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Banning stock buybacks


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#1 diogenes227

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Posted 26 February 2019 - 02:32 PM

BANNING STOCK BUYBACKS

 

 

The widespread use of share buybacks among publicly traded American firms has reached an inflection point. Although academics and researchers at think tanks have been critical of the practice for years, politicians and the public at large are starting to pay attention, too. Proposals from politicians such as Chuck Schumer, Marco Rubio and Tammy Baldwin seek to give the SEC greater oversight over buybacks by restricting them, ending their tax advantages or by banning the practice altogether. Indeed, buybacks disproportionately benefit investors and executives, with little heed for the other stakeholders who have spent the time, effort and money on creating the profits the company is redistributing in the first place. It's time to ban stock buybacks.

That may be a tall order. Buybacks make some investors and many corporate executives very, very rich. There are also some legitimate reasons for companies to repurchase shares — for instance, if their leaders believe the stock is undervalued, or to make shareholders whole after employees receive stock grants. And they represent one reliable way for management to boost the company's stock price — which makes sense, given the uncertainty around Brexit, trade wars and government shutdowns. And they are decisions that mostly fly under the radar — ordinary people seldom wake up in the morning breathless with anticipation about the latest buyback news.

But we should care more. The bulk of executive pay is now tied to a company's stock price, creating an incentive to make that price as high as possible. Prior to a 1982 SEC rule change, buybacks were illegal, as they were seen as a form of stock price manipulation. You don't have to be a genius to realize that if the bulk of executive compensation is tied to a company's stock price and buybacks make that price go up, that there will be powerful incentives for executives to put money into buybacks. Even buyback proponents recognize that the current lack of transparency and incentives to make decisions for the benefit of executives is problematic.

Still, though, stock buybacks are rife with unintended consequences.

 

Increased risks for long-term shareholders

Essentially, a company is trading in a safe asset (cash) for a risky one (stock) when it buys back stock. The value of cash doesn't change with the vagaries of the market, but the value of a company's stock can vary. Further, companies tend to invest in buybacks when they have cash and times are good; and they refrain from the practice in hard times. In other words, they're using current shareholder's money to, in effect, buy high and sell low.

Less money for investment

Money used to repurchase shares extracts capital from the organization that could otherwise be used as a buffer against hard times, to pay and develop workers, to invest in innovation, to create the foundation for a more robust future and to contribute to healthier local communities. The numbers are staggering. In 2018 alone, companies spent a record $1 trillion on buybacks. Unlike other ways of returning excess cash to investors, such as dividends, buybacks can distort financial measures, such as earnings per share. Fewer shares? Voila, higher earnings per share.

 

A recent analysis by CNBC found that companies in the S&P 1500 that engaged in the most buybacks relative to their market capitalizations underperformed compared to their peers who didn't engage in the practice. Analysis by Deloitte found that the share of GDP being directed toward stock buybacks was increasing steadily, while the share devoted to investments in equipment and structures is flat or falling. Just look at General Electric. GE spent $24 billion on buybacks in 2016 and 2017, at an average price of $30.30 per share and $19.65 per share, respectively. Today, the stock is worth about $10 a share.
And we can't forget Sears. Since 2005, it spent $6 billion buying back shares, which it could have used for long-term investment that might have kept it from going bankrupt.

Money that flows out of organizations to shareholders is money that could have gone toward worker pay. One recent analysis found that the top five companies in the restaurant industry spent so much on buybacks from 2015 to 2017 that they could have afforded pay increases by an average of 25% for ordinary workers without changing anything else about their operations. Starbucks, for instance, could have given every one of its workers a $7,000 raise if it reallocated funds from buybacks to compensation.

Distorted reality

The buyback phenomenon is also associated with a uniquely American anomaly. Our corporate leaders make more — a lot more — than CEOs in other parts of the world.

They are also compensated at a much higher worker-to-CEO pay ratio than in other places, according to a Bloomberg analysis. And this is in an environment in which a major predictor of how well a company's stock performs is beyond executive control. In a context in which most stocks are rising, even moderately competent leaders can appear to be doing well. After the great recession, in which share prices took a beating, almost every company was going to experience an increased stock price as the economy recovered, increases which rewarded whoever happened to be in the top jobs at the time.

Buybacks distort incentives in other ways, too. Dividends encourage stockholders to retain stocks for a long time, since that's how they will make money. Buybacks, however, reward those who sell their stocks — not those who hang in there. This has led even hard-nosed investors, such as Blackrock's Larry Fink, to express concern that companies are not investing enough for the long term.

 

The role of buybacks in any number of negative outcomes — from underinvestment in the future to exacerbating income inequality — needs to be better understood. It's about time this practice is getting the scrutiny that it deserves.


"If you've heard this story before, don't stop me because I'd like to hear it again," Groucho Marx (on market history?).

“I've learned in options trading simple is best and the obvious is often the most elusive to recognize.”

 

"The god of trading rewards persistence, experience and discipline, and absolutely nothing else."


#2 12SPX

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Posted 26 February 2019 - 04:28 PM

Interesting post.  I always think about stocks like Apple or Google in regards to this as their stocks always go up so when they are going down such as Sears or GE its obvious they should have just put the money into making the business better instead of trying to protect the stock price.



#3 redfoliage2

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Posted 26 February 2019 - 06:25 PM

It's all up to the Fed.  As long as the interest rates remain low companies will keep buying back stocks ...............



#4 Iblayz

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Posted 26 February 2019 - 10:07 PM

There is another issue here that is not mentioned. The stock market dramatically reduces competition in this country and, to a large degree, stifles innovation. Its just a big game. Company ABC reaches a point where size, revenue and market penetration makes it very difficult to maintain growth. And, in the wacky market's eyes, if you aren't growing you are dying and your stock price gets killed. So company ABC finds an innovative upstart that is in a hot market or has developed a hot niche in a old market, makes a ridiculously overpriced offer for that company which the owner would be a near fool to turn down.....and buys it. Voila.....instant growth and instant increased revenue. But, competition is reduced and so is innovation. Competition is reduced for a number of reasons. One, a small, nimble and innovative player has been removed from the marketplace. Two, the purchasing player often has the incentive of stifling a known or perceived threat by means of the purchase. And those are just a couple of reasons. Innovation, while not necessarily stifled in the short term, is almost always muted in the long term as the larger player establishes its "control and grip" and subjects the brilliant innovators to the constraints of corporate bureaucracy.

It is not common for most of these purchases to be made in cash although it does happen. More often than not, a substantial part of the transaction is made with company owned shares. And therein lies the rub. Company ABC's executives are all wound up in the stock price, especially in the form of stock-based compensation. They never want it to go down. The company makes three or four billion in free cash flow for a few years. Now there is no doubt that some of that money should go to stockholders. After all, the purpose of owning a company is to make money. But, the execs know if they give a billion dollars a year back to the stockholders, that cash is GONE. Period. If, on the other hand, they choose to buy back shares, it is like putting all or at least some of that money in the bank. They can spend it in the future when they choose to drastically overpay for a young, innovative startup or a dangerous competitor. If the stock price goes up, they look like geniuses. If it goes down....so what. Let's say they buy back two billion worth of stock and the price goes down 40%. They still have 1.2 billion in the war chest for one of these wacky acquisitions. If that 2 billion had gone to stockholders, well.....you get the picture.

#5 alexnewbee

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Posted 27 February 2019 - 03:51 AM

No chance, this will cause immediate implosion of a stock market. Well, unless someone indeed wants such an implosion. :)


"we do G.d's work" Lloyd Blankfein