Share Buyback and Innovation : A Case Study Analysis of Apple and Alphabet
Oztap, Haluk (2020)
Oztap, Haluk
2020
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Julkaisun pysyvä osoite on
https://urn.fi/URN:NBN:fi:amk-202101251492
https://urn.fi/URN:NBN:fi:amk-202101251492
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Abstract
Stock buybacks is a controversial topic and continues to attract interest from the academics and practitioners alike. The divergent viewpoint on the impact of buybacks on innovation is a reason that motivated this research. The aim of this research was to analyse the effect of share buyback on innovation at Apple and Alphabet and to establish whether engaging in buyback means there is a trade-off with innovation. The study included a combination of relevant theories (signalling hypothesis, managerial incentive and flexibility hypothesis, Schumpeterian innovation) and empirical analysis using the financial data on Apple and Alphabet from 2010 onwards. Both the companies started their share buyback programs from 2012 and 2013 respectively. Regression and Pearson correlation techniques were employed to assess the existence of a relationship between share buyback and investment in R&D.
When it comes to Apple, share buyback and R&D have a moderate and positive correlation (+0.2495). It means that an increase in share buyback has coincided with the increase in R&D spending by Apple to enhance its innovation. However, the correlation between share buyback and R&D as a proportion of sales is -0.82, which signifies a strong and negative correlation between share buyback and R&D as a proportion of revenue at Apple. It clearly indicates that as the share buyback has accelerated at Apple over time (especially since2017), the period has coincided with a reduction in R&D spending as a proportion of revenue. For Alphabet, the correlation between R&D spending and share buyback is strong and positive (0.871). This is unsurprising, as the trend in R&D spending and share buyback at Google is upwards. The correlation between R&D as a % of sales and share buyback is positive but moderate (0.311). It shows that an increase in share buyback has not deterred Alphabet from spending more on R&D as a proportion of the company’s sales. The positive relationship between share buyback and R&D spending at Alphabet is also supported through the regression analysis.
The study offers several recommendations. Firstly, consistent with the signalling hypothesis and as seen in case of Apple, management of a business should only engage in share buyback if they are highly confident that the share price is below the intrinsic value. As management tend to understand the business better than the external stakeholders, they are able to better value the business and know when the market is undervaluing the business.
Secondly, share buyback should not be at the expense of giving up R&D spending. As noted through the analysis of Alphabet, a company can engage in buyback while pursuing an increase in R&D spending. This is because although share buyback can help to boost the share price in the short-term, a lack of R&D spending would reduce the long-term competitiveness of the business.
Finally, share buyback can be a preferred option over dividend payout for high growth businesses. This is because share buyback provides flexibility to the management in terms of the extent to which they want to buy back the company’s shares from the open market and whether they want to continue to engage in buyback in the future. The above argument is in contrast to the dividend policy, which is expected to be ongoing once companies commit to paying the dividend, as cancelling the dividend serves as a signal to the investors that the company is possibly experiencing cash flow difficulties.
Key words: Share buyback, innovation, R&D spending, Apple, Alphabet, Schumpeter, signalling, flexibility and managerial incentive hypothesis
Stock buybacks is a controversial topic and continues to attract interest from the academics and practitioners alike. The divergent viewpoint on the impact of buybacks on innovation is a reason that motivated this research. The aim of this research was to analyse the effect of share buyback on innovation at Apple and Alphabet and to establish whether engaging in buyback means there is a trade-off with innovation. The study included a combination of relevant theories (signalling hypothesis, managerial incentive and flexibility hypothesis, Schumpeterian innovation) and empirical analysis using the financial data on Apple and Alphabet from 2010 onwards. Both the companies started their share buyback programs from 2012 and 2013 respectively. Regression and Pearson correlation techniques were employed to assess the existence of a relationship between share buyback and investment in R&D.
When it comes to Apple, share buyback and R&D have a moderate and positive correlation (+0.2495). It means that an increase in share buyback has coincided with the increase in R&D spending by Apple to enhance its innovation. However, the correlation between share buyback and R&D as a proportion of sales is -0.82, which signifies a strong and negative correlation between share buyback and R&D as a proportion of revenue at Apple. It clearly indicates that as the share buyback has accelerated at Apple over time (especially since2017), the period has coincided with a reduction in R&D spending as a proportion of revenue. For Alphabet, the correlation between R&D spending and share buyback is strong and positive (0.871). This is unsurprising, as the trend in R&D spending and share buyback at Google is upwards. The correlation between R&D as a % of sales and share buyback is positive but moderate (0.311). It shows that an increase in share buyback has not deterred Alphabet from spending more on R&D as a proportion of the company’s sales. The positive relationship between share buyback and R&D spending at Alphabet is also supported through the regression analysis.
The study offers several recommendations. Firstly, consistent with the signalling hypothesis and as seen in case of Apple, management of a business should only engage in share buyback if they are highly confident that the share price is below the intrinsic value. As management tend to understand the business better than the external stakeholders, they are able to better value the business and know when the market is undervaluing the business.
Secondly, share buyback should not be at the expense of giving up R&D spending. As noted through the analysis of Alphabet, a company can engage in buyback while pursuing an increase in R&D spending. This is because although share buyback can help to boost the share price in the short-term, a lack of R&D spending would reduce the long-term competitiveness of the business.
Finally, share buyback can be a preferred option over dividend payout for high growth businesses. This is because share buyback provides flexibility to the management in terms of the extent to which they want to buy back the company’s shares from the open market and whether they want to continue to engage in buyback in the future. The above argument is in contrast to the dividend policy, which is expected to be ongoing once companies commit to paying the dividend, as cancelling the dividend serves as a signal to the investors that the company is possibly experiencing cash flow difficulties.
Key words: Share buyback, innovation, R&D spending, Apple, Alphabet, Schumpeter, signalling, flexibility and managerial incentive hypothesis