By Randall Smith
Share buybacks: Yea or nay?
For investors, one of the big results of the election could wind
up being the fate of corporate stock buybacks. The widely used
financial tool -- which has been a source of support for the
record-setting stock market -- has been attacked by some academics
and progressive politicians. Now, those politicians will be in a
better position to do something about it.
Buybacks have been a particularly hot issue since 2018 when,
under terms of the Trump administration's corporate tax cuts, big
U.S. companies repatriated billions of dollars that had been
stashed for years in overseas tax havens. In the resulting binge,
the dollar value of big companies' repurchases of their own stock
shot up 55% to a record $806 billion. Buyback foes complained that
such repurchases enriched shareholders, generally wealthier
Americans, at the expense of workers, new plants and research, and
broader economic development
Buybacks are down about 30% this year, as companies conserve
cash to ride out the pandemic. But the issue remains prominent for
Democrats who just took the White House and retained the House as
they plan their legislative and regulatory agenda.
With that in mind, here is what investors need to know about
buybacks -- and why they are controversial.
What is a stock buyback?
It occurs when a company uses some of its cash to repurchase its
own shares. Other choices include investing for growth,
acquisitions, paying down debt or paying dividends.
Legalized in 1982 by the Reagan administration, buybacks took
off after a 1992 tax bill capped corporate tax deductions for top
executives' pay at $1 million, but left a loophole for
"performance" pay tied to stocks. Now, with stocks and options
making up about two-thirds of C-suite pay, many buybacks merely
offset new issues to executives and employees.
They are used most heavily by mature tech companies like Apple
Inc., Microsoft Corp. and Oracle Corp., while shunned by a small
but fierce minority led by Amazon.com Inc. and Netflix Inc. A
decade ago, Exxon Mobil Corp. did the most. This year, Berkshire
Hathawayà Inc. jumped in big with $15.7 billion to shrink a $146
billion cash pile.
A study of 610 companies over three decades by a stock-analysis
unit of MSCI Inc. found the most active repurchasers were "older,
more established" companies first listed between 1980 and 2001.
Many companies begin with "one big idea," and ride through their
life cycle without another, says Rene Stulz, a business-school
professor at Ohio State University. The result is that as companies
get older, they don't need as much cash to invest in new growth
MSCI also found that buybacks began moving up steadily from less
than 1% of the companies' assets before 1994 to an average of 4.1%
for the past five years. The percentage of companies in the S&P
500 doing buybacks has more than doubled to 85% since 1992,
according to research by Goldman Sachs.
In the current low-interest-rate environment, many companies
have taken on more debt, whose interest cost can be tax-deductible,
to buy back shares whose dividends may be more costly. Corporate
debt levels at 20-year highs have financed much of the buyback
What are the arguments in favor of buybacks?
Money managers at mutual-fund giants Fidelity Investments and T.
Rowe Price Group Inc. say buybacks generally help drive higher
stock valuations. Goldman Sachs strategist David Kostin says
companies can vary buybacks as earnings fluctuate, while keeping
"steady growth in dividends," avoiding a dividend cut that can hurt
the stock price.
"Buybacks are really just dividends with a different kind of
shell around them," says Ric Marshall, lead author of the MSCI
study. "They're just a tool for moving positive cash flow to
investors. Most professional investors would say they're happy with
them." He added that buybacks may be better for some investors if
taxed at capital-gains rates rather than as dividends, which may be
taxed at higher ordinary income-tax rates.
Reducing a company's share count via buybacks can increase
earnings per share, a key valuation metric. And investors who sell
their shares and receive buyback proceeds can redirect the cash to
different companies with better growth prospects, including
venture-backed startups or initial public offerings.
What are the arguments against?
Critics led by William Lazonick, economics professor emeritus at
the University of Massachusetts Lowell, say buybacks starve
companies of cash for innovation and worker pay, and favor
executives aiming to jack up the stock prices because their
compensation is increasingly stock-based.
The buyback trend has become controversial since a 2014 article
by Prof. Lazonick in the Harvard Business Review, "Profits Without
Prosperity." The S&P 500 companies that had been publicly
listed from 2003 through 2012, he found, had spent amounts equal to
54% of their earnings for buybacks and 37% for dividends, leaving
"very little for investments in productive capabilities or higher
incomes for employees."
Critics say this formulation exaggerates buybacks' impact by
implying that funds for research and development and capital
spending come solely out of net income, and ignores that much of
the buyback spending merely offsets new issues of stock.
Prof. Lazonick also decried rising CEO pay, "mass plant
closings" and offshoring "millions of unionized blue-collar jobs."
Maximizing shareholder value with buybacks was "predatory value
extraction," he said. Such criticism reflects the wider debate over
wealth inequality and "shareholder first" capitalism.
If nothing else, the critics argue that cutting the number of
shares outstanding can help executives hit earnings-per-share
targets; 49% of big companies link executive pay to EPS.
The MSCI study found that as buybacks soared since 1988,
dividends held relatively steady at around 2% of assets. But
capital spending has fallen from 7.4% in the 1990s to 4% in the
past five years. Spending for R&D also has dropped, from 3% to
That supports the notion that buybacks may detract from spending
for growth. However, MSCI found buybacks haven't hurt 10-year
capital returns at most companies. Analysts link some of the drop
in capital spending for physical facilities to the rise of tech
companies, many of which are "capital light," investing in software
development versus hardware or manufacturing.
Where do political parties stand?
The political push to curtail buybacks comes mainly from
For instance, last year, Sen. Chuck Schumer (D., N.Y.) joined
Vermont progressive Bernie Sanders in urging that companies be
required to address their workers' needs, including pay and
benefits, before planning buybacks. A House subcommittee held a
hearing on buyback limits, and the Senate convened a panel led by
Sen. Elizabeth Warren (D., Mass.) also backed limits during her
presidential campaign. Another Senate Democrat, Sherrod Brown of
Ohio, also introduced a bill in July 2019 to require companies to
give bonuses to employees tied to the value of their buybacks and
"Buybacks suppress wages, drive income and wealth inequality"
and allow "speculators to extract value from public companies,"
Sen. Tammy Baldwin (D., Wis.) said last year in re-introducing her
Reward Work Act, which would ban open-market buybacks and require
employee board seats. The bill didn't move out of committee.
Some Republicans support milder measures. For instance, Sen.
Marco Rubio (R., Fla.) wrote in the Atlantic in late 2018 that
stocks sold in corporate buybacks should be taxed at the same rate
But Republican Trey Hollingsworth of Indiana at the House
hearing called the issue of buybacks versus worker pay a "fake
choice," saying wages are set by workforce supply and demand, and
buybacks are "separate decisions."
What happens now?
With Democrats in the White House, "this is an issue that's
going to be on the table" if they also take the Senate, says Tom
Quaadman, head of the center for capital-markets competitiveness at
the U.S. Chamber of Commerce. Legislation is less likely if
Republicans hold the Senate after two Georgia runoffs in
But a Democratic-led SEC could enact tougher disclosure
requirements by itself. During the campaign, President-elect Joe
Biden criticized buybacks and expressed support for tighter
regulatory supervision -- but not a progressive Baldwin-style ban
nor Schumer-Sanders overhauls.
The Council of Institutional Investors, for example, has urged
disclosure of how buyback plans might affect executive
compensation, and faster two-day reporting on executions. A ban
might not pass the Senate even if Democrats win a majority because
most legislation requires 60 votes.
Should investors care? Buybacks executed by Goldman Sachs
clients accounted for 4.1% of all their stocks' buy orders in
2017-19, Goldman says. So banning or limiting them could hit the
size of 401(k) nest eggs, although estimates vary of any possible
Mr. Smith, a former financial reporter for The Wall Street
Journal, is a writer in New York. He can be reached at
(END) Dow Jones Newswires
December 05, 2020 11:46 ET (16:46 GMT)
Copyright (c) 2020 Dow Jones & Company, Inc.