Zeev, I'm not sure I can agree to that.
IMHO, even if the payout of dividends were not taxed at all - on average and in the long term - the advantage to the shareholder resulting from share buybacks is bigger than if surplus cash were being paid out in dividends.
A consistent long term share buyback scheme is a consistent advantage to the shareholder through its anti-dilutive effect on ESOPs while a dividend payout is a one time event which is only of advantage to the shareholder if s/he finds an alternative investment that offers a higher yield than that company.
In general only companies are buying back shares, and more so if they do it on a regular basis, that generate free cash flows significantly higher than required re-investment of retained earnings to finance future growth.
These companies by and large are trading at more or less "fat multiples" to book because they usually achieve a high return on that book. Technically you are right that buybacks "dilute" the book value of remaining shareholders as they lower equity. But in practice the lowered book assures that the return on it remains higher as if the money were retained. I would say that the advantage to the shareholder resulting from the anti-dilutive effect is higher than the "disadvantage" of the lowered book.
Companies that display the economic characteristics to enable them to continually buy back shares are being assigned an "economic goodwill" by Mr. Market as Warren Buffett has termed it. That is a deserved price/book premium to the average company, in fact buybacks are lowering the book value of the company but they tend to increase the price/book multiple.
In terms of the "hidden secondary" you mention, in many cases the money flowing into corporate coffers through ESOPs are negligible given the very low strikes usually being granted.
MRK, INTC and KO would be trading a lot lower today if they had paid out their surplus cash in dividends rather than buying back their shares during the last 10 plus years. Of course the advantage is only available to these shareholders who also kept their shares for such long time periods as the shrinking number of outstanding shares has in effect increased their stakes in the company.
But I agree, an important reason for buybacks surely is to mask overly generous options plans for top managers, so the company does not go into their hands by the majority simply by overpaying themselves. CSCO comes to mind here.
But the reasons mentioned above are the ones that make share buybacks such a welcome feature of Buffett's preferred companies.
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