth Warren and Tammy Baldwin both share the sentiment that stock buybacks should be forbidden by the SEC because they are a form of market manipulation.

Senator Baldwin issued the following statement in regards to share buybacks:

Senator Baldwin and Senator Warren’s concerns regarding share buybacks reflect a growing sentiment among policymakers and investors alike. In recent years, the surge in share repurchases has triggered a reevaluation of the regulatory framework governing these transactions, with the Securities and Exchange Commission (SEC) at the center of the debate.

The landscape has evolved significantly since 1982 when the SEC issued the ‘safe harbor’ rule. At that time, buybacks were a rare occurrence, barely registering on the corporate financial radar. Fast forward to last year, where the cumulative spending on share repurchases soared to an astonishing $500 billion, highlighting the increasing significance of this practice in the world of finance.

Senator Warren’s assertion that these buybacks were historically regarded as stock manipulation raises critical questions about the SEC’s stance on this matter. The SEC’s apparent reluctance to categorize share buybacks as manipulation is evident in the statement made by SEC Chair Mary White. White acknowledges the challenges in monitoring stock buybacks, citing the lack of detailed trading data as a significant hurdle.

The core issue here is that Rule 10b-18, which provides the ‘safe harbor’ for buybacks, is a voluntary regulation, and issuers cannot technically violate it. This voluntary nature of the rule raises concerns about the effectiveness of oversight and the potential for abuse.

The SEC’s position highlights a growing debate in financial and regulatory circles, with proponents of stricter oversight arguing that the absence of comprehensive data and enforcement mechanisms can create opportunities for manipulation. As share buybacks continue to rise in popularity, the question of whether the SEC should take a more proactive role in monitoring and regulating this practice remains a subject of intense scrutiny and discussion.

Top Investors Join the chorus

Brian Reynolds Chief Market Strategist at New Albion Partners:

“Pension funds have to make 7.5%,” so they are putting their money “in these levered credit funds that mimic Long-Term Capital Management in the 1990s.” Those funds, in turn, “buy enormous amounts of corporate bonds from companies which put cash onto company balance sheets…and they use it to jack their stock price up, either through buybacks or mergers and acquisitions…It’s just a daisy chain of financial engineering, and it’s probably going to intensify in coming years.”

Stanley Druckenmiller:

“If you’re running a business for the long term, the last thing you should be doing is borrowing money to buy back stock.”

Druckenmiller told CNBC in March that he is extremely concerned about the doubling in U.S. corporate debt to roughly $7 trillion, up from about $3.5 trillion in 2007. “Most of that mix has been in more highly leveraged stuff,” he said. “And if you look at what corporations have been using it for, it’s all financial engineering.”

Larry Fink, CEO of BlackRock

“It is critical … to understand that corporate leaders’ duty of care and loyalty is not to every investor or trader who owns their companies’ shares at any moment in time, but to the company and its long-term owners,” Fink wrote in the letter, dated March 31, 2015.

James Montier:

He labels share buybacks as the “The World’s Dumbest Idea,”. He states that shareholders are not providing capital to corporations but are instead extracting it and demonstrates that since 1980 public companies have repurchased more equity than they have issued.

Harvard Business review stated the following in article title profits without prosperity

In 2012 the 500 highest-paid executives named in proxy statements of U.S. public companies received, on average, $30.3 million each; 42% of their compensation came from stock options and 41% from stock awards. By increasing the demand for a company’s shares, open-market buybacks automatically lift its stock price, even if only temporarily, and can enable the company to hit quarterly earnings per share (EPS) targets. Full Story

The old way of increasing EPS was to increase profits, but the cunning and gray method is to decrease the number of outstanding shares. In the current environment, where real profits are not easy to achieve, taking this route provides unscrupulous individuals in the corporate world with an easy fix.

In a recent report, CNN money states that that dividend and stock buybacks will new a new high of $ one trillion in 2015. Gold Sachs is expecting that number to surge for 2016; they state this number will increase by 7% in 2016, surpassing the one trillion mark.