Share buybacks aren’t perfect, but neither are they evil

Are share buybacks really the great corporate evil the progressive wing of U.S. politicians makes them out to be? The practice, which has ballooned in the post-recession era, was the target this week of a diatribe in The New York Times by Bernie Sanders and Chuck Schumer, senators both, who called corporate share repurchases “an enormous problem for workers and for the long-term strength of the economy.”

No doubt, the good senators see a winner in making share buybacks a political issue. And as headline-grabbing efforts go, their timing is good: Stock repurchases in the United States exceeded US$1 trillion last year — a record high “fuelled by the Trump tax cut,” as Sanders and Schumer (correctly) point out in their op-ed. They go on to claim that share buybacks are having two negative impacts: First, only shareholders benefit financially from them, and since rich people own (a lot) more stock than others, buybacks are aggravating income inequality in America; and second, they divert cash from more productive and equitable uses, like corporate investments or giving raises to workers.

So what you end up with are relatively poorer ordinary folks, along with corporations that are constrained from meaningfully contributing to the overall economy “in terms of R&D, equipment, higher wages, paid medical leave, retirement benefits and worker retraining.”

To fight this double whammy of badness, the senators promise legislation that would ban corporations from buying back shares unless workers and the economy get “paid” first, in the form of higher minimum wages or some other kind of investment.

This seems a rather odd plank to walk out on, if only because presumably few Americans (or other nationalities) either know or care much about stock buybacks anyway, and because there are so many sexier targets on the right: the unstable Republican administration, the Russia investigation, Stormy Daniels, tax cuts, foreign policy, and on and on. Still, maybe stock buybacks will serve progressives well as a straw man for anti-big-business politicking. Time, and the results of the 2020 federal election, will no doubt tell.

But are they really a “problem”? I admit I’ve never been a huge fan of the share repurchasing craze, if only because it seems a lazy way for corporate executives to deploy extra cash. It’s also true that the soaring values of stock buybacks — not just in the States; they reached a record high in Canada last year as well — have coincided with business investment remaining relatively flat.

I tend to think (and perhaps it’s only a bias) that companies that invest in research and development are better positioned for long-term health and return to shareholders, so to the extent that buybacks discourage that, they are cause for concern. As well, I wonder how the buyback addiction will evolve. Are corporations financing buybacks with (cheap) debt, and what will happen when rates soar? Are some, at least, going to start abusing them simply to juice the short-term stock price? Long-term investors might be better served by companies dispersing cash through sustainable dividends — which are harder for CEOs to stop once they’ve started them, and therefore more dependable (though hardly risk-free).

… the soaring values of stock buybacks have coincided with business investment remaining relatively flat.

The thing, though, is this: There isn’t much evidence that stock buybacks are damaging to the economy or to corporate fortunes. And the rationale for tying them to other expenditures, such as wages or pensions, is just looney and will likely be ineffective.

A 2017 study by the Federal Reserve looked across developed economies for a correlation between stock buybacks and stagnant capital investment — and couldn’t find one. As for corporate health, you would expect that a problematic devotion to buying back shares would show up as some sort of caution sign in the books. In other words, to the extent that share repurchases lower corporate assets or are financed through debt, they should (if this is a crisis we’re talking about) have some damaging effect on leverage ratios. But they haven’t, as far as I can see. If you look at the S&P 500 alone, total debt has soared post-recession — but so have total assets and, to a lesser extent, total equity. Cash and equivalents have risen sharply, which suggests that even with buybacks, corporations are still pretty flush. About the only leverage component that has remained flat? Interest expense.

Sanders and Schumer would be demanding that corporations turn a short-term gain into a long-term liability

So on the evidence, it doesn’t look like stock buybacks are damaging to economies or to corporations. That leaves equity (in the sense of fairness) as the chief criticism. No doubt, everyone deserves a raise. But earmarking excess cash for higher wages is not a good idea. For many companies, surplus cash might be a short-term thing, and they can just choose to not buy back shares when cash turns tight — but higher compensation costs are recurring, and harder (and more painful for everybody) to reduce. Basically, Sanders and Schumer would be demanding that corporations turn a short-term gain into a long-term liability. That’s not good for business, and probably not for workers, either.

Finally, from an investor’s perspective, it’s worth pointing out that requiring CEOs to invest in their businesses might not have the expected benefits. It might be true that stock buybacks don’t add to the productive value of the corporation, but unlike the bad acquisitions and diversifications and pet projects that litter the history of business, and which tend to be fuelled by an excess of cash, at least they do no direct harm.

So cash buybacks might not be perfect, and it’s possible they are ripe for abuse. But the alternatives might just be a lot worse.

Read More

Leave a Reply

Your email address will not be published.