Wave of corporate defaults owes much to foolhardy share buybacks

There was a time in the postwar period when big corporations routinely aspired to a triple A credit rating. Then came an intellectual revolution. 

In the 1980s Michael Jensen of Harvard University wrote eloquently about the agency problem, originally identified by Adam Smith, whereby agents (executives) managed companies in their own interest rather than that of their principals (shareholders).

Interestingly, very little buying took place when the markets were low in 2008-09 while buybacks proliferated in the peak years of 2018 and 2019.

Such expensive buying can be explained by another principal-agent problem. 

Since so many bonuses and incentive structures are related to earnings and share prices executives have an incentive to shrink the equity to bump up earnings per share. But they do so at the cost of systematically weakening the balance sheet of the corporate sector. 

John Plender FT 29 April 2020




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